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Firms Prepping for Climate Change Have Higher ROE: Study

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S&P 500 firms that are actively preparing for climate change demonstrated an 18% higher return on equity and 50% lower volatility of earnings, according to a report released Tuesday by CDP, an organization that collects self-reported data from companies about climate change and water and forest sustainability to help institutional investors mitigate risks.

The 2014 survey, “Climate action and profitability: CDP S&P 500 Climate Change Report 2014,” was launched on behalf of 767 investors representing $92 trillion in U.S. assets. This is the ninth annual report on S&P 500 industry leaders, which the report defines as firms that have CDP disclosure and performance scores in the first quartile.

The 2014 report is based on responses from 337 companies. Based on their responses to CDP’s questionnaire, each company receives a disclosure score, between 0 and 100, that reflects its transparency regarding information like emissions measurement, climate change initiatives and risk and opportunities to the business.

Those that score above 50 are assigned a performance band, between A and E, which indicates the level of action they’ve taken on climate change policies. In 2014, 48% of respondents scored in the highest performance bands: A, A- or B.

“The unprecedented environmental challenges that we confront today — reducing greenhouse gas emissions, safeguarding water resources and preventing the destruction of forests — are also economic problems,” Paul Simpson, chief executive officer for CDP, wrote in the report. He said that over three-quarters of companies who responded to the 2014 survey reported some physical risk from climate change.

Simpson noted that efforts to examine and prepare for the effects of climate change are not the work of a vocal minority. In the United States, a “record number of shareholder resolutions” in 2014 led to commitments from 20 international corporations to “reduce greenhouse gas emissions or sustainably source palm oil,” he wrote.

Norges Bank, the $260 billion Norwegian pension fund, requires companies it invests in to show strategies for climate change risk mitigation and has divested from timber and palm oil companies that didn’t meet its standards, according to Simpson.

In the European Union, public interest companies with more than 500 employees, which covers about 6,000 companies, are required to disclose environmental, social and governance criteria to investors. In March, China’s National Development and Reform Commission required companies that emitted more than 13,000 metric tons of carbon dioxide equivalent in 2010 to begin reporting annual emissions.

“There is a palpable sea change in approach by companies driven by a growing recognition that there is a cost associated with the carbon they emit,” Simpson wrote. “Measurement, transparency and accountability drives positive change in the world of business and investment.”

The report stated that the results “do not suggest a causal relationship between present-day leadership on a long-term issue such as climate change and short-term financial performance based on the data available.”

However, CDP said it was not unlikely that the most profitable companies are also “engaging on climate change in defense of their industry-leading ROE.”

While the report found industry leaders had 18% higher ROE than their low-scoring peers, their ROE was 67% higher than non-respondents.

“The data suggests that U.S. corporate climate change management, as measured by CDP disclosure and performance versus industry peers, reflects higher-quality management, as measured by return on equity,” according to the report.

The report found firms in the top two quartiles had average dividend growth of 19.8% over the last three years, compared with 16.3% in the third quartile and 13.8% in the fourth.

Despite these results, CDP noted in the report that equity markets don’t appear to consider climate change leadership in valuations. “We observe no discernible market premium ascribed to companies that lead on 2014 CDP disclosure and/or performance scores,” according to the report.

The report found above average companies by CDP’s standards trade at a 4% discount. CDP called this an “opportunity” for long-term investors.

Check out Wet Suit: Insurers Seek Damages From Towns Over Climate Change on ThinkAdvisor.