The Value Relevance of a Firm's Carbon Risk Profile

The aim of this paper is to provide insights into the capital market's role in incentivizing firms to engage meaningfully in the transition to a net zero carbon emissions economy. We investigate whether capital markets negatively value a broader concept of carbon risk exposure in addition to its historic carbon footprint and offset assessed penalties by considering carbon mitigation activities undertaken by the firm. We develop a conceptual framework of a firm's ‘carbon risk profile’ from the literature comprising: (a) carbon risk exposure (current emissions and broader risk notions of fossil fuel dependency and carbon visibility); and (b) carbon mitigation activities (realized emissions reductions and anticipatory proactive activities). We confirm and operationalize this framework using interviews with managers and environmental, social, and governance analysts. Based on a sample of 310 firm‐year observations for ASX200 firms from 2014–2020 in high‐carbon sectors, our results suggest material valuation penalties for the broader carbon risk exposure concept. Further, we find that capital markets attach value to a firm's intangible capability to proactively mitigate its carbon risk exposure. Building on these results, to further mobilize capital markets in the push towards net zero emissions, policymakers and regulators may wish to undertake initiatives to increase carbon‐related disclosures on both risks and mitigation activities.