Alexandre Garel, Arthur Romec, Zacharias Sautner, Alexander F Wagner
Review of Finance, Volume 28, Issue 4, July 2024, Pages 1151–1186, https://doi.org/10.1093/rof/rfae010
Biodiversity, the variety of living organisms in all habitats, is deteriorating at an unprecedented and alarming rate. Given the potentially dramatic financial consequences of the loss of biodiversity, firms, investors, and financial market regulators are increasingly paying attention to the topic. However, the link between biodiversity and finance has received little attention by academics. In this paper, we take a step toward filling this gap by introducing to the finance literature a science-based measure, the corporate biodiversity footprint (CBF), and exploring whether investors price this footprint.
Developed by Iceberg Data Lab (IDL), the CBF aggregates the biodiversity loss caused by a firm’s annual activities related to land use, greenhouse gas (GHG) emissions, water pollution, and air pollution. To quantify this loss, the CBF builds on the concept of Mean Species Abundance (MSA), which measures the relative abundance of native species in ecosystems, compared to their abundance in undisturbed ecosystems. The CBF expresses this loss in terms of km².MSA, and quantifies not only the direct impact of a firm, but also the biodiversity loss along the value chain.
Our sample consists of 2,106 listed firms from 34 countries for which CBF data are available from IDL over the years 2018-2021. While the sample period includes only a few years, the most important global policy developments concerning biodiversity are also quite recent. We examine the pricing of the CBF by regressing firms’ monthly stock returns on their one-year lagged CBF values. On average, we find no evidence that the CBF is related to returns between 2019 and 2022. However, we do find a relationship between the CBF and returns following major biodiversity-related policy changes, signifying that the biodiversity footprint had then started to be priced. In October 2021, the first part of the UN Biodiversity Conference (COP15) concluded with the Kunming Declaration, which calls for countries to act urgently to protect biodiversity by aligning financial flows to support its conservation and sustainable use. The event arguably increased both investor awareness about the loss of biodiversity and the prospect of, and uncertainty about, future biodiversity regulation or litigation. Between the Kunming Declaration and December 2022, a one-standard deviation higher log(CBF) value is associated with monthly returns that are 18.5 basis points higher (2.2% annualized).
We conduct an event study to examine whether and how investors revised their valuations of large-CBF stocks around the Kunming Declaration. If the declaration raised investor awareness of biodiversity issues and the prospect of regulation, we would expect investors to revise downward their valuation of large-CBF stocks. Indeed, in the 3 days following the declaration, relative to the three days before, large-CBF stocks experienced a cumulative stock price decline of 1.14%, relative to small-CBF stocks.
Our evidence suggests that investors have started to anticipate that new regulations or litigation will target large-CBF firms. Thus, the increase in policy uncertainty leads to investors demanding a biodiversity footprint premium. In sum, the CBF appears to reflect exposure to biodiversity transition risks, and our results reflect the pricing of such risks.