Climate Risk and American Depositary Receipts
Climate Risk and American Depositary Receipts
Introduction
Climate change has become a key driver of corporate behavior and investor decisions amid the global shift toward a green economy. American Depositary Receipts (ADRs), which represent shares of foreign companies traded on U.S. exchanges, offer exposure to international markets where firms operate under diverse regulatory and environmental, social, and governance (ESG) frameworks. These differences could make ADRs particularly appealing to climate-conscious investors. Compared to U.S. domestic stocks, ADRs may also offer access to industries with different climate risk profiles, enhancing their role in sustainable investment strategies.
Investors increasingly incorporate climate risk and sustainability into their financial decisions, recognizing the value of environmentally responsible assets. Research shows that climate awareness among fund managers boosts support for green initiatives (Di Giuli et al., 2022), and firms adopt eco-friendly technologies to align with CSR goals (Sadiq et al., 2024). Climate risk also shapes corporate strategies — firms facing higher climate risk tend to adopt less conservative accounting practices (Li et al., 2024), disclosures more to attract green investment (Feng and Huang, 2024), and engage in CSR activities to mitigate negative performance impacts (Ozkan et al., 2023). To hedge climate risk, firms use strategies such as incorporating climate news (Engle et al., 2020), constructing and optimizing decarbonized index (Andersson et al., 2016), and aligning portfolios with carbon budgets targeting a 1.5°C limit (Bolton et al., 2022).
Previous studies also shed light on the evolving relation between environmental risks and asset pricing. Some paper investigates carbon risk in financial markets, specifically how carbon emission risk is priced in equity or options markets, either as a characteristic of the firm or as a risk factor (e.g., Bolton and Kacperczyk, 2021, Ilhan et al., 2021). Some other papers explore the asset pricing implications of extreme weather events, such as hurricanes (e.g., Hong et al., 2019; Addoum Ng and Ortiz-Bobea, 2020). Sautner et al. (2023b) assess pricing of firm-level climate change exposure for S&P 500 stocks and discover a positive and significant ex ante risk premium using forward-looking option-implied information.
The effect of climate risk on ADRs is still not clear in the literature. Chowdhury et al. (2021) discover that ADRs listed on U.S. markets achieve a higher CSR disclosure compared to U.S. domestic firms and thus these foreign stocks exhibit a higher liquidity and lower idiosyncratic volatility. Boubakri et al. (2016) find that firms cross-listed on U.S. market exhibit higher CSR performance compared to their non-cross-listed peers. Antoniuk and Leirvik (2024) find that events related to climate change policy have significantly impacted returns. Ramelli et al. (2021) study the impacts of Trump’s 2016 election on the market reaction to carbon-intensive firms and find that companies with responsible strategies on climate change are rewarded.
Despite growing interest in socially responsible investing, the impact of climate risk on ADRs remains underexplored. This study is the first, to our knowledge, to directly examine this relation. We address two critical questions: (1) how climate risk affects the performance of ADR firms and (2) how this impact differs from that on U.S. domestic firms. Our findings reveal a significant and positive and consistent relation between climate change exposure and excess returns for ADRs, suggesting a realized risk premium for firms with greater climate-related risks. This finding remains robust across various tests, including the exclusion of zero-exposure observations and economic crisis periods. In contrast, U.S. domestic firms do not exhibit a similar premium, highlighting the greater relevance of climate risk in international investment decisions.
Our research contributes valuable evidence to the climate finance literature by examining the underexplored ADR market, building on prior works by Antoniuk and Leirvik (2024) and Ramelli et al. (2021). We provide empirical evidence on how climate risk affects ADRs, addressing gaps in both climate finance and ADR research, including those noted by Huo et al. (2018) and Chowdhury et al. (2021). Our findings offer valuable insights for investors, policymakers, and corporate managers, aiding informed investment decisions, sustainability assessments, and regulatory evaluations, as well as portfolio diversification strategies.
The paper is organized as follows. Section 2 describes data, and Section 3 presents methodology used in this paper. Section 4 summarizes t
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