Biodiversity Loss and its Consequences

Biodiversity, the variety of living organisms in all habitats, is deteriorating at an unprecedented and alarming rate. Biodiversity collapse jeopardizes the goods and services humans obtain from all ecosystems, with potentially far-reaching economic implications. Given the potentially dramatic financial consequences of the loss of biodiversity, firms, investors, and financial market regulators are increasingly paying attention to the topic. For example, the Taskforce on Nature-related Financial Disclosures (TNFD), modeled after the Taskforce on Climate-related Financial Disclosures (TCFD), was launched in 2021 and released its final disclosure recommendations in September 2023. Also in September 2023, the Network for Greening the Financial System released a framework to help central banks and supervisors identify and assess nature-related transition and physical risks.

However, the link between biodiversity and finance has received little attention by academics. In our paper, we take a step toward filling this gap by introducing to the finance literature a science-based measure, the corporate biodiversity footprint (CBF), and exploring whether investors price this footprint.

Measuring Biodiversity Impact

Developed by Iceberg Data Lab (IDL), the CBF aggregates the biodiversity loss caused by a firm’s annual activities related to land use, greenhouse gas (GHG) emissions, water pollution, and air pollution. To quantify this loss, the CBF, builds on the concept of Mean Species Abundance (MSA), which measures the relative abundance of native species in ecosystems, compared to their abundance in undisturbed ecosystems. The CBF quantifies not only the direct impact of a firm, but also the biodiversity loss along the entire value chain. Thus, the CBF contains scope 1, 2, and 3 components, whereby scope 1 measures the biodiversity impact of the firm’s direct activities, such as the area artificialized or occupied due to its business activity; scope 2 measures the biodiversity impact induced by the purchase of electricity, heat, and cooling; and scope 3 measures all indirect biodiversity impacts (i.e., products sold or purchased, or investments made).

The sample in our paper consists of 2,106 listed firms from 34 countries for which CBF data are available from IDL over the years 2018-2021. While the sample period includes only a few years, the most important global policy developments concerning biodiversity are also quite recent. Retail & Wholesale, Paper & Forest, and Food are the sectors with the largest average CBF, reflecting these sectors’ intensive land use or contribution to air pollution. While there is a sizeable industry component to the CBF, there is large heterogeneity within each industry.

Corporate Biodiversity Footprint and Stock Returns

How can a firm’s CBF be expected to correlate with its stock returns? A first possibility is that large-CBF stocks will earn higher returns, as these firms potentially face higher transition risks. These transition risks may result from legal fines or the costs of compliance with an increasingly demanding regulatory environment regarding biodiversity preservation. Uncertainty associated with future regulation or litigation may lead investors to require a risk premium for holding large-CBF stocks. A second possibility is that large-CBF stocks will earn higher returns due to mispricing, which may originate from unexpected cash flow shocks. A biodiversity impact is an externality, and some firms may, therefore, not invest in mitigating or reducing their biodiversity impacts. As a result, they may enjoy unexpectedly higher earnings and returns. A third possibility is that large-CBF stocks will earn lower returns. Evidence shows that brown (green) stocks had lower (higher) returns, due to unexpected shifts in investor preferences for green stocks and as climate attention or concerns increased. If growing concerns about biodiversity loss gradually shift investor preferences, then large-CBF stocks will see lower returns. These channels compete against the null hypothesis that the CBF is unrelated to returns.

Main Results: Biodiversity Footprint Premium

We examine the pricing of the corporate biodiversity footprint by regressing firms’ monthly stock returns on their one-year lagged CBF values. On average, we find no evidence that the CBF is related to returns between 2019 and 2022. However, we do find a relationship between the CBF and returns following major biodiversity-related policy changes, signifying that the biodiversity footprint had then started to be priced. In October 2021, the first part of the UN Biodiversity Conference (COP15) concluded with the Kunming Declaration, a global agreement signed by more than 100 countries. Similar to the Paris Agreement, the Kunming Declaration calls for countries to act urgently to protect biodiversity by aligning financial flows to support its conservation and sustainable use. The event arguably increased both investor awareness about the loss of biodiversity and the prospect of, and uncertainty about, future biodiversity regulation or litigation. Between the Kunming Declaration and December 2022, a one-standard deviation higher log(CBF) value is associated with monthly returns that are 18.5 basis points higher (or 2.2% annualized).

Event Study Evidence: Kunming Declaration and TNFD Launch

We conduct an event study to examine closely whether and how investors revised their valuations of large-CBF stocks around the Kunming Declaration. If the declaration raised investor awareness of biodiversity issues and the prospect of regulation aimed at preserving it, we would expect investors to revise downward their valuation of large-CBF stocks. Indeed, in the three days following the declaration, relative to the three days before, large-CBF stocks experienced a cumulative stock price decline of 1.14%, relative to small-CBF stocks.

The signing of the Kunming Declaration is a salient event, but this does not preclude the possibility that other events had similar effects. In fact, the launch of the TNFD on June 4, 2021, was another salient event that contributed to raising awareness of biodiversity issues and the associated transition risks (though the TNFD is primarily concerned with disclosure, it increases the odds of a firm being targeted by litigation based on its disclosed information). In the three days following the TNFD launch, relative to the three days before, investors reduced their valuation of large-CBF stocks by 1.5%, relative to small-CBF stocks.

Conclusions

Our evidence suggests that investors have started to anticipate that new regulations or litigation will target large-CBF firms. The results of our event studies indicate that around relevant events (Kunming, TNFD), the stock prices of such firms were bid down; higher returns of large-CBF firms followed. Thus, the increase in policy uncertainty associated with these events leads to investors demanding a biodiversity footprint premium. To corroborate this interpretation, we demonstrate that the biodiversity footprint premium is larger in countries with low biodiversity protection; firms in such countries face greater transition risks, due to the prospect of future “catch-up” regulations.

Overall, our results indicate that investors have started to ask for a risk premium in light of the uncertainty associated with future biodiversity regulation.