Carnegie Mellon University


November 08, 2021

New Index of Utility Firms’ Environmental Performance Monetizes Pollution Damage

Model Can Help Guide Investment, Capital Allocation Decisions

Investing according to environmental, social, and governance (ESG) criteria is gaining momentum, though most environmental performance indices focus only on the tonnage of carbon dioxide (CO2) emissions. A new analysis proposes an index of U.S. publicly traded utility firms’ environmental performance that includes eight pollutants expressed in terms of the monetary damage they cause. This multipollutant index can help investors and asset managers make investment and capital allocation decisions. It can also help financial and securities regulators standardize ESG disclosure requirements, a recent goal of the Securities and Exchange Commission.

The analysis, by a researcher at Carnegie Mellon University (CMU), appears as a National Bureau of Economic Research working paper.

“In the U.S. utility sector from 2014 to 2017, indices that tracked only CO2 mischaracterized firms’ environmental performance and underestimated the effect of that performance on financial outcomes when compared to this new multipollutant index,” says Nicholas Z. Muller, Professor of Economics, Engineering, and Public Policy at CMU’s Tepper School of Business, who wrote the analysis. “The main issue has been a focus on physical emissions rather than the monetary damage caused by those emissions. If the goal of ESG is to align the behavior of financial market participants with more socially beneficial environmental outcomes, calculating monetary damage is essential.”

In his analysis, Muller computed the monetary damage from eight pollutants, then introduced a summary statistic that relates relative pollution damage to relative firm value. Since damages from different types of pollution vary, totaling a significant amount of different types of pollution overlooks vast differences in their value. Moreover, without monetization, CO2 dominates environmental performance because emissions are so much more abundant than other types of pollution. More worthwhile, Muller argues, is having a common unit of account—the monetary damage of pollutants—by which various emissions can be weighed.

Muller applied the new index to the U.S. utility industry from 2014 to 2017, then explored the relationship between this new measure of performance and a number of financial outcomes, including current and future prices, price/earnings ratios, returns, earnings, and three measures of risk. He also compared the new index to indices based only on greenhouse gases and only on emissions.

Including multiple pollutants reflects a broader range of reputational and regulatory risks, Muller notes, and monetizing the effects of pollutants appropriately weights emissions: CO2 dominates the mass of other pollutants, yet the marginal damages from other pollutants are larger than CO2.
Dirtier firms exhibited lower share prices and higher forward returns, with the effect twice as large for the multipollutant index as for indices that measure only CO2 emissions, Muller says. Analysts’ earnings forecasts for dirtier firms systematically undershot actual earnings, with errors between three and five times more sensitive to the multipollutant index than to indices that calculate only CO2 emissions.

The multipollutant index can provide asset managers, investors, and other market participants new insights, relative to the standard reliance on carbon intensity, into the relationship between environmental performance and financial outcomes, suggests Muller. Such insights can inform new capital allocation strategies. From the perspective of ESG disclosure requirements, an index based on the multipollutant index is more likely to affect capital allocation decisions than is disclosure of carbon intensity.

Furthermore, in the United States, the new model can be applied to sectors other than utilities, including industrials, consumer staples, and energy. “Analyses of these segments of the economy will determine whether the relationships between pollution intensity and financial outcomes in the utility sector manifest in other sectors, and this will matter to asset managers, investors, and analysts,” says Muller.


Summarized from an NBER Working Paper, Measuring Firm Environmental Performance to Inform Asset Management and Standardized Disclosure by Muller, NZ (Carnegie Mellon University). Copyright 2021 The Author. All rights reserved.