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ABACUS, Vol. 49, No. 1, 2013 doi: 10.1111/abac.12006
LARELLE CHAPPLE, PETER M. CLARKSON AND DANIEL L. GOLD
The Cost of Carbon: Capital Market Effects

of the Proposed Emission Trading
Scheme (ETS)
In March 2008, the Australian Government announced its intention to

introduce a national Emissions Trading Scheme (ETS), now expected
to start in 2015. This impending development provides an ideal setting to
investigate the impact an ETS in Australia will have on the market valu-
ation of Australian Securities Exchange (ASX) firms. This is the first
empirical study into the pricing effects of the ETS in Australia. Primarily,
we hypothesize that firm value will be negatively related to a firm’s
carbon intensity profile. That is, there will be a greater impact on firm
value for high carbon emitters in the period prior (2007) to the introduc-
tion of the ETS, whether for reasons relating to the existence of
unbooked liabilities associated with future compliance and/or abatement
costs, or for reasons relating to reduced future earnings. Using a sample
of 58 Australian listed firms (constrained by the current availability of
emissions data) which comprise larger, more profitable and less risky
listed Australian firms, we first undertake an event study focusing on five
distinct information events argued to impact the probability of the pro-
posed ETS being enacted. Here, we find direct evidence that the capital
market is indeed pricing the proposed ETS. Second, using a modified
version of the Ohlson (1995) valuation model, we undertake a valuation
analysis designed not only to complement the event study results, but
more importantly to provide insights into the capital market’s assess-
ment of the magnitude of the economic impact of the proposed ETS
as reflected in market capitalization. Here, our results show that the
market assesses the most carbon intensive sample firms a market value
decrement relative to other sample firms of between 7% and 10% of
market capitalization. Further, based on the carbon emission profile of
the sample firms we imply a ‘future carbon permit price’ of between
Larelle Chapple is a Professor in the School of Accountancy, QUT Business School, Queensland
University of Technology; Peter M. Clarkson (P.Clarkson@business.uq.edu.au) of a Professor in the UQ
Business School, The University of Queensland and an Adjunct Professor in the Beedie School of
Business, Simon Fraser University; and Daniel L. Gold is a graduate from the Commerce Honours
program, UQ Business School, The University of Queensland
This study is based on Daniel Gold’s Honours thesis completed in the UQ Business School at The
University of Queensland. The authors would like to thank participants at the Abacus Sustainability
Forum held at The University of Sydney in November 2010, and most notably the discussant, Tim
Jordan, for their comments. They would also like to thank participants at The University of Auckland,
Deakin University, Griffith University, LaTrobe University, and as well Stephen Gray, Jason Hall, Bill
Hartnett, Darren Lee, Michel Magnan and Irene Tutticci for their comments on earlier versions of
the manuscript.
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AUD$17 per tonne and AUD$26 per tonne of carbon dioxide emitted.
This study is more precise than industry reports, which set a carbon price
of between AUD$15 to AUD$74 per tonne.
Key words: Cost of carbon; Emissions trading scheme; Environmental
liabilities; Market valuation.
In March 2008, the Australian Federal Government announced its intention to

introduce a national Emissions Trading Scheme (ETS), originally intended to start in
2011 and now expected in 2015. Although the proposed legislation, the Carbon
Pollution Reduction Scheme (CPRS) Bill 2009 and 10 related bills, was rejected in
the senate of the Australian Parliament in 2009, at the time the Australian govern-
ment remained committed to an ETS in the form as represented by these Bills.1 The
imposition of an ETS within Australia was then further delayed with the passage of
the Clean Energy Future Legislative Package in December 2011 which introduced a
carbon tax with a price of $23 per tonne applying to around 500 of the nation’s
biggest polluters from 1 July 2012. Importantly, in conjunction, this legislation also
provided that the carbon price would transition to a flexible price cap-and-trade
emissions trading scheme on 1 July 2015, linking Australia to international carbon
markets.
Prior to the promulgation of the 2009 draft legislation, the market had expected
carbon emissions legislation regulation to take the form of a ‘cap and trade’ scheme,
setting an overall environmental cap by issuing a set number of permits, and allowing
entities to trade permits, thereby putting a price on carbon (Commonwealth, 2008a).
Senator the Hon. Penny Wong, when she was Minister for Climate Change and
Water in Australia, confirmed that the implementation of an ETS within Australia
‘may be the most significant economic and structural reform undertaken in Australia
since trade liberalization in the 1980s’ (Wong, 2008). More broadly, emissions trading
is the topic of the moment, not only in Australia but worldwide. With the imple-
mentation of an ETS within the European Union and impending introduction of an
ETS in an increasing number of additional jurisdictions including Australia, emis-
sions trading will continue to be given attention as one of the few truly global
socioeconomic political issues.
When an ETS in Australia becomes a reality, the resultant ‘cost of carbon’ means
that it will be critical for Australian firms to understand their carbon footprint. Any
asset that increases a firm’s emission profile will increase its carbon liability. Con-
versely, any asset that has the potential to reduce emissions could add value in the
form of reduced compliance burdens or greenhouse gas (GHG) credits.2 A material
impact on firm valuation is therefore likely to result.
1
Coinciding with the release of the 2011 Garnaut updated report (Garnaut, 2011), the financial press
continued to speculate that the ETS remained a major policy commitment of the Australian Govern-
ment: Taylor (2011).
2
GHG credits cannot be created in sectors already covered by the scheme. Given the very broad
coverage of the proposed ETS there will be limited scope to pursue offset activities (Commonwealth,
White paper, 2008d).
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CAPITAL MARKET EFFECTS OF THE PROPOSED ETS
The objective of this study is to investigate the impact an ETS in Australia will
have on the market valuation of Australian Securities Exchange (ASX) firms. There
have been numerous industry and policy reports (summarized in section 2). Apart
from the tabling of draft CPRS legislation in the Australian parliament in May 2009,
the most influential document released by Australian Government (via Treasury)
was the economic modelling report on the impact of carbon trading (Common-
wealth, 2008c). This report predicted that ‘Australia’s aggregate economic costs of
mitigation are small, although the costs to sectors and regions vary’. Despite this
knowledge base emanating from industry and government, there is only limited
evidence drawn from rigorous academic study on the market effects of the cost of
carbon. Here, we recognize that there are two research themes that could be fol-
lowed by analogy, either the established literature on the impact of environmental
regulation, such as Cormier et al. (1993), or the more recent studies of ETS as
introduced in other jurisdictions such as Daskalakis et al. (2008). However, none of
these studies uses corporate carbon emissions data to assess the market value impact
of an ETS.3
We aim to provide evidence on the impact of carbon trading in the Australian
capital market. We hypothesize that firms affected by the proposed ETS will be
assessed a market value penalty, with more affected (more carbon intensive) firms
suffering a greater penalty. Herein, the findings from institutional and applied
research suggest that the penalty is likely attributable to (a) unbooked liabilities
associated with future compliance and/or abatement costs, and/or (b) reasons relat-
ing to reduced future earnings. In this regard, the degree to which market valuation
is affected during the period prior to passage of the proposed legislation will depend
upon the probability with which capital markets assess the imposition of an ETS
(and also to the exact details of the proposed regulation). Mitigating factors include
policy outcomes as they relate to the details of the legislation and its implementa-
tion, and the cost pass-through ability of the firm.
We conduct our analysis into the market value impact of the proposed ETS
utilizing two separate but aligned methods. First, we undertake an event study
focusing on five distinct information events argued to impact the probability of the
proposed ETS being enacted. Here, we seek direct evidence that the capital market
is indeed pricing the proposed ETS. Second, using a modified version of the Ohlson
(1995) valuation model, we undertake a valuation analysis designed not only to
complement the event study results but, more importantly, to provide insights into
the capital market’s assessment of the magnitude of the economic impact of the
proposed ETS as reflected in market capitalization.
Based on a sample of 58 Australian listed firms from 2007 for which GHG
emissions data could be obtained, we find that the market assesses the most carbon
intensive firms within our sample a market valuation decrement relative to other
3
Related studies by Griffin et al. (2012) and Matsumura et al. (2011) investigate the market value
implications of carbon emissions using emissions data voluntarily reported by U.S. S&P firms but
cannot speak to the valuation implications of an ETS given their U.S. experimental setting (see section
2.2 for a further discussion of these studies).
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sample firms. Given that our primary analysis suffers the potential confound that our
sample high carbon intensity firms are smaller, less profitable and more risky than
their low carbon intensity counterparts, we also conduct additional sensitivity analy-
ses which indicate that our results are robust to the challenges.
We argue that it is timely to examine the impact of a national ETS and further that
the Australian context provides the ideal experimental setting. First, as the ETS is
still proposed, there is a natural context to experiment with the market’s anticipation
in 2007 of the new regulation. Second, the availability GHG data for this year ‘of
anticipation’ provides an opportunity that is not necessarily available in subsequent
years, where the anticipation effect may have dissipated. Third, the proposed format
of the national ETS will follow that already established in other jurisdictions, so the
market problems and valuation effects are readily referable to a global context.
The impact of a national ETS on the valuation, as illuminated in this study using
a sample of Australian listed firms, is important for several reasons. First, there are
potential direct corporate implications. From the firm’s perspective, an ETS is a risk
management issue, requiring firm resources to assess its carbon price exposures and
possibly to develop carbon hedging strategies. Further, an ETS may bring new types
of mergers and acquisitions (M&A), and restructuring transactions to market. For
example, heavy emitters may find it beneficial to diversify into clean energy genera-
tion, or acquire forestry type assets to offset their carbon deficits (Freehills, 2007).
Restructuring may also be geared towards improving transparency, with assets
housed in separate stapled holding vehicles depending on their carbon metrics. A
number of these vehicles could even be sold to the public via the development of the
Sustainable Investment Market (SIM), which is paving the way for clean-technology
businesses to list.4 In conjunction, advisory firms which take the lead will have a new
market to explore.
Second, the implementation of an ETS presents both risks and opportunities to
the funds management industry. Recent survey data measured the global carbon
trading market at US$60 billion in 2007, up 80% on 2006 (Cleantech, 2008). This
figure is expected to increase sharply following the introduction of an ETS both in
Australia and internationally.5 In this context, the adoption of an ETS presents both
potential threats and opportunities for institutional investors. This is exemplified by
the formation of the Investor Group on Climate Change (IGCC) Australia/NZ,
which has extended the reach of the carbon disclosure project (CDP) to Australasia.6
For these parties to remain competitive, emissions trading will increase the need for
portfolio assets to be managed accordingly.
4
SIM derives from the Financial and Energy Exchange (FEX), launched in 2007 by former US Vice
President, Al Gore.
5
Gunther (2008) predicts that the global carbon market could, even based on conservative estimates,
reach US$1trillion annually by 2020.
6
The IGCC Australia/NZ consists of a group of institutional investors headed by VicSuper, Catholic
Super, AMP Capital and BT Financial. To help raise awareness of climate change investment risks in
Australia, one of the group’s first initiatives was to extend the CDP survey to the ASX100 and NZ50.
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Finally, arguably the limited availability of corporate greenhouse gas (GHG)

emissions data historically opens the possibility that carbon risks may not be fully
understood by either firms or investors.This ‘knowledge deficit’ may create arbitrage
opportunities for those with an information advantage. Similarly, pricing distortions
may emerge as analysts have difficulties modifying valuations to take account of
what might be substantial carbon related liabilities, or assets, for listed firms. To the
extent that the market is unable to identify an adequate risk premium associated
with the proposed ETS, anomalies may lead to legitimate arbitrage potential.
1 REGULATORY BACKGROUND
1.1 Overview
In this section, we present background material to explain the regulatory setting
through which an Australian Emissions Trading Scheme (ETS) will be introduced.
Herein, a solid consensus has emerged among scientists and public officials that
greenhouse gas (GHG) emissions from burning fossil fuels contribute significantly
to climate changes. The two most prominent strategies for reducing greenhouse
gases are ETSs, modelled on the Kyoto Protocol, and carbon-based taxes. These
approaches both result in higher prices for fossil fuels, but in different ways. The
critical economic distinction is that an ETS directly controls the quantity of emis-
sions while carbon taxes directly control their price.7 Within this context and con-
sistent with Weitzman (1974), the Task Group on Emissions Trading (OECD, 2007)
notes that a hybrid model, which exploits the relative advantages of both an ETS and
a carbon tax, may be optimal. Notwithstanding, the international landscape is evolv-
ing toward reduction in emissions incentivized with linked trading schemes.
1.2 The European Union Emissions Trading Scheme

Existing ETSs include the European Union ETS (EU ETS), the Japanese voluntary
ETS, the Norwegian system, the U.S.’s Regional Greenhouse Gas Initiative, and
Canada’s Alberta Climate Change and Emissions Management Act (Organization
for Economic Co-operation and Development, 2007).8 Our discussion focuses on the
EU ETS as it has the longest standing history and it is by far the largest. Lessons
learned from the introduction of the EU ETS are likely to shape Australia’s scheme
in years to come (Commonwealth, 2008a).
Created in January 2005, the EU ETS is the first and largest multi-country ETS
in the world. As of 1 January 2008, it applied to all 27 EU Member States and to
the three members of the European Economic Area, Norway, Iceland, and Liech-
tenstein. It covered over 10,000 installations (firms and other emission intensive
7
The quantity of emissions is set with the Government’s pollution reduction objectives. In Australia, the
Government’s long-term goal is to reduce national emissions by 60% compared with 2000 levels by
2050 (Commonwealth, 2008b).
8
For further information on these and other ETS, see: http://www.greenhouse.gov.au/greenpaper/
factsheets/fs11.
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facilities) in the energy and industrial sectors which were collectively responsible
for close to one-half of the EU’s Carbon Dioxide (CO2) emissions and 40% of its
total greenhouse gas (GHG) emissions (European Commission, 2008).
The first trading period of the EU ETS (phase I) concluded at the end of 2007.
Throughout this pilot phase, a number of problems were identified. In particular, an
excessive allocation of free allowances resulted in volatile prices and windfall profits
to electricity generators (Ellerman and Buchner, 2006). The European Commission
(2008) suggested that the over-allocation of allowances was due to a reliance on
emission projections before verified emissions data were available. When the veri-
fied emissions data were publicly released (highlighting the over-allocation), the
market price of allowances fell dramatically.9 Moreover, the majority of phase I
allowances were distributed free of charge, which it is estimated helped deliver a £9
billion windfall to emitters at the expense of energy consumers (Garnaut Climate
Change Review, March 2008). These issues are important as it is highly likely that
other national schemes, including that of Australia, will be modelled on the EU ETS
and linked to it in the future (Betz, 2007).
1.3 Australian Policy

Australia’s approach this past decade to emission reduction encompasses numerous
policies at the federal and state/territory levels.10 While these policies have helped to
ensure that Australia remains on-track in achieving greenhouse gas (GHG) reduc-
tions, they have also been heavily criticized.11 In light of such criticism, the Com-
monwealth and States agreed to bring the existing Mandatory Renewable Energy
Target (MRET) and various state-based targets into a single, expanded national
scheme by early 2009 (Commonwealth, 2008b), although it is likely to be phased out
when the national ETS matures.
In addition to existing mandatory schemes, there has also been a growing market
for means by which firms can voluntarily reduce their GHG emissions. These include
products that reduce emissions directly such as solar hot water systems, indirectly
such as green power, and offsets such as greenhouse friendly gas, petrol and air travel
costs. However, there is a limit on the extent to which voluntary activity can meet a
significant proportion of Australia’s future abatement challenge. As a national ETS
9
Leaks of 2005 emissions data from the Netherlands, France and the Czech Republic caused a 25% fall
in carbon prices in two days (24–25 Apr 2006). By 12 May 2006, the price had fallen to EUR9.75/tonne
from a high of EUR31.00/tonne only three weeks earlier (Deutsche Bank, 2007b).
10
For example, the Mandatory Renewable Energy Act (MRET) scheme which mandates the purchase
of renewable electricity by electricity retailers and large direct electricity users through the acquisi-
tion of renewable energy certificates from eligible sources. Other mandatory energy efficiency
schemes include the NSW Greenhouse Gas Abatement Scheme (GGAS), the Victorian Renewable
Energy Target (VRET), Queensland’s 13% Gas Scheme, Western Australia’s Renewable Energy
Target (WARET) and South Australia’s Climate Change and Greenhouse Emissions Reduction Bill
2007—see Deutsche Bank (2007a) for a summary.
11
See Energy Retailers Association of Australia, submission to the Prime Ministerial Task Group on
Emissions Trading. Cited in Garnaut Climate Change Review (March 2008).
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develops, the market for such measures is also likely to be discontinued (Garnaut
Climate Change Review, March 2008). Importantly, the future of Australia’s existing
policies on GHG abatement is likely to be met with uncertainty until detailed ETS
legislation becomes available. This may have the effect of discouraging investment in
the existing schemes while businesses await clarification on what is to come.
1.4 Proposed Australian Emissions Trading Scheme

Based on global experience, the ETS has intrinsic features (such as permit allocation
and emission coverage) and extrinsic features (such as compensation arrangements
and the cap on emissions) that shape its design. Both features have the potential to
affect share market valuations. As with the EU experience, a particular controversy
resides in the allocation of free allowances. In proposing an ‘orderly gradual transi-
tion’ towards a low-carbon economy, the Australian Government’s stance appears
softer than that taken by the Garnaut Climate Change Review.12 The Government is
willing to allocate approximately 25% of scheme permits to Trade Exposed Emis-
sion Intensive Industry (TEEII) for free and supports compensation for strongly
affected industries (Commonwealth, 2008d).13
Despite a clearer road map which is developing, the bottom line for business is
that this area remains a confusing and fast moving landscape. Firms continue to face
significant regulatory and financial uncertainty in all areas of their operations that
are impacted by emissions trading.
1.5 The Proposed Legislation for the Emissions Trading Scheme

Legislation in the form of the Carbon Pollution Reduction Scheme Bill 2009 and
associated legislation was rejected by the Senate of Australian parliament. As at the
end of the sample period of this study, the expected key feature of the legislation is
the cap and trade scheme. That is, it ‘involves setting a national scheme cap for a
particular year and issuing units up to the level of that cap. The scheme cap for a
particular year is a quantity of greenhouse gases that have a carbon dioxide equiva-
lence of a specified number of tonnes’ (Explanatory Memorandum, 2009, p. 18). The
scheme cap numbers are not specified in the legislation, but will be set by regulation.
The scheme will primarily apply liability for GHG emissions where the operations
result in 25,000 tonnes or more emissions per year. The Australian Climate Change
Regulatory Authority will issue emission units up to the yearly cap. The emission
units will be issued:
• via auction—a ‘large proportion’ (but as yet unspecified number) of units will be
auctioned.
12
The Garnaut Climate Change Review is an independent study by Ross Garnaut, a Professor of
Economics at the Australian National University, commissioned by Australia’s State and Territory
Governments on 30 April 2007.
13
Strongly affected industries should not be confused with TEEII. The former implies highly carbon
intensive with few, if any, abatement opportunities, but non-trade exposed. Garnaut is opposed to such
compensation and recommends 100% auctioning of permits. Further, Garnaut suggests 30% of
permit revenue should be used to compensate TEEII.
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• in relation to emission intensive trade exposed activities—intended as an assis-

tance measure. Such industries still have an incentive to reduce emissions, but it is
recognized that their activities still must occur. Accordingly, assistance is linked to
production not emission levels.
• in relation to coal fired electricity generators.
• for $10 for the first year of the scheme’s operation—as a transitional measure, an
unlimited number of units will be available at the fixed price, for the liable entities
to purchase. The purchase is limited to each entity to cover their emissions
liability—that is, liable entities cannot purchase more units than they need for
compliance.
2 BACKGROUND LITERATURE AND HYPOTHESIS DEVELOPMENT
2.1 Industry Background

It is generally acknowledged that historically, the Carbon Disclosure Project (CDP)
has been the most significant source of information on emissions, allowing industry
to better understand the implications to shareholder value presented by emissions
trading.The CDP was formed in 2000 with the objective of seeking information from
the world’s largest companies on the business risks and opportunities presented
by climate change. The project acquires the data through the use of large-scale
questionnaires.14
The release of CDP1, which presented the results from the first CDP question-
naire, coincided with the European Parliament’s directive establishing a scheme for
emission allowance trading of greenhouse gases.15 This directive triggered the
release of numerous reports focusing on the connection between emissions trading
and firm value. For example, in September 2003, UBS released a report entitled ETS:
Bonanza or Bust? in which a scenario-based analysis led to a value-at-risk measure
specific to emissions trading. Such findings were then incorporated into price targets
featured in subsequent broker reports.
This framework was extended by the Carbon Trust (2006) in the U.K., which used
a top-down approach to quantify the potential long-term impact of EU emissions
trading on profits. It used 10 firms, each deemed representative of a specific sector of
the broader economy, and applied a potential 2013 emissions regulatory regime to
each firm’s 2004 performance to rank industry sectors based on the risks associated
with the impending emissions trading regulation. The building materials and bulk
commodity chemicals sectors were found to have the largest profit risk exposure at
around 10% of EBIT, a figure viewed as reflective of both their high carbon intensity
and the challenges they faced in terms of passing on carbon costs to consumers.
14
CDP is an organization based in London that collects emissions data directly from companies. It
commenced its data surveys in 2003. As at the end of 2010, CDP claimed to represent 551 signatory
institutional investors, all seeking to better understand the possible impacts on the value of invest-
ments driven by climate change. This is achieved by an annual survey sent to thousands of the world’s
largest companies. It has become the world’s largest repository of corporate greenhouse gas (GHG)
emissions data: www.cdproject.net.
15
EU Emissions Allowance Trading Directive, 22 July 2003.
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Within Australia, similar research is more limited given the more recent decision
to introduce emissions trading. Nevertheless, a number of reports produced by the
investment industry have emerged over our study period which ranges from 2007 to
2009, with a particular focus on 2007. To begin, following a series of mandated
assignments for the Australian Government, in late 2005 Innovest Asia Pacific
produced a report that focused primarily on disclosure and management responsi-
bility issues pertaining to GHG emissions and ASX200 firms. The key finding was
that while many ASX200 companies were performing in-line with their best-practice
global peers at that time, smaller ASX companies were lagging behind. The report
also indicated that a large number of firms in high carbon intensity sectors displayed
low carbon risk awareness.
Citigroup (2006) undertook a similar analysis using ASX100 firms but additionally
included scenario analysis on carbon prices, thereby producing theoretical financial
exposure estimates and rankings. Their analysis initially focussed on firms that
provided climate change related information through the CDP, but was subsequently
expanded by making a number of ‘informed’ assumptions. They concluded that firms
able to participate in carbon markets from sectors such as renewable energy and
gas, sustainable property, recycling and financial institutions should benefit from
carbon regulation,but that firms in emission intensive industries,those highly exposed
to fuel costs, and those finding it difficult to cut energy costs were at risk.
Regnan (2007) reported that a carbon price of AUD$30/tonne would lead to over
40 ASX200 firms suffering earnings decreases in excess of 5% while the Investor
Group on Climate Change (2007) concluded that with a carbon price of AUD$25/
tonne and full auctioning of permits, the Steel and Construction Materials sectors
would have low-cycle EBITDA margins reduced by 41% and 79%, respectively. In
both cases, however, these impacts represented worst-case scenarios which over-
looked the possibility of price pass-through and/or emissions reduction activities,
and were mitigated with the possibilities of fewer emissions being covered by the
scheme and a greater portion of the emission permits being awarded by the Gov-
ernment for free.
VicSuper (2007) provided further insight into the potential effects to ASX200
companies of an ETS using two carbon price scenarios. Specifically, using the EU
ETS phase II price of carbon at 31 March 2007 (equivalent to AUD$28.81 per tonne
of CO2), 57 ASX companies were found to have a carbon exposure greater than 1%
of sales while using the social cost of carbon (estimated by the Stern review, 2006, to
be AUD$110.68), the average impact on the ASX200 was 4.39% of sales.16 The
ability of firms to pass on these costs was identified as the critical factor in deter-
mining the business impact of emissions trading. Importantly, carbon intensity was
also found to vary considerably between industries, with just four sectors (Metals
and Mining, Construction Materials, Oil and Gas, and Airlines) found to contribute
74% of direct carbon emissions in Australia.
16
The Stern Review is a 2006 report delivered to the British Government on the economics of climate
change. The social cost of carbon is the net present value of the climate change impacts from 1 tonne
of CO2 emitted.
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Continuing, industry reports investigating the potential financial impacts implied

specifically by the Government’s ETS design preferences outlined in the Green
Paper were released by Citigroup (2008) and Port Jackson Partners Limited (2008).
While neither report adopted empirical techniques, both concluded that a number of
ASX companies will be significantly threatened by the ETS in its current form.
Finally, near the end of our study period, Deutsche Bank (2009) undertook a dis-
counted cash flow (DCF) analysis of the carbon liability of the top 25 Australian
emitters, representing 94% of the emissions of the ASX 100. Based on a series of
assumptions regarding the allocation of free permits and the ability for cost pass-
through, as well as the assumption that following an initial fixed price of $10 per
tonne the price of carbon in Australia will converge to the global price, Deutsche
Bank concludes that ‘the valuation impacts are relatively benign: -3% or less for 17
of the top 25 emitters. This is a result of the combination of the allocation of free
permits, and in many cases the ability to pass through the incremental carbon cost.’
In sum, while the results of industry research conducted both in Australia and
internationally predominantly using scenario analysis vary in specifics, there appear
to be two consistent messages:
1. while the valuation impacts of an ETS appear largely dependent on the ability of
firms to pass through carbon costs and on ETS policy outcomes, it is highly likely
that corporate earnings will be adversely affected in a meaningful fashion; and
2. businesses in the building materials, bulk commodity chemicals, steel production,
and construction materials industry sectors are consistently identified as being
most at risk (sectors which not coincidentally are high emitters of CO2).17
2.2 Academic Literature

Academic research examining the relationship between environmental and finan-
cial performance is divided. Some studies compare financial to environmental per-
formance of firms over time (e.g., Jaggi and Freedman, 1992; Hart and Ahuja, 1996;
Clarkson, Li et al. 2011) while others directly analyse the effect of environmental
performance on market value (e.g., Cormier et al., 1993; Hughes, 2000; Clarkson
et al., 2004), with the latter undertaken either using valuation model technology
typically based on Ohlson (1995) or through event study methodology. In this
study, our focus is on the potential valuation impact of an emissions trading regu-
lation in Australia on ASX companies. Directly relevant academic literature is
discussed below.
In environmental literature, numerous studies combine accounting information
with ‘other information’ to analyse firm value. Cormier et al. (1993) investigate the
17
The idea that Materials sector firms are most at risk from an ETS is intuitively appealing. The GICS
Materials Sector (GICS code 15) encompasses a wide range of commodity-related manufactur-
ing industries including chemicals, construction materials, metals, minerals and mining and steel, all
known to be high emitters of CO2. Moreover, for many, the price of their product is determined in
international markets where their foreign competitors may not face the same stringent environmental
regulations. As such, the ability to pass on future carbon costs is likely constrained. These factors lead
to industries within this classification being labelled as Trade Exposed Emission Intensive Industries
(TEEII).
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relation between market valuation and social performance, measured by a firm’s

pollution record relative to environmental regulations, finding that pollution perfor-
mance is interpreted by the market as providing information about environmental
liabilities. Hughes, (2000) uses sulphur dioxide emissions to assess the value rel-
evance of future environmental liabilities faced by electric utilities as a result of
Phase One of the 1990 Clean Air Act Amendments. He concludes that, on average,
exposure to unbooked future environmental liabilities decreased the mean 1990
share price of the relevant utilities by 16%. In contrast, those utilities not targeted by
the amendments faced minimal exposure to environmental liabilities and their share
price was unaffected.
Similar conclusions follow from Clarkson et al., (2004) based on a sample of U.S.
pulp and paper firms, measuring environmental performance using toxic release
inventory (TRI) figures reported to the EPA. They find that investors use TRI data
to assess unbooked environmental liabilities, which they interpret to represent
future abatement spending obligations of high-polluting firms, equal to approxi-
mately 16.6% of market capitalization. Support for figures of this magnitude follow
from Barth and McNichols, (1994) who estimate investors’ assessment of firm’s
unrecognized environmental liabilities (proxied by number of Superfund sites) to be
28.6% of equity.
Of those studies that use the event study framework to analyse the effect of
environmental performance on market value, two stand out as being particularly
relevant. Klassen and McLaughlin, (1996) find significant positive returns for strong
environmental management as indicated by positive news related to winning
environmental performance awards. Significant negative returns were found for
weak environmental management as indicated by negative news environmental
crises. Interestingly, cross-sectional analysis of the positive news events revealed
first-time award announcements were associated with much greater increases in
market value, and smaller increases were observed for award winning firms in
‘dirty’ industries.
Hamilton (1995) uses an event study to examine the market reaction to the first
release of TRI data in America.18 For a sample of 436 firms with TRI data, firms were
found to experience an average loss of $4.1million in market value on the day when
the TRI data were released, suggestive of the release leading investors to increase
the present value of estimated pollution costs by this amount, on average. Hamil-
ton’s results were stronger for firms which enjoyed media coverage of their releases
(-$6.2 million) and firms with Superfund sites (-$5.9 million).19
Of more immediate note, Johnson et al. (2008) examine the value relevance of
sulphur dioxide (SO2) emission allowances held by U.S. electric utilities. While
explicitly recognizing that SO2 is not a greenhouse gas (GHG), they argue that
18
TRI is a publicly available database provided by the Environmental Protection Agency. It has become
the standard metric to measure a company’s waste generation and pollution reduction activities
across a wide range of industries (including chemical, mining, paper, and oil and gas) in America.
19
Superfund sites are toxic waste sites which are placed on the U.S. Environmental Protection Agency’s
National Priority List based on a scoring process that rates their current or potential health impacts.
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their examination has the potential to inform the GHG debate because the SO2
allowances have been subject to a cap and trade market since 1995. They find that
the SO2 emission allowances of their sample firms are valued by the market, with the
value comprised of two components, an asset value and a real option value.
Finally, two studies conducted subsequent to ours directly examine the valuation
implications of carbon emissions using U.S. data. Using carbon emissions data
obtained either directly from CDP disclosures or by estimating it for non-disclosers
based on the emissions data provided by the disclosers, Griffin et al. (2012) find
greenhouse gas emissions levels to be negatively associated with stock price and
further, ‘the negative relation is more pronounced for carbon-intensive companies’.
In a similar fashion, also based on CDP disclosures, Matsumura et al. (2011) find a
negative association between carbon emissions and firm value with the estimated
relationship implying an assessed penalty of $202 per ton of emissions. Noting that
this value far exceeds the spot price of carbon, they suggest that it may also reflect
the present value of the firm’s future carbon emissions as well as other indirect costs
associated with carbon emissions such as regulatory intervention, litigation and
remediation expenses, and potential reputational implications. However, as pointed
out in footnote 3, one limitation of these studies is that they have been conducted in
a setting wherein there are no apparent prospects for the implementation of carbon
regulation.
2.3 Hypothesis Development

The results of both the academic and industry-based research reviewed above
indicate that the impending introduction of a national Emissions Trading Scheme
in Australia should adversely impact corporate earnings. Further, they suggest that
the earnings of firms in the materials sector (CIGS Sector 15) are at greater risk.
However, prior literature also suggests that firms can mitigate the impact of an
ETS through emissions reduction activities and/or by passing carbon costs onto
their customers. Finally, the research indicates that impacts of an ETS are ulti-
mately sensitive to a number of key legislative outcomes including the overall
scheme cap, the price of carbon, permit allocation and compensation. Clearly,
without specifics which will only be confirmed in the final enacted legislation, the
resultant effects on cost pass-through ability and firm valuation will be difficult to
determine. As discussed below, these outcomes could serve to help alleviate the
negative financial impacts imposed on ASX companies but could alternatively
also result in a multitude of future liabilities that depress earnings (and ultimately
valuation).
Thus, while the ability for firms to pass carbon-related costs on to customers in
conjunction with policy-based issues on compensation and permit allocation have
the potential to alleviate the negative financial impacts associated with an ETS, its
implementation within Australia is likely to impose significant new compliance costs
on firms as well as adversely affect corporate earnings. Further, the impact of an ETS
should be greater for carbon intensive firms, specifically those in the materials sector,
GICS Sector 15. Thus, from the perspective of shareholders, firm value is also likely
to be adversely affected, whether for reasons relating to the existence of unbooked
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liabilities associated with future compliance and/or abatement costs, or whether for
reasons relating to reduced future earnings.20 Further, the impact on value should be
greater for firms facing the greater future costs and/or earnings reductions. This then
suggests the following hypothesis:
H1: Market value will be negatively related to a firm’s carbon intensity profile.
In terms of the mitigating factors, perhaps the most contentious issue is the
extent to which some businesses, notably power stations and firms in Trade
Exposed Emission Intensive Industries (TEEI), will be compensated (via free
permits or otherwise) for the economic burden of an ETS. When the European
Union ETS commenced in 2005, a slow start was necessary given first mover con-
sequences and the associated risks of jeopardizing international competitiveness.
Nevertheless, the Green Paper (2008a) suggests that a limited amount of direct
assistance should be extended to coal-fired electricity generators. While at least
some compensation is almost certain, the key question is whether or not it will be
sufficient. The length of the compensation provision is also important, because
compensation to TEEII will be gradually reduced as other countries formally adopt
some form of regulation relating to carbon emissions. Thus, it is likely that the
implementation of an ETS will have an adverse effect on even the firms receiving
some form of compensation.
In terms of cost pass-through, the ease with which cost pass-through occurred in
the early stages of the European Union ETS is unlikely in Australia. This view is
endorsed by John Boshier, Executive Director of the National Generators Forum,
who has stated ‘the National Electricity Market [in Australia] doesn’t work like
this. Coal generators will be faced with the situation where they not only cannot
recoup their high carbon costs but also find themselves generating far less electric-
ity in a carbon-constrained nation. This will slash their asset values and render
some unviable, leading to premature closure of plant’ (Weisser, 2008). In their
discussion of the empirical literature, Hourcade et al. (2007) note that high cost
pass-through is often met with limited empirical support. There are also few politi-
cal votes in sharply rising prices and Australia’s ongoing drought combined with
commodity-based cost increases for electricity generators has already driven elec-
tricity prices to record levels (Eslake and Toth, 2008). With consumer price inflation
already at the upper-end of the Reserve Bank of Australia’s target, there will be
considerable pressure on the Government to avoid excessive price hikes (Rollins,
2008). Lastly, as TEEI firms are by definition unable to pass on higher costs, it can
reasonably be concluded that cost pass-through is unlikely to fully shelter high
carbon intensity firms from the adverse financial consequences imposed by an ETS
in Australia.
20
Clearly, the degree to which market valuation is affected during the period prior to passage of the
legislation will depend upon the probability with which shareholders assess the imposition of such
a scheme and its exact details. Nevertheless, in an efficient market, given a positive probability of
implementation, value should be adversely affected.
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3 METHODOLOGY
In this study, we seek insights into the capital market’s assessment of the proposed
Australian emissions trading scheme (ETS), an assessment which is hypothesized to
be conditional on a firm’s carbon intensity profile. We conduct our analysis in two
stages. First, we undertake an event study focusing on five distinct information
events argued to impact the probability of the proposed ETS being enacted. Here,
we seek direct evidence that the capital market is indeed pricing the proposed ETS.
Second, we undertake a valuation analysis designed not only to complement the
event study results but, more importantly, to provide insights into the capital mar-
ket’s assessment of the magnitude of the economic impact of the proposed ETS as
reflected in market capitalization. Below, we describe the sampling criterion and the
way in which carbon intensity is measured in section 3.1, the event study method-
ology in section 3.2, the valuation model methodology in section 3.3, and finally,
present descriptive statistics for the sample firms in section 3.4.
3.1 Sample Data and Carbon Intensity Measure

The requirement for greenhouse gas (GHG) emissions data represents the binding
constraint on data availability because, until recently, it has not been compulsory for
ASX listed firms to report such data. As such, historical GHG emissions data must
be sourced from private providers rather from public organizations. Further, as with
other environmental performance data (e.g., the U.S. Environmental Protection
Agency’s [EPA] TRI database), the GHG data are typically only available with a
significant delay. However, as discussed below, there are several sources through
which 2007 GHG emissions data can be sourced. As such, our sample data consist of
all Australian firms for which GHG emissions data are available for 2007.21
Specifically, to obtain GHG emissions data we consider two sources. First, Citi-
group (2008) provides domestic GHG emission figures for 42 ASX firms that it
provided global emissions statistics for in an earlier report. The Australian propor-
tion of each firm’s GHG emissions is important because emissions generated by
ASX firms outside Australia are not subject to the domestic environmental regu-
lation. The majority of Citigroup’s figures are derived from the Carbon Disclosure
Project (CDP) and are published in the report’s appendix.22 Second, VicSuper
(2007) relies on an even greater number of GHG emission estimates (provided
by Trucost Plc), although none of these figures are made publicly available.23
The VicSuper report does, however, explicitly identify 63 ASX firms with extreme
21
There appears to be considerable slippage in data availability for 2008. For example, VicSuper which
covered 63 ASX firms in 2007 appears to only provide an assessment of 12 firms for 2008.
22
A small number of the Citigroup data is derived from in-house estimates; however, the majority
comes direct from CDP4 and CDP5 (the fourth and fifth CDP reports).
23
Trucost Plc is a specialist research organization. Where CDP data were unavailable, Trucost employed
a proprietary environmental profiling system to estimate corporate GHG emissions (see Evaulation
Process, VicSuper 2007, p. 27).
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emissions figures, 19 of which are not covered by Citigroup. Specifically, the report
identifies 19 firms with carbon (CO2) emissions greater than 1,000 tonnes per $1
million of sales and 44 with emissions of less than 40 tonnes of per $1 million of
sales.
To our knowledge, these two datasets represent the only publicly available sources
of GHG emission data for Australian firms at the time of our study. Our data are
comprised of the 61 unique firms from these two sources (42 from Citigroup and 19
from VicSuper).24 Of these, three lack the requisite accounting data to conduct the
valuation analyses. The final sample consists of the remaining 58 firms, 40 from the
Citigroup dataset and 18 from the VicSuper dataset.
To develop our carbon intensity measure, we focus on the 40 firms sourced from
the Citigroup database because, as discussed above, primary GHG emissions data
are publicly available for these firms but not for the 18 VicSuper firms. Thus, we
begin by measuring the carbon intensity (CI) of the Citigroup firms in a manner
consistent with VicSuper, that is,
Total Australian GHG Emissions

CI = (1)
Sales Re vene $1, 000, 000
In order to pool the Citigroup and VicSuper sample firms, we next partition the
Citigroup firms into high and low CI groups. Since it is ultimately an empirical
question as to how the market identifies the ‘at risk’ (high versus low CI) firms, we
alternatively partition these firms at the median value of CI and then using cut-off
points wherein the top 35% (14 firms) or only the top 20% (8 firms) based on CI are
classified as high carbon intensity firms. For notational purposes, we designate these
alternative partitions as P50, P35, and P20. Additionally, given the industry research
discussed in section 2.1 which identifies firms in the Materials industry sector (GICS
sector 15) as being most at risk under an ETS, we adopt this classification as an
alternative partitioning scheme (denoted M). As a fifth and final partition (MP20),
we then intersect the P20 and M schemes.
Table 1 presents descriptive statistics for the carbon intensity metric, CI, both for
the overall sample of 40 Citigroup firms and for these firms by category (high versus
low CI) under each partitioning scheme. For the overall sample, the mean (median)
value of CI is 357.852 (119.021). Thus, on average, these firms emit 357.852 tonnes of
CO2 per $1 million of sales. Turning to the most stringent partitioning scheme, P20,
the mean (median) value of CI for the eight firms classified as high carbon intensity
is 1,290.022 (1,157.577) whereas mean (median) value for the 32 firms classified
as low carbon intensity is 151.166 (70.877). The differences in mean and median
values are both significant at the 1% level. Further, based on mean sales revenue
figures, the subset of 8 high CI firms emit 70.037 million tonnes of CO2 in total
24
Under the proposed ETS, firms may face different impacts for their direct carbon emissions (Scope 1
emissions) and emissions attributed to the generation of electricity that they purchase (Scope 2
emissions). We make no distinction between Scope 1 and Scope 2 emissions following Citigroup
(2008) which suggests that the differences in their financial impacts are likely to be small.
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Table 1
DESCRIPTIVE STATISTICS FOR CARBON INTENSITY (CI) BY PARTITIONING SCHEME

FOR A SAMPLE OF 40 AUSTRALIAN COMPANIES WITH AVAILABLE GREENHOUSE
GAS EMISSIONS DATA FOR 2007 IN THE CITIGROUP DATABASE
Scheme Mean Median Std dev. Minimum Maximum
Overall Sample 357.852 119.021 500.560 1.265 1,860.720
P50 (20/20)
High CI 682.438*** 552.927*** 739.262 124.691 1,860.720
Low CI 33.266 17.746 32.281 1.265 115.025
P35 (14/26)
High CI 871.213*** 775.014*** 506.406 259.336 1,860.720
Low CI 59.485 38.903 60.097 1.265 200.767
P20 (8/32)
High CI 1,290.022*** 1,157.577*** 343.603 890.704 1,860.720
Low CI 151.166 70.877 192.785 1.265 659.323
M (9/31)
Materials 786.316*** 657.163*** 586.825 19.798 1,860.720
Non-materials 211.184 69.011 373.880 1.265 1405.586
MP20 (8/32)
High CI 1,355.158*** 1,332.741*** 447.369 890.704 1,860.720
Low CI 246.803 75.338 360.750 1.265 1406.588
CI is measured as tonnes of carbon (CO2) emissions per $1 million of sales revenue.

The partitioning schemes are as defined in section 3.1.
The figures in parenthesis are the partition sample sizes, with the first figure the number of firms classified
as high carbon intensity, and the second figure the number of low carbon intensity firms.
*** Two-tailed tests for difference in mean and median values between high and low CI partitions,
as appropriate, significant at the 1% level.
whereas the subset of 32 low CI firms emit only 60.631 million tonnes in total.25 Thus,
a small minority of firms are responsible for a majority of the total GHG emissions
emanating from our sample firms.
Of particular note from an experimental design perspective, the eight firms clas-
sified as low carbon intensity by VicSuper (<40 tonnes of carbon emissions per $1
million of sales) would also be classified as low under all schemes while the 10 firms
classified as high carbon intensity by VicSuper (>1,000 tonnes per $1 million of
sales) would be classified as high under all schemes. Thus, the partitioning criterion
applied by VicSuper is consistent with each of our schemes and the pooling of the
18 VicSuper firms with the 40 Citigroup firms is appropriate. For the combined
sample of 58 firms drawn from the Citigroup and VicSuper databases, 30 firms are
then designated high carbon intensity firms under P50 (20 + 10), 24 firms under P35,
25
The mean sales figures for the high and low CI firms under the P20 partitioning scheme are
$6,786.441 million and $12,533.959 million, respectively.
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© 2013 The Authors
and 18 under P20. Seventeen firms are classified as ‘at risk’ under the Materials
sector scheme (M) and 11 firms under the combined scheme MP20.
Finally, for brevity, in reporting both the event study and valuation analyses we
tabulate and discuss results based only on the P20 partitioning scheme. We do,
however, discuss results based on the other schemes for purposes of sensitivity.
3.2 Event Study

We examine the share market reaction to five ETS-specific information events
argued to impact the market’s assessment of the expected cost of an ETS by
updating the probability of enactment.These events have been selected from a series
of information events relating to an ETS in Australia as the key events most likely
to have impacted market expectations regarding ultimate enactment and because
they are relatively isolated from other potentially confounding ETS-related infor-
mation events.26 We prefer a focus on events believed to impact the probability of
enactment rather than those that relate to changes in the details given the uncer-
tainties regarding the ability of firms to pass through costs and details of the scheme
such as permit allocation, emission coverage, the cap and compensation arrange-
ments. We expect carbon intensive firms to experience negative abnormal returns
with events that increase the likelihood of an ETS and positive abnormal returns
with events that decrease the likelihood. Further, we expect the share market reac-
tion to be stronger for those firms with the greatest exposure (i.e., the highest carbon
intensity firms).
In detail, the specific information events we consider are:
1. 11 December 2006 Australian Government establishes a task group to

design an ETS;
2. 30 May 2007 Australia’s opposition leader K. Rudd commits to
introducing an ETS;
3. 26 November 2007 K. Rudd, after winning the federal election, ratifies
Kyoto;
4. 16 July 2008 Government releases Green Paper on design of an ETS;
and
5. 4 May 2009 Government announces delays to the implementation of
an ETS.
Here, events 1 to 4 represent events which likely increased the probability of an

Australian ETS while arguably event 5 reduced the likelihood. In greater detail,
events 1 and 2 have widely been identified as the key events relevant to the then
governing Liberal Party and the then opposition Australian Labor Party, which
26
For example, Event 1 was chosen in preference to then Prime Minister John Howard’s formal
commitment to introducing an ETS (2 June 2007) because he had long been a climate change sceptic.
Thus, Event 1 marks the primary (and arguably most informative) change in his political stance.
Moreover, the returns would potentially be confounded by Kevin Rudd’s formal commitment to
an ETS only three days prior (30 May 2007).
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ABACUS
revealed an in-principle acceptance of the basic notion of an Australian ETS by

both. Because an emissions trading scheme is the primary tool for regulating emis-
sions under the Kyoto Protocol, confirmation that an ETS would be introduced in
Australia was provided when Kevin Rudd won the federal election and then imme-
diately signed the instrument that led to Australia’s ratification of Kyoto (event 3).
Event 4 marks the date on which the now Labor Government publicly released its
Green Paper on the proposed design of an ETS. Conversely, event 5 proposed a
delay of a much anticipated ETS and at the same time raised its threshold. The
widely held reaction to the proposed higher threshold at the time was that it would
be uncompetitive globally (especially given expectations regarding the likely
outcome from the December 2009 meetings in Copenhagen) and thereby the
announcement was broadly viewed as reducing the likelihood of an ETS.
The econometric model we employ is an augmented form of the standard market
model. Specifically, we use a model which comprises the market model variables to
capture the normal returns-generating process augmented with a set of indicator
variables that allow the return-generating process to shift in mean when information
is released to market participants (Schipper and Thompson, 1983; Besanko et al.,
2001; Stango, 2003). Thus, our base econometric model is:
rjt = α j + β j rmt + ∑ δ jk Dk + ε jt (2)

k
where
rjt = the return to security j for day t;
rmt = the return to the market as proxied for by the S&P ASX 200 index for day
t; and
Dk = an indicator variable set equal to one within the event window for event
k (k = 1, .., 5) and zero otherwise, where the five selected information
events are those detailed above.
Following prior environmental event studies (e.g., Klassen and McLaughlin, 1996),
we define the event window as the three-day window centred at the announce-
ment date (i.e., t-1 to t+1).
A fundamental problem inherent in regulatory event studies is that of event and
industry clustering which results in issues of auto- and cross-correlation. If the
abnormal returns across any of the events are correlated or if the covariance
between the firm-specific abnormal returns is non-zero, aggregating abnormal
returns can be problematic. To confront the threat associated with cross-correlation,
we estimate our model at the portfolio level as follows:
rpt = α p + β p rmt + ∑ δ pk Dk + ε jt (3)

k
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© 2013 The Authors
where rpt is the mean portfolio return for day t and all remaining variables are as
previously defined. Within the context of this model, firms are grouped together into
portfolios and the mean daily portfolio return is calculated for each trading day t.
This portfolio approach removes the cross-correlations between firm abnormal
returns, and also removes some of the time-series correlation which arises from
having many observations for the same firm over time. By basing the analysis on the
mean portfolio returns, firm-specific residuals tend to offset each other within the
portfolio. Finally, a further advantage of the portfolio approach is that portfolios can
be formed based on the full sample or on any subset of the sample (e.g., high versus
low carbon intensity firms). We therefore base our event study on equation (3),
estimating the model over the period from 1 December 2006 to 31 May 2009. All
p-values are presented on an adjusted basis using White’s consistent covariance
matrix to compute standard errors.27
3.3 Valuation Model Analysis

Here, we employ a modified version of the Ohlson (1995) valuation model to gain
insights into the market’s assessment of the economic impact of the proposed ETS.
This approach follows prior studies that seek to document the existence of
unbooked environmental liabilities (e.g., Barth and McNichols, 1994; Cormier et al.,
1993; Cormier and Magnan, 1997; Hughes, 2000; Clarkson et al., 2004). Specifically,
the base form of our econometric model is:
V = α 0 + α 1 BV + α 2 AE + α 3 EP + α 4 EMIT + ε (4)
where
V = market value of common equity, calculated three months after the
balance date;
BV = book value of common equity;
AE = abnormal earnings to common defined as earnings to common equity less

an assumed cost of capital based on the CAPM times beginning-of-period
book value of common equity;28
27
Alternatively, for sensitivity purposes we repeat our analysis using equation (2) and a pooled GLS
technique. The pooled GLS technique allows for cross-sectional heteroskedasticity and serial corre-
lation, and provides a better specification than OLS by using within-company correlation coefficients
as estimates of the autoregressive parameters for each cross-sectional unit. The technique uses
estimated autoregressive parameters to transform the observations and obtain more efficient estima-
tors. Results based on this alternative approach (not reported) are qualitatively identical to those
reported in Table 4 based on the portfolio approach.
28
The cost of equity capital is based on the CAPM with b estimated using 60 months of historical
return data, RF equal to 6.0%, and the market price of risk ([E(RM)—RF]) also equal to 6.0%
(Reserve Bank of Australia, 2008; Truong et al., 2006). Sensitivity analysis indicates that the results
are not sensitive to a reasonable range of figures for either the risk-free rate or the market price
of risk.
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ABACUS
EP = environmental performance (discussed in detail below); and
EMIT = an indicator variable assuming the value of 1 for high carbon intensity
firms and 0 otherwise.29
In employing this model we are implying, as predicted by hypothesis H1, that the
market uses a firm’s carbon emissions as ‘other information’ that predicts future
negative abnormal earnings beyond a knowledge of current abnormal earnings. As
previously argued, this reduction in abnormal earnings derives from either or both
of increased future compliance and/or abatement costs or reduced future earnings as
a result of the implementation of an ETS. In terms of the model, a negative coeffi-
cient on EMIT (i.e., a4 < 0) would indicate that, ceteris paribus, the market assesses
high-emitting firms with lower market valuation relative to low-emitting firms.
Within this model, in addition to EMIT we also include a measure designed to
capture the firm’s general environmental performance, EP. Absent such a measure,
it is possible that the coefficient on EMIT may simply be capturing unbooked
environmental liabilities following from the firm’s performance on other aspects of
its environmental management (e.g., Cormier and Magnan, 1997; Hughes, 2000;
Clarkson et al., 2004), rather than the impact of the proposed ETS on firm valua-
tion. To measure EP, we follow the environmental literature (e.g., Patten, 2002;
Al-Tuwaijri et al., 2004; Clarkson, Overell et al. 2011) by using a quantitative measure
of environmental performance which represents the Australian analogue of the
U.S. EPA’s TRI.30 Specifically, we use data from the Australian National Pollutant
Inventory (NPI) to proxy for environmental performance. The NPI, established in
1998, requires all facilities that emit above threshold levels to submit annual reports
that quantify their emissions of various land, water and air pollutants. This informa-
tion is then compiled and made publicly available on the NPI website. In this sense,
the advantages of using TRI to assess environmental performance also apply to NPI.
However, the NPI data have an additional advantage in that they assign a ‘Total
Risk’ score to each substance and report the emissions of individual substances for
29
As previously discussed, primary GHG emissions data are not available for 18 of our sample firms.
Rather, these firms have been pre-classified as high versus low carbon intensive within the VicSuper
database. Given this pre-classification, we defer to the use of a dichotomous rather than a continuous
measure to capture emissions.
30
Although toxic emissions represent only one facet of environmental performance, Patten, (2002)
argues that TRI data have the advantages of being based on the same measures for all firms and
covering a large, diversified set of firms. Ilinitch et al., (1998) note that these factors have led scholars
‘to rely upon the TRI as the environmental performance indicator of choice’ but caution that it is an
aggregate measure of substances wherein the substances are not weighted according to relative risk
or harm. Since the TRI contain data only on U.S. firms, Australian studies have historically relied on
alternative measures such as the incidence of successful prosecution (Deegan and Rankin, 1996).
While argued to provide an objective and legal assessment of ‘poor’ environmental performance,
this measure has been criticized for the restriction that it imposes on variance within sample and
the fact that the level and frequency of environmental penalties may be more reflective of a
company’s willingness to wage legal battles (and the regulators’ persistence in pursuing them) than
their disregard of regulations (Ilinitch et al., 1998).
20
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each facility. This allows the measurement of weighted totals, as opposed to raw
aggregates, in the assessment of environmental performance. The NPI reporting list
contains 90 substances. Each substance is assigned a score by the NPI to reflect the
relative risk that it poses, with the risk score being a function of its environmental
hazard, human health hazard, and likelihood of exposure to the Australian popula-
tion or environment.31 To assess firm-level environmental performance, we multiply
the quantity of each substance emitted by its risk score to arrive at a weighted
aggregation, arguing that this represents a more accurate measure than does a
simple aggregation of raw emissions. Consistent with prior studies, we then scale our
weighted measure by firm sales (Patten, 2002; Clarkson, Overell et al. 2011).Thus, the
measure of EP we use is a risk-adjusted measure of toxic releases per $1,000 of sales.
Finally, to conduct our empirical analysis, we initially scale all items (other than
EP and EMIT) by the number of common shares outstanding (Barth and Clinch,
2005; Clarkson et al., 2004) to arrive at our primary econometric model:
P = ϕ 0 + ϕ 1 BVPS + ϕ 2 AEPS + ϕ 3 EP + ϕ 4 EMIT + υ (5)
where P is price per share, BVPS is book value of common equity per share, AEPS
is abnormal earnings per share, and both EP and EMIT are as previously defined.
Then, in order to consider the sensitivity to the choice of scalar, we repeat the
analysis after alternatively scaling all items (other than EP and EMIT) by book
value of common equity. This alternative model is:
V BV = λ 0 + λ 1 (1 BV ) + λ 2 ( AE BV ) + λ 3 EP + λ 4 EMIT + τ (6)
where all variables are as previously defined.32 Again, within both models, H1
predicts a negative coefficient on EMIT (i.e., j4 < 0 or l 4 < 0, as appropriate).
3.4 Descriptive Statistics

Table 2 presents descriptive statistics for measures of size, profitability, risk and
environmental performance for the final sample of 58 firms, both overall and parti-
tioned by scheme P50 into high and low CI firms. As can be seen from the first
column, overall the sample is broadly distributed along all dimensions. The mean
(median) market capitalization (V) is $21,754.2 ($7,018.3) million, ranging from
$466.0 million to $258,188.1 million. Further, the mean (median) book value of
common equity (BV) and earnings (E) are $5,587.5 ($3,155.6) million and $1,411.0
($549.2) million, respectively, and the mean (median) value of beta (b) is 0.952
31
The Technical Advisory Panel to the NPI was formed in 1997 to recommend the substances for
inclusion and to advise details of the hazard and risk of each. The risk score is calculated as follows:
Risk Score = (Environment Hazard Score + Human Health Hazard Score) x Exposure. Each variable
was scored by the Technical Advisory Panel on a relative basis between 0 and 3. Risk scores therefore
fall between 0 and 18 (www.npi.gov.au). For further details on the NPI, see Clarkson, Overell et al.
(2011) and Cowan and Deegan (2011).
32
Results for the version of this model without an intercept, the more literal version of the model scaled
by book value, are qualitatively identical to those reported in Table 5.
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Table 2
DESCRIPTIVE STATISTICS FOR A SAMPLE OF 58 AUSTRALIAN COMPANIES WITH

AVAILABLE GREENHOUSE GAS EMISSIONS DATA FOR 2007
Variable Overall sample P50 Non-P50 p-value

(n = 58) (n = 30) (n = 28)
Market capitalization (V)

Mean 21,754.231 22,573.160 20,876.807 0.883
Median 7,018.349 5,032.226 12,831.031 0.009
Std dev. 43,580.585 57,021.222 21,220.269
Minimum 466.002 466.002 1,217.959
Maximum 258,188.090 258,188.090 72,691.938
Book value (BV)
Mean 5,587.531 4,509.242 6,742.841 0.251
Median 3,155.616 2,632.773 3,960.906 0.030
Std dev. 7,352.823 7,380.355 7,259.619
Minimum 445.075 445.075 664.021
Maximum 32,966.380 32,966.380 27,720.588
Earnings (E)
Mean 1,410.998 1,351.035 1,475.244 0.527
Median 549.240 436.746 969.535 0.024
Std dev. 2,595.055 3,330.277 1,461.325
Minimum -143.771 -143.771 -74.808
Maximum 15,728.667 15,728.667 4,587.156
Beta (b)
Mean 0.952 1.138 0.753 <0.001
Median 0.826 1.275 0.691 <0.001
Std dev. 0.378 0.372 0.283
Minimum 0.498 0.502 0.501
Maximum 1.891 1.908 1.643
Environmental performance (EP)
Mean 0.116 0.132 0.099 0.506
Median 0.024 0.027 0.022 0.094
Std dev 0.186 0.201 0.172
Minimum 0.000 0.000 0.000
Maximum 0.814 0.814 0.766
Variable definitions: V is market capitalization; BV is book value of equity; E is earnings to common

equity; b is systematic risk, estimated using 60 months of historical return data; EP is a risk-adjusted
measure of toxic releases per $1,000 of sales; and CI is carbon intensity calculated as tonnes of CO2
emissions from Australian operations per $1 million of sales revenue. Descriptive statistics for CI are
based only on the subset of 40 firms for which emissions data are available. V, BV and E are expressed in
AUD$ millions.
The high and low CI partitions are based on partitioning scheme P50 (based on the median value of CI)
as described in section 3.1
p-values are for tests for difference in mean and median values, as appropriate, and are two-tailed.
22
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Table 3
FREQUENCY DISTRIBUTION BY GICS INDUSTRY SECTOR FOR A SAMPLE OF 58

AUSTRALIAN COMPANIES WITH AVAILABLE GREENHOUSE GAS EMISSIONS DATA
FOR 2007
Industry sector (GICS) Overall sample P50 Non-P50

(n = 58) (n = 30) (n = 28)
Energy (10) 6 5 1
Materials (15) 17 16 1
Industrials (20) 4 2 2
Consumer—discretionary (25) 1 1
Consumer—staples (30) 7 3 4
Financials (40) 17 17
Telecommunications (50) 1 1
Utilities (55) 5 4 1
Total 58 30 28
Chi-square test statistic (p-value) 36.820 <0.001
Industry sectors are based on the Global Industry Classification Standards (GICS).
The high and low CI partitions are based on partitioning scheme P50 (based on the median value of CI)
as described in section 3.1.
The chi-square test is for the test of independence between industry classification and CI partition.
(0.826). Thus, on balance, our sample firms appear to be the larger, more profitable,
and less risky listed Australian firms. The mean (median) value of the environmental
performance (EP) measure, a risk-adjusted measure of toxic releases per $1,000 of
sales, is 0.116 (0.024). Tests for differences in median values between the high and
low CI firms are significant at less than the 5% level for all measures except EP
where the significance is at the 10% level.33
Table 3 presents a frequency distribution for our sample firms by GICS industry
sector, again overall and partitioned using scheme P50. As revealed, the overall
sample has representation across the broad industry sectors that comprise the ASX
but is weighted towards the Materials (GICS Sector 15) and the Financial (GICS
Sector 40) sectors. Within these sectors, the partitioned distributions reveal perhaps
not unexpectedly that the high CI firms are skewed towards the Materials sector
(16 of the 17 Materials sector firms reside in this partition) while the low CI firms are
skewed towards the Financial sector (all 17 of the Financial sector firms reside in this
partition). The null hypothesis of independence between industry distribution and
CI partition is rejected at less than the 1% level, with a chi-squared test statistic of
36.820.34
33
Tests for mean differences in size and profitability figures are influenced by several large outliers.
34
While perhaps technically inappropriate given the limited number of observations in some cells, the
test statistic nevertheless is indicative of the differing industry compositions for the two partitions.
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ABACUS
4 RESULTS
4.1 Event Study Results

Event study results based on equation (3) (the portfolio approach) are presented in
Table 4. The first column presents results for the full sample while the second and
third columns present results for the P20 and non-P20 subsamples, respectively. The
final column presents p-values for tests of difference in coefficient estimates between
the models for these two subsamples. As can be seen, based on the full sample, there
is a significant market reaction in the expected direction to events 2 (Opposition
commitment to introducing an ETS) and 5 (announced delay to implementation of
an ETS). For event 2, the coefficient on the event indicator variable is -0.018 (p =
0.046) while for event 5, the coefficient on the indicator variable is 0.021 (p = 0.020).
Table 4
EVENT STUDY MARKET MODEL ESTIMATES OVER THE PERIOD 1 DECEMBER 2006 TO
31 MAY 2009 FOR A SAMPLE OF 58 AUSTRALIAN COMPANIES WITH AVAILABLE 2007
GREENHOUSE GAS EMISSIONS DATA
Coefficient Overall sample P20 Non-P20 p-value

(n = 58) (n = 18) (n = 40)
a 0.001 0.001 0.001 0.862

(0.006) (0.009) (0.004)
b 0.959 1.142 0.716 <0.001
(<0.001) (<0.001) (<0.001)
d1 -0.011 -0.014 -0.011 0.370
(0.193) (0.162) (0.218)
d2 -0.018 -0.023 -0.010 0.041
(0.046) (0.013) (0.176)
d3 -0.011 -0.019 -0.005 0.093
(0.204) (0.067) (0.529)
d4 -0.007 -0.011 -0.005 0.745
(0.486) (0.485) (0.649)
d5 0.021 0.024 0.012 0.048
(0.020) (0.002) (0.079)
The econometric model is: rpt = ap + bp rmt + Sk dpk Dk + e.

Variable definitions: rpt is the mean portfolio return for day t, rmt is the return to the market as proxied for
by the S&P ASX 200 index for day t, and the Dk are indicator variables set equal to one within the event
window for event k (k = 1, . . , 5) and zero otherwise.
The five information events considered are 1: 11 December 2006, Australian Government establishes a
task group to design ETS; 2: 30 May 2007, Australia’s opposition leader K. Rudd commits to introducing
ETS; 3: 26 November 2007, K. Rudd, after winning the federal election, ratifies Kyoto; 4: 16 July 2008,
Government releases Green Paper on design of ETS; and 5: 4 May 2009, Government announces delay
to implement.
p-values are for the tests of differences in coefficient estimates between the high and low CI samples
based on theP20 partitioning scheme, and are two-tailed.
24
© 2013 The Authors
For the remaining events, while the sign of the coefficient on each event indicator
variable is negative as predicted, the coefficient is not significant.
When the sample is partitioned on the basis of the P20 scheme we find, as
expected, the share market reaction is stronger for firms designated as being the
most carbon intensive. For the P20 portfolio, the coefficients on the indicator vari-
ables are negative and significant for events 2 (-0.023, p = 0.013) and 3 (-0.019,
p = 0.067), and positive and significant for event 5 (0.024, p = 0.002). Conversely,
for the non-P20 portfolio, only the coefficient on the event 5 indicator is signifi-
cant (0.012, p = 0.079). Coefficients on the indicator variables for the remaining
events again have the predicted sign but are consistently insignificant. Finally, the
p-values for tests of differences in the coefficients for events 2 (p = 0.041), 3 (p =
0.093) and 5 (p = 0.048) confirm a stronger share price reaction for the P20
subsample.35
Taken together, these results provide evidence of a share market reaction to
information releases regarding an Australian ETS as predicted by hypothesis H1,
with a strong share price adjustment documented in the expected direction at the
time of both information events 2 and 5. Further, as predicted, the reaction is
stronger for the higher carbon intensity firms.
4.2 Valuation Model Results

4.2.1 Primary results Results for our two valuation models (equations (5) and (6))
based on partitioning scheme P20 are presented in Panel A of Table 5. To begin, in
terms of model reasonableness, for the price-based model, the coefficients on both
BVPS and AEPS are positive and highly significant, although they are higher than
those reported in many valuation studies.36 Similarly, for the V/BV-based model, the
coefficient on AE/BV is also positive and highly significant. In addition, consistent
with previous environmental studies, the coefficient on EP is negative and highly
significant in both models, indicative of unbooked environmental liabilities other
than those related to carbon emissions.
Turning to the measure of interest, EMIT, for the price-based model, its coefficient
estimate is -0.497 (p = 0.039), and for the V/BV-based model its coefficient estimate
is -0.232 (p = 0.048). Thus, the results indicate that, consistent with H1, the market
assesses the most carbon intensive sample firms (as defined by partitioning scheme
P20) a market value decrement relative to other (non-P20) sample firms. Further,
35
When alternatively based on the least stringent partitioning scheme, P50, while the coefficients on
events 2, 3 and 5 are greater for the P50 portfolio than for the non-P50 portfolio, none of the
differences is significant. Based on the P35 partitioning scheme, the coefficients on these three events
are again greater for the P35 than the non-P35 portfolios, and now the difference is weakly significant
for events 2 (p = 0.082) and 5 (p = 0.077). For the most stringent partitioning scheme, MP20, the
differences are significant for all three events (event 2, p = 0.039; event 3, p = 0.052; event 5, p = 0.034).
Alternatively, for the partitioning scheme based on the Materials industry sector (M), there are no
significant differences in the coefficients between the M and non-M portfolios.
36
This issue is addressed in sensitivity analyses reported at the end of the section.
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ABACUS
Table 5
VALUATION MODEL RESULTS FOR A SAMPLE OF 58 AUSTRALIAN COMPANIES WITH

AVAILABLE GREENHOUSE GAS EMISSIONS DATA FOR 2007
Panel A: Primary valuation model results
Scaled by common shares Scaled by book value of equity
Variable Estimate Variable Estimate
Intercept 0.280 Intercept 2.336

(0.902) (<0.001)
BVPS 1.789 1 / BV 244.609
(<0.001) (0.442)
AEPS 14.216 AE / BV 7.249
(<0.001) (0.002)
EP -1.050 EP -0.389
(0.031) (0.040)
EMIT -0.497 EMIT -0.232
(0.039) (0.048)
Adjusted R2 0.863 Adjusted R2 0.302
Panel B: Sensitivity analyses
Matched on price (P) Matched on V/BV Industry and firm fixed effects
Price-based V/BV-based
Variable Estimate Variable Estimate Var. Est. Var. Est.
Intercept 2.014 Intercept 2.145 Inter 4.844 Inter 3.586

(0.089) (<0.001) (0.126) (<0.001)
BVPS 1.346 1 / BV -348.277 BVPS 1.236 1 / BV 62.902
(<0.001) (0.314) (<0.001) (0.848)
AEPS 5.441 AE / BV 4.398 AEPS 5.400 AE / BV 6.989
(<0.001) (0.002) (<0.001) (0.001)
EP -0.886 EP -0.294 EP -1.107 EP -0.402
(0.039) (0.047) (0.027) (0.041)
EMIT -0.406 EMIT -0.280 EMIT -0.436 EMIT -0.248
(0.043) (0.067) (0.059) (0.029)
Adj. R2 0.769 Adj. R2 0.258 Adj. R2 0.870 Adj. R2 0.342
The price based model is: P = d0 + d1 BVPS + d2 AEPS + d3 EP + d4 EMIT + u.

The V/BV-based model is: V/BV = l0 + l1 (1 /BV) + l2 (AE/BV) + l3 EP + l4 EMIT + t.
Variable definitions: V is market capitalization; BV is book value of common equity; AE is abnormal
earnings to common equity; EP is a risk-adjusted measure of toxic releases per $1,000 of sales; EMIT is
an indicator variable assuming the value of 1 for high carbon intensity firms and 0 otherwise, where high
carbon intensity firms are identified based on partitioning scheme P20 as described in section 3.1; P is
price per share; BVPS is book value of equity per share; and AEPS is abnormal earnings per share to
common equity.
Two-tailed p-values presented in parentheses.
26
© 2013 The Authors
this conclusion is robust to the choice scalars and holds after controlling for the
firm’s general environmental performance as proxied for by EP.37
By way of context, the coefficient estimate on EMIT for the price-based model
implies an assessed market value penalty of 6.57% of market capitalization for high
relative to low CI firms while the coefficient estimate on EMIT for the V/BV model
implies an assessed penalty of 10.08%.38 Additionally, based on the carbon emission
profile of the sample firms, these figures imply a ‘future carbon permit price’ of
between $17 and $26 per tonne.
As possible benchmarks against which to view these figures, Citigroup (2008)
suggests that for eight of Australia’s highest carbon intensive firms, a carbon cost of
$20 per tonne under the proposed ETS could create a liability of between 20% and
40% of market capitalization assuming zero price pass-though. In reference to 10
TEEI firms from the steel, cement, mineral sands and aluminium sectors, the study
concludes that under this same carbon price assumption, a stringent scheme would
lead to loss in firm value of between 0.5% and 7.0%.39 These results are less
pessimistic than Port Jackson Partners Limited (2008) who analyse 14 (undisclosed)
TEEI firms, finding that with carbon at $40 per tonne, the proposed scheme would
result in four firms closing, three facing a high risk of future negative cash flows, and
annual profits being reduced by more than 10% for the remaining seven. They are,
however, much more pessimistic than the DCF analysis developed by Deutsche
Bank (2009) who view the impact of an ETS as relatively ‘benign’. However, the
Deutsche Bank analysis was conducted near the end of 2009, by which time pro-
posed changes to the CPRS had resulted in the view that the allocation of free
allowances would be relatively more liberal than the belief generally held by the
market in 2007 when we conducted our valuation model analysis.40
37
The results again depend on the choice of partitioning scheme. For the least stringent scheme, P50,
the coefficients on EMIT are positive in both models instead of negative as predicted by H1 but
insignificant. For the scheme P35, the coefficients on EMIT at -0.121 (p = 0.426) and -0.007 (p = 0.218)
for the price-based and V/BV-based models, respectively, are now negative as predicted but remain
insignificant. Finally, for the most stringent partitioning scheme, MP20, the coefficients on EMIT at
-0.449 (p = 0.015) and -0.298 (p = 0.023) for the price-based and V/BV-based models, respectively, are
consistently negative and significant. Alternatively, for the partitioning scheme based on the Materials
industry sector (M), the coefficients on EMIT are positive but insignificant in both models.
38
These figures also fit reasonably well with recent academic studies into the market valuation impact
of environmental performance. For example, Barth and McNichols (1994) report average estimates of
unbooked environmental liabilities of 28.6% of market capitalization, while Hughes (2000) and
Clarkson et al. (2004) report figures of 16.3% and 16.6% of market capitalization in their studies. For
our sample firms, the aggregate coefficients on EP and EMIT imply an unbooked liability of between
19% and 26%.
39
A stringent scheme is defined as one that reduces Australia’s total GHG emissions by 80% of
1990 levels by 2020.
40
As discussed in section 2.1, in addition to the price of carbon, the magnitude of the impact of the
proposed ETS on market valuation relies critically on details regarding the allocation of free permits
and the ability to pass-through carbon costs. Differing assumptions regarding these key factors serve
to distinquish the Citigroup, Port Jackson and Deutsche Bank analyses from each other. For example,
in addition to a significant difference in carbon price assumptions, the primary distinction between the
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ABACUS
With regard to the implied carbon permit price, Stanford (2008) suggests that
professional estimates are between $15 and $75 per tonne, although recent short-
term forecasts generally tend towards the lower range of this band (Taylor, 2008), a
fact likely explained by the Green Paper’s indicative initial carbon price of $20 per
tonne and/or the landmark AGL/Westpac deal where in May 2008 rights to emit
10,000 tonnes of carbon were sold for $19 per tonne (Mark, 2008). These figures are,
however, significantly lower than the preceding 12 month average Australian dollar
price of carbon permits in the EU ETS at approximately $38 and the CSIRO’s
$40 per tonne mid-range ‘moderate outlook’ for 2020 (CSIRO, 2008).
4.2.2 Sensitivity analyses One possible alternative explanation for our valuation
model results is the fact that the values of the dependent variables, alternatively price
(P) and V/BV, differ between the high and low CI partitions, and thus the negative
coefficient on EMIT may simply be capturing these differences. Specifically, for the
P20 scheme, the mean (median) price for the low emission (EMIT = 0) firms at 21.778
(13.010) is significantly higher than those for the high emission (EMIT = 1) firms at
7.066 (5.175). The p-value on the difference in mean (median) values is 0.003 (0.024).
Similarly, the mean (median) value of V/BV is 3.621 (2.872) for the low emission firms
and 2.069 (1.896) for the high emission firms. Again, the differences are significant,
with a p-value on the difference in mean (median) values of 0.002 (0.019).
To address this potential challenge, we create two matched samples within scheme
P20 and then repeat our analyses based on these matched samples. We initially
match each of the 18 high CI (EMIT = 1) firms with a low CI (EMIT = 0) firm on the
basis of price (P). Following we then match on V/BV.41 The results based on the
matched samples, presented in the first two columns of Panel B of Table 5, reveal two
points of note. First, while still positive and highly significant, the coefficient esti-
mates on BVPS and AEPS in the price-based model, and the coefficient on AE/BV
in the V/BV model, are more palatable. Thus, one possible explanation for the higher
than expected coefficient estimates on the book value and abnormal earnings terms
in the original analyses is that they were acting to capture differences in the size of
these measures between the high and low CI sample firms.42
Citigroup and Port Jackson analysis of TEEI firms is that Port Jackson assumes zero cost pass-through
whereas Citigroup works on the assumption that all costs associated with non-trade exposed activities
will be passed on to customers. Thus, while all analyses, including ours, suggest that the proposed ETS
will have an adverse effect on market valuation, the documented magnitude of the impact differs
across studies based on the assumptions being made regarding the exact details of the ETS. In this
regard, our figures reflect the beliefs held by the market at the time of our valuation study, 2007.
41
As designed, following the matching procedures, there is no difference between the high and low CI
firms in terms of price (P) or V/BV, as appropriate. In fact, for the ‘price-matched’ sample, both the
mean and median values of P are now slightly larger for the high CI firms, and for the ‘V/BV-matched’
sample, the mean value of V/BV is slightly larger for the high CI firms, although the differences are
not statistically significant at conventional levels.
42
In fact, when the high and low CI firms are analysed separately, the coefficients on the book value and
abnormal earnings terms are more in line with expectations. For example, for the P20 scheme, the
coefficients on BVPS and AEPS in the price-based model (equation (4)) are 1.001 and 5.570,
respectively, for the high CI firms and 1.572 and 7.553, respectively, for low CI firms. These figures
28
© 2013 The Authors
Second and of more direct relevance to the current study, the coefficients on
EMIT remain negative and significant in both regressions. For the price-based model
(equation (3)), the coefficient on EMIT is now -0.406 (p = 0.043). For the V/BV-
based model (equation (4)), the coefficient on EMIT is now -0.280 (p = 0.067). Thus,
while these coefficient estimates are slightly smaller and their statistical significance
marginally weaker than those reported in Panel A of Table 5 based on the full
sample of 58 firms, the results continue to support H1.
In conjunction with this analysis, we also run both the price-based and the
V/BV-based models for partitioning scheme P20 with industry and firm fixed
effects. As revealed in Table 3, the industry sector composition of the high and low
CI samples are relatively distinct, with the high CI sample dominated by firms
from the Materials sector (GICS sector 15) and the low CI sample dominated by
firms from the Financials sector (GICS sector 40).43 The mean (median) price and
V/BV for the Materials sector are $13.99 ($7.19) and $4.70 ($3.06) while the analo-
gous values for the Financials sector are $19.79 ($9.00) and $6.41 ($4.45), respec-
tively. Thus, differences in P and V/BV between the high and low CI samples
appear at least partially related to their differing industry compositions. The
results, presented in the final two columns of Panel B of Table 5, again confirm an
inverse relation between market valuation and EMIT. For the price-based model,
the coefficient on EMIT is -0.436 (p = 0.059) while for the V/BV-based model the
coefficient on EMIT is -0.248 (p = 0.029). The significance of the coefficients on
the remaining variables in both models remain qualitatively similar, although as
with the matched-pair analysis, the coefficients on BVPS and AEPS in the price-
based model, and the coefficient on AE/BV in the V/BV model are again more
palatable than in the primary analyses.
Taken together, the results for the two alternative strategies designed to confront
concerns regarding differences in P and V/BV between the high and low CI samples
driving our primary results provide renewed confidence. We continue to find a
consistent and unambiguous inverse relationship between market valuation and
carbon intensity based on these two strategies, consistent with the results from our
primary analysis based on the full sample of 58 firms.
5 SUMMARY AND CONCLUSIONS
The objective of this study has been to empirically assess the impact of the proposed
carbon emissions trading scheme (ETS) within Australia on the market value of
affected firms. We hypothesize that affected firms will be assessed a market value
contrast with those reported in Panel A of Table 4 for the pooled sample, and also with the estimates
of 1.901 and 15.825, respectively, for the model without either EP or EMIT (a standard BVPS and
AEPS model) for the pooled sample.
43
While the frequency distribution presented in Table 3 is based on partitioning scheme P50, the
relative importance of these two sectors remains consistent across partitioning schemes including
P20.
29
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ABACUS
penalty, with more affected firms suffering a greater penalty. The findings from
institutional and applied research suggest that the penalty is likely to arise for
reasons relating to the existence of unbooked liabilities associated with future
compliance and/or abatement costs, or for reasons relating to reduced future earn-
ings. In this regard, the degree to which market valuation is affected during the
period prior to passage of the legislation will depend upon the probability with
which capital markets assess the imposition of an ETS and also its exact details.
Mitigating factors include policy outcomes as they relate to the details of the legis-
lation and its implementation, and the cost pass-through ability of the firm.
Based on a sample of 58 Australian listed firms from 2007 for which GHG
emissions data could be obtained, we find that the market appears to assess a market
value penalty for those firms classified as most highly at risk (those with the greatest
carbon intensity measures). Our GHG emissions data are drawn from two sources,
Citigroup (2008) and VicSuper (2007). The former makes primary GHG emissions
data publicly available while the latter simply identifies a set of firms which it
classifies as either high risk or low risk without providing emissions data. Given that
our analysis suffers the potential confound that our sample high carbon intensity
firms are smaller, less profitable, and more risky than their low carbon intensity
counterparts, we also conducted additional sensitivity analysis. These sensitivity
analyses indicate that results are robust to the challenges.
As argued at the outset, it is hoped that by rigorously documenting the assessed
market value penalty, this study provides insights into the capital market implica-
tions of the proposed ETS in Australia and potentially elsewhere.As carbon markets
expand, most likely in an exponential fashion, the results of this study become
increasingly relevant to a broad audience, namely all stakeholders that may be
affected by the new reform.
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ABACUS, Vol. 49, No. 1, 2013 doi: 10.1111/abac.12006

LARELLE CHAPPLE, PETER M. CLARKSON AND DANIEL L. GOLD

The Cost of Carbon: Capital Market Effects

In March 2008, the Australian Government announced its intention to

In March 2008, the Australian Federal Government announced its intention to

Finally, arguably the limited availability of corporate greenhouse gas (GHG)

1.2 The European Union Emissions Trading Scheme

1.3 Australian Policy

1.4 Proposed Australian Emissions Trading Scheme

1.5 The Proposed Legislation for the Emissions Trading Scheme

• in relation to emission intensive trade exposed activities—intended as an assis-

2 BACKGROUND LITERATURE AND HYPOTHESIS DEVELOPMENT

2.1 Industry Background

Continuing, industry reports investigating the potential financial impacts implied

2.2 Academic Literature

relation between market valuation and social performance, measured by a firm’s

2.3 Hypothesis Development

3.1 Sample Data and Carbon Intensity Measure

Total Australian GHG Emissions

DESCRIPTIVE STATISTICS FOR CARBON INTENSITY (CI) BY PARTITIONING SCHEME

Scheme Mean Median Std dev. Minimum Maximum

Overall Sample 357.852 119.021 500.560 1.265 1,860.720

CI is measured as tonnes of carbon (CO2) emissions per $1 million of sales revenue.

3.2 Event Study

1. 11 December 2006 Australian Government establishes a task group to

Here, events 1 to 4 represent events which likely increased the probability of an

revealed an in-principle acceptance of the basic notion of an Australian ETS by

rjt = α j + β j rmt + ∑ δ jk Dk + ε jt (2)

rpt = α p + β p rmt + ∑ δ pk Dk + ε jt (3)

3.3 Valuation Model Analysis

BV = book value of common equity;

AE = abnormal earnings to common defined as earnings to common equity less

EP = environmental performance (discussed in detail below); and

P = ϕ 0 + ϕ 1 BVPS + ϕ 2 AEPS + ϕ 3 EP + ϕ 4 EMIT + υ (5)

3.4 Descriptive Statistics

DESCRIPTIVE STATISTICS FOR A SAMPLE OF 58 AUSTRALIAN COMPANIES WITH

Variable Overall sample P50 Non-P50 p-value

Market capitalization (V)

Variable definitions: V is market capitalization; BV is book value of equity; E is earnings to common

FREQUENCY DISTRIBUTION BY GICS INDUSTRY SECTOR FOR A SAMPLE OF 58

Industry sector (GICS) Overall sample P50 Non-P50

4.1 Event Study Results

Coefficient Overall sample P20 Non-P20 p-value

a 0.001 0.001 0.001 0.862

The econometric model is: rpt = ap + bp rmt + Sk dpk Dk + e.

4.2 Valuation Model Results

VALUATION MODEL RESULTS FOR A SAMPLE OF 58 AUSTRALIAN COMPANIES WITH

Panel A: Primary valuation model results

Scaled by common shares Scaled by book value of equity

Variable Estimate Variable Estimate

Intercept 0.280 Intercept 2.336

Panel B: Sensitivity analyses

Variable Estimate Variable Estimate Var. Est. Var. Est.

Intercept 2.014 Intercept 2.145 Inter 4.844 Inter 3.586

The price based model is: P = d0 + d1 BVPS + d2 AEPS + d3 EP + d4 EMIT + u.

5 SUMMARY AND CONCLUSIONS

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