Does the Stock Market Price in Climate Change?

Yes, but it is just going way too slow.

Photo by Alexander Mils on Unsplash

We human beings are just simple animals. Like any animal, we do what we are incentivized to do.

If our society had systems in place to incentivize climate action and action on the other environmental catastrophes we are facing, we wouldn't have the problem we have now. But we don't have those incentives, so we do have those problems.

Again, blame an equation that oversimplifies things.

Back when I spoke about energy blindness, I discussed the flaws and the assumptions behind the production function.

Finance has a similar problem. The net present value (NPV) model that we learn in finance or business school, helps us value an asset today but doesn't do a very good job of valuing things in the long term.   

Here is the Net Present Value (NPV) equation in all its glory. I was blissfully unaware of this for about half my life. Then I went to business school and learned it:

It is a pretty elegant equation. To understand something’s worth, you take that cash flow from that thing (usually measured annually) and divide it by a risk-free interest rate (the rate you get from a government bond) over a certain amount of time. If the NPV is positive, the value of the project is higher than the risk-free rate, and you should make that investment. If it is negative, you shouldn’t.

It generally works well in the short term. But it breaks down in the long term where cashflows and discount rates become more uncertain. It also ignores externalities.

It also tends to focus people’s imaginations on the short term, because that is what they can measure.

The Stock Market.

Warren Buffett's famous quotes about the nature of the stock market sum up this issue quite nicely:

 The market is a voting machine in the short term and a weighing machine in the long term.”

In the short term, the value of something depends largely on people's perceptions of its value at that moment. And despite what you learned in your finance textbook, markets aren't efficient. They don't have all the information. The people that make up a market can't see into the future. In some cases, regulations and policies make it hard to find the information investors need to make informed decisions.

Companies want to give as little information as possible to investors and their shareholders. It costs time and money to track this information, and the time they spend gathering this information or talking to shareholders about it is time they can’t spend running the business. Over time, laws and standards have developed to ensure that investors, shareholders, and the public get the information they need. But this is often a long, drawn-out process.

For example, oil and gas companies have known for over 40 years about the impacts of greenhouse gases, and countries started getting together for annual “Conference of the Parties” (COP) meetings on climate change in the mid-90s.

But it is only in the last few years that data on the impacts that companies are having on climate change has begun to surface, and much of that disclosure is voluntary. The Securities and Exchange Commission (SEC) just came out with disclosure rules about climate change. The rules were first proposed two years ago, have been watered down from their first proposal, and the SEC is now being sued, so implementation of the rules is on hold.  

We knew about climate change and the impacts it could have over 40 years ago, and it is only now, that we are taking baby steps about requiring companies to disclose information about it.

That, my friend, is not an efficient market for information.

Long-term market efficiency will come too late.

In the long term, markets tend to be efficient. Reality catches up with a bad or false narrative over time. If a company doesn't have a product or service that is useful, or if they slowly destroy civilization to make a profit, people eventually figure it out. But that can take a long time.  Oil companies have spent billions of dollars on a disinformation campaign about climate change for the past 40 years or so. Why? There was a lot of money to be made. The people with leadership positions at these companies probably understood the consequences in the long term, but in the short term, the incentives were just too good to pass up.

An internal memo at Exxon from 1977, predicted the greenhouse gas emissions problem we see today with great accuracy. Since then, Exxon has spent more than $30 million on think tanks that promote climate denial, according to Greenpeace. In the last 30 years, Exxon-Mobil has made profits of $775 billion. That is why they did it. The money.

Incentives for most companies and investors are for the most part very short-term.

The average tenure of a CEO in the United States is about 7.2 years. The median number is just 4.8 years. CEO’s are therefore incentivized to think short-term, because they don’t have a lot of time to make big money. The average tenure of CEOs in Europe is about 15 years, so they have more leeway to think for the long term.

Pay for executives is becoming more long-term, with more long-term incentives, with about 60% of CEO incentive pay at S&P 500 companies in the US (Big US companies) tied to “long-term” incentives. Some of these incentives are “long-term” in name only, however. These incentives sometimes include “options” that incentivize short-term actions to goose the stock price in the short term so that executives can “cash out” their options and profit.

Pay for executives at S&P 500 companies in the US are starting to be tied to climate. As of 2023, about 54% of these companies had some compensation tied to climate in some way. The devil is in the details, however. These incentives must be meaningful. Just adopting a net zero target doesn’t do much by itself. Many companies are also leaning heavily on “carbon offsets” to meet climate reduction goals. As I’ve written before, these offsets don’t have the best reputation for … offsetting much of anything.

These executive compensation plans tied to climate action only mean something if they are tied to real action. Sadly, they often are not.

CDP’s Corporate Environmental Action Tracker report from June 2023 shows climate actions against commitments from nearly 10,000 global companies covering 16% of global emissions. Only 60% of disclosing companies have emissions reduction targets, and only 81 (less than 1%) disclosed a credible climate transition plan.

If 54% of companies in the US say they tie pay to climate in some way, and less than 1% of global companies have credible climate transition plans, I’m guessing most of those 54% of US companies don’t have the most robust carbon reduction plans.

We are simple creatures. We do what we are incentivized to do.

If we can get away with saying we will do something, but not be required to do it … we will do that.

It is only when society requires us to act that we will.

We aren’t there yet.