Impacts of Climate Litigation on Firm Value

Climate change litigation is “on the rise and here to stay”, yet little is known about the financial risk this poses, say researchers for the Grantham Institute at the London School of Economics. This paper demonstrates that financial regulators must do more to incorporate climate litigation risk into risk frameworks.

The results uncover a causal link between climate litigation and stock prices, and finds that an unfavourable legal verdict reduces the value of large carbon-intensive firms by an average 1.5%.

The authors – Misato Sato, Glen Gostlow, Catherine Higham, Joana Setzer and Frank Venmans – outline the “unstoppable rise” of climate litigation. The authors highlight an uptick in momentum since 2019 as an increasing number of decisions have been passed which can be understood as negative for the defending firm. Claimants include individuals, environmental organisations, local and state governments, businesses and young people’s movements. The authors argue that as climate research improves so too does the likelihood of successful climate litigation.

The study shows that investors’ awareness of climate litigation risk is rising. Climate litigation has repercussions for firms, including both direct costs, such as insurance premiums, credit ratings, payouts, rising costs of capital, and reputational costs, which affect both staff and public perception of a company.

The study quantifies the financial system’s response and the results reveal that capital markets are responding to such litigation. It covers 108 cases filed against publicly listed companies in Europe and the US and uses event study regressions to conduct a value-weighted, multi-event study. The results estimate an aggregate market-wide effect of litigation on firm value by considering abnormal returns following case filings and verdicts.

The most pronounced stock market responses were found in response to cases against the largest emitters, so-called “carbon majors”, reducing firm value by an average of -0.57% following case filings and -1.5% following unfavourable judgements. Overall, case filings or an unfavourable court decision were found to reduce average firm value by -0.41%

The study also finds that the average costs of a negative climate decision (US$360mn) “far exceed” those of defending a typical major litigation case (US$3mn). This suggests investors will increasingly price in “expectations of lower future cash flows and reputational risk” for high-emitting firms. The authors say these figures should be interpreted with caution, as they are influenced by costs borne by the largest companies and outliers may skew the results.

Particularly pronounced effects emerged in novel cases, such as those concerned with new legal arguments, new jurisdictions or new industries, as these attract greater attention from the media and by extension the markets.

Finally, the authors note that the impact on firm value is likely to be underestimated due to the parameters of the study. For instance, the use of a short event window of three days to assess the impact of cases on firm value, as well as the lack of consideration for indirect effects.