Introduction

The study explores how industrial pollution affects asset pricing, focusing on whether firms with higher toxic emissions earn higher returns. It introduces the concept of a “pollution premium”, where investors require compensation for exposure to environmental policy uncertainty and pollution-related risks. Using U.S. data between 1991 and 2016, the research analyses emissions of over 3,000 publicly listed firms regulated under the Toxics Release Inventory (TRI) program.

Background And Motivation

The report highlights growing investor and regulatory focus on environmental risks, particularly as pollution and carbon emissions face increasing scrutiny. Traditional asset pricing models have largely excluded environmental externalities, overlooking how pollution may influence expected returns. The research posits that firms with greater pollution exposure face higher uncertainty regarding future environmental regulation, clean-up costs, and potential litigation, warranting a risk premium in the form of higher returns.

Data And Variable Construction

The dataset combines TRI records with firm-level financial data from Compustat and stock return data from CRSP. Pollution intensity is measured as toxic emissions scaled by total assets. Firms are grouped into portfolios based on their emission levels. Additional variables capture firm size, book-to-market ratio, leverage, and other financial characteristics. The study controls for standard risk factors, including market, size, value, momentum, and profitability.

Empirical Results

Results show a robust and statistically significant pollution premium. Firms with high emission intensity earn approximately 4.4% higher annual risk-adjusted returns compared to low-emission firms. This effect persists after controlling for traditional asset pricing factors, including the Fama-French five-factor model. The premium is strongest among firms in pollution-intensive industries such as chemicals, metals, and energy.

Environmental Policy Uncertainty

The analysis introduces a novel Environmental Policy Uncertainty (EPU) index to capture shifts in regulatory risk. Firms more sensitive to EPU shocks experience higher expected returns, suggesting that pollution-related risks represent a priced factor in capital markets. In periods of heightened regulatory uncertainty, high-emission firms earn even larger premiums, consistent with investors demanding compensation for potential environmental policy tightening.

Robustness Tests

The study’s findings remain consistent across multiple tests. Results hold when controlling for carbon emissions, excluding outliers, and using alternative pollution intensity measures. Portfolios sorted by emissions within industries also confirm the premium is not solely sector-driven. The analysis further rules out explanations based on liquidity, size, or financial distress.

Implications And Discussion

The findings imply that markets rationally price pollution risk, with investors demanding higher returns from firms exposed to potential environmental liabilities. The existence of a pollution premium challenges the notion that markets ignore environmental externalities. It also indicates that firms face an implicit cost of capital penalty tied to their pollution profile.

For policymakers, the study suggests that stronger or more predictable environmental regulation could reduce this risk premium by lowering uncertainty. For investors, it highlights that excluding high-pollution firms from portfolios may lead to slightly lower returns, reflecting the risk premium foregone. However, integrating pollution metrics into risk assessment frameworks could improve long-term portfolio resilience and alignment with sustainability objectives.

Conclusion

The report concludes that industrial pollution is a systematic risk factor in financial markets. Firms with higher emissions yield higher expected returns, compensating investors for exposure to environmental policy uncertainty. The results bridge environmental economics and asset pricing, underscoring that pollution is not only a social or ecological concern but also a financially material risk.