High Carbon Emissions: Increased Costs, Lower Investor Confidence, Financial Instability

A landmark international study has uncovered a compelling connection between carbon emissions and financial instability among companies. Spanning 63 countries and nearly 20 years (2003–2021), the research reveals that businesses in high-emission sectors like manufacturing, transport, and energy are financially vulnerable due to their environmental impact.

A Shift in Focus: From Banks to Real-Economy Firms

While earlier research primarily investigated climate risks in the financial sector, this study is the first to assess how such risks directly threaten the financial soundness of non-financial firms. By examining a broad dataset across different regions and economic contexts, the findings provide new clarity on how climate exposure translates into corporate financial fragility.

Emissions as a Financial Burden

The study establishes that firms with higher levels of carbon emissions face greater financial instability. These companies often grapple with rising costs, tighter regulatory scrutiny, reputational harm, and erratic profits—all of which undermine their financial resilience. Whether emissions come directly from operations, energy consumption, or other pollutants, the economic toll is clear and consistent.

“The cost of inaction is now quantifiable,” said Dr Freeman Owusu, of Loughborough Business School. “Companies that continue to emit high levels of carbon are not only harming the environment – they are risking their own survival.”

The Risk Is Global and Deeply Systemic

Carbon risk is not just a local or industry-specific issue, it is a global and systemic financial threat. The study found that the impact is most severe for companies located in countries with high per capita emissions, weak governance, and poor environmental oversight. Additionally, firms with limited capacity for innovation or low investment in research and development are particularly susceptible. The challenges are even more pronounced in developing and emerging economies.

High Emissions Undermine Financial Health

Companies with heavy carbon footprints often experience greater earnings volatility and weaker financial indicators, including lower Z-scores, a widely used measure of a firm’s stability. This volatility erodes investor confidence, making it harder for such firms to access capital and plan for long-term growth in an increasingly climate-conscious economy.

What Helps Firms Mitigate Carbon Risk?

Some companies are better equipped to manage carbon-related financial threats. The study highlights that strong governance structures, environmental innovation, and sound financial buffers can soften the blow, particularly when it comes to direct (Scope 1) emissions. These internal strengths can help stabilize firms and maintain investor trust even under environmental pressure.

The Challenge of Indirect Emissions

While direct emissions are somewhat controllable, indirect emissions—from purchased electricity (Scope 2) and supply chains (Scope 3), pose a greater challenge. These are harder to monitor and manage, largely because they depend on third-party behaviour and suffer from poor data transparency. As a result, they represent a persistent risk that firms often struggle to mitigate.

Dr Owusu said: “The findings send a clear message to corporate leaders, investors and regulators – that carbon risk is not just an environmental issue, it’s a core financial one.”

“From rising compliance costs and regulatory risks to reputational damage and investor distrust, carbon emissions are no longer just an environmental issue – they are a serious business risk. Firms must act now to reduce their carbon footprint, invest in environmental innovation, and strengthen internal governance. The most resilient companies will be those that treat sustainability as a strategic priority, not a side issue. In a world shaped by climate change, long-term profitability depends on taking responsibility for emissions today.”

Policy and Reform: What Needs to Change?

To build corporate and systemic resilience, the study urges stronger regulatory enforcement, improved emissions disclosure, support for clean technology innovation, and institutional reforms—especially in developing countries. These steps are crucial to align corporate financial stability with environmental responsibility.

A Methodologically Rigorous Analysis

The study’s conclusions are grounded in solid empirical evidence, using advanced econometric techniques such as Two-Stage Least Squares (2SLS), Propensity Score Matching, Entropy Balancing, and System GMM. This robust approach ensures the findings are statistically reliable and not driven by bias or noise in the data.

A Critical Step Toward Sustainable Finance

This research makes a meaningful contribution to the growing field of sustainable finance. It offers clear, evidence-based insights for businesses, investors, and policymakers seeking to navigate the intersection of environmental accountability and economic performance. As climate challenges intensify, aligning corporate strategy with sustainability goals is not just ethical—it’s essential for financial survival.