Every year the RSM Erasmus Platform for Sustainable Value Creation aims to publish a number of student master theses on its platform website. This year, my thesis was selected to be included in this publication. My master thesis study looks into whether the disclosure of science-based targets (SBTs) is incorporated into investment decisions. I tested this hypothesis by observing the effect of adoption, achievement and difficulty of SBTs on firm valuation by investors. You can read the thesis working paper here.
Adoption of targets
My first theory is that the adoption of science-based targets should reveal previously undisclosed information to investors, namely that (1) the firm has the ambition to become aligned with science-based decarbonisation pathways; and (2) the firm has the required resources and plans in place to achieve their targets. The second point is supported by the premise that the science-based targets initiative (SBTi) has a strict verification process to determine if the company is well-prepared for the targets it aims to set.
This disclosure of new information is expected to positively influence the valuation of the company by investors, thereby improving the firm’s market-based financial performance. Despite positive expectations, the study finds that firms which adopt science-based targets are not awarded a higher value from investors than their counterparts who choose not to adopt. An indication that the assumed reduction in information asymmetry is not impactful enough or, at least, not strongly perceived by investors.
Achievement of targets
Coming to the second hypothesis, I tested whether the achievement of targets, intermediate or otherwise, has an effect on firm valuation by investors. I compared the reported realised emission reduction to the required reduction needed to meet its long-term target. The difference between the two shows whether and by how much a company is on track to achieve their science-based target. Unfortunately, similar to the adoption of targets, the findings show that investors do not significantly consider a company’s actual emission reduction relative to their reported targets.
While the moment of adoption is a key point in the science-based target-setting process, specifically from an investor perspective, the crucial phase for the company setting the target is the period following their adoption when the targeted reduction should start to materialise. Companies with adopted targets typically report their carbon emissions in their annual sustainability and/or integrated reports. Using this information, investors can determine whether the company is on track to meet its science-based targets. According to the results from my second hypothesis, the information disclosed by companies on their decarbonization progress is not incorporated into investor valuations.
Difficulty of targets
A third, highly relevant, element to science-based targets is the difficulty of the target, the company’s ‘ambition level’. At first glance, an 80% reduction target would be more ambitious and noticeable than a 30% reduction, regardless of the factors that could explain the difference between the two (e.g., industry-specific technological hurdles).
To determine whether the difficulty of targets influences the investment decisions of investors, I tested its moderating effect within the relationship between target achievement and firm valuation. My results indicated that the achievement of relatively difficult targets was more likely to be considered by investors in terms of firm valuation.
When this research was conducted, no corporate science-based targets had reached their maturity date. I expect this to impact the study’s findings, and it means that different results could be observed when more data becomes available. In addition, there are several limitations to this study, including limitations to the research design and type of analysis. In particular, studying the direct effect of adoption and achievement on firm valuation can be viewed as overly simplistic.
Considering these factors, my goal in this research has not been to find a definitive answer to the research question. Instead, this study’s purpose is to act as an initial exploration of an area of research that could shed light on factors which influence our progress towards the goals of the Paris Agreement. The findings from subsequent studies focusing on this topic will hopefully bring about practical recommendations for investors, companies and policymakers.
Despite the initial hope that the adoption of such targets would provide investors with valuable insights into a company's commitment and preparedness, my research reveals that this information alone may not significantly sway investor decisions. However, the study does underscore the role investors play in shaping the trajectory of sustainable practices.
Investors have the power to incentivise and drive change within companies by emphasising not only the adoption of targets but also the achievement of these targets, particularly the challenging ones. By holding companies accountable for their environmental commitments, investors can contribute substantially to global decarbonisation efforts. Furthermore, the long-term perspective of investment in decarbonisation aligns with the broader goal of building organisational resilience against future challenges, such as carbon taxation, while safeguarding the future of our planet. In this way, investors can play a pivotal role in addressing climate change and promoting a sustainable future for all.