The impact of carbon emissions on stock returns and financial performance : analyzing regional variations and governance mechanisms in Asia, the Middle East, and Europe

Abstract

This research addresses a pertinent question in asset pricing: whether firms’ carbon emissions affect their stock returns. To investigate this, the study conducts a comprehensive analysis of approximately five thousand firms across Asia, the Middle East, and Europe, employing robust econometric methods. The findings indicate that higher-emitting firms earn lower monthly returns in all these regions, although the strength of this relationship varies across regions. This negative return-emission relationship is further explained through the lens of financial performance. Additional analysis reveals that firms with higher carbon emissions also exhibit weaker financial fundamentals. These findings suggest that emissions are not only an environmental concern but also a proxy for broader operational inefficiencies, regulatory exposure, and reputational risk. High-emitting firms often face higher compliance costs, reduced demand from ESG-conscious investors, and lower stakeholder trust—factors that collectively deteriorate profitability. As financial performance declines, so do market expectations of future cash flows, thereby translating into lower stock returns. By controlling for industry and time-fixed effects and addressing potential issues of multicollinearity and serial correlation through two-way clustered standard errors, this study provides robust empirical evidence that carbon emissions are priced in financial markets, both directly through performance and indirectly through investor sentiment. The results have significant implications for investors, policymakers, and firms operating in increasingly sustainability-focused economies.