The Future of Emissions

Abstract

We argue for the introduction of firm-level emission futures contracts as a novel way of assessing the real impact of ESG initiatives. Our measure is based on the forward-looking market-based valuation of firm-level CO 2 emissions. We establish both theoretically and empirically that backward-looking subjective ratings are limited to the extent that they fail to capture future reductions in emissions. We show evidence that although lower emissions have predicted higher E ratings, higher E ratings have predicted higher, not lower, emissions. As such, by following these subjective ratings, investors may have inadvertently allocated their money to firms that pollute more, not less. We discuss several applications of our new measure, including executive pay and investment management. † University of Pennsylvania and NBER: julesv@wharton.upenn.edu. ‡ Copenhagen Business School: anbr.fi@cbs.dk.