To tackle the challenges of climate change, more investment needs to be mobilised in low-carbon technologies and capital assets. But what implications are there for firms as they diversify into the green marketplace?

This report examines whether environmental policy and economic performance are complementary or contradictory, how environmental innovation affects the bottom line and how financial markets respond to more stringent environmental regulations. It also provides important insights into the potential role of climate policy within COVID-19 stimulus packages, linking COVID crisis economic support for firms to policies ensuring a green recovery.

Main messages

  • Firms that diversify into the green market space have higher profit margins than other firms, but not higher profitability as measured using accounting rate of return.
  • Firms producing green goods and services tend to have lower asset turnover than other firms, perhaps reflecting both more recent capital investments and higher investment costs. The lower operating efficiency of assets explains why higher profit margins do not translate into higher profitability (return on investments).
  • A notable exception is the energy sector, which has been the focus of climate policy over the past few decades. For this sector we find evidence that firms with higher green revenues on average have higher profitability, and that this is also associated with better stock market performance.
  • The experience in the energy sector highlights the importance of comprehensive policy frameworks that target the decarbonisation of key emissions-intensive sectors, in addition to a strong carbon price signal in the economy, for triggering shifts in technology and investment towards carbon neutrality.
  • Financial markets responded positively to the signing of the Paris Agreement, suggesting that strengthening climate policy signals and reducing regulatory uncertainty can help to open up and drive investments into new markets for green goods and services.
  • However, the Paris Agreement has not triggered investors to divest substantially from fossil fuel firms and therefore additional policies are likely needed to establish clear incentives for decarbonisation.

Recommendations for governments to help firms transition towards carbon neutrality

  • Policies that help create clearly distinguished green goods and production processes may further encourage the shift into green markets.
  • Supporting financing costs for green investments and encouraging investment in new technologies along the supply chain will likely play an important role in ensuring ‘going green’ is economically viable.
  • Learning from the energy sector experience, comprehensive policy packages should be implemented that target the decarbonisation of key sectors in order to trigger shifts in technologies and investments towards carbon neutrality in hard-to-decarbonise industries.

Background research papers

The report draws on two complementary studies, both recently published as working papers by the Grantham Research Institute:

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