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By Devesh Kumar, CFA :

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By Devesh Kumar, CFA, Carlos Juarez, and Ronald Ying, P.E.

Research suggests that from a portfolio and stock selection perspective, investors with a focus on environment, social, and governance (( ESG )) investing and the food sector should target mega-cap stocks over large-cap stocks for protection against negative ESG news. In the short term, investors should not be distracted by negative ESG news in food stocks as the market does not seem to react to it negatively.


Does the Stock Market Care About Climate Change and Environment Risk?

The goal of this research was to determine a financial/investment approach to defining environmental risk. There have been various techniques used to analyze investments in climate-aware assets, including sorting companies by their carbon footprint or by their standings in widely accepted ESG rankings. Environmental risk is defined by a myriad of issues to which public companies contribute. In particular, climate change and the actions that lead to climate change come to the forefront of considerations for all companies. The production and emission of greenhouse gasses (GHGs) and actions such as deforestation can be directly connected to various companies. When investing in companies, investors should be aware of these factors and how their investment might be affected.

Our approach to this research was to determine the impact of events and news related to a company's connection to climate change, and examine the impact on financial returns in order to determine the costs of investing in these assets.


How to Quantify Environmental Risk in Stock Market?

Residual Return Model: In order to analyze the effects of climate change risk and environmental risk, our study relied on event studies that were shown to have delivered abnormal or residual returns. Our event studies derived the cumulative abnormal returns (( CAR )) related to our collected events using the Fama-French three-factor pricing model ("Fama-French"). Fama-French is given by the following equation...

...where r is the adjusted return for the stock; MRP represents the market risk premium from the capital asset pricing model ((CAPM)); SMB (Small Minus Big) represents the factor that adjusts for the variable size of the company; and HML (High Minus Low) is the factor that adjusts for the premium of the growth stock against the value of stock. The term α is the abnormal or residual return that becomes larger if certain events have enough of an impact that they are not able to be filtered out by the first three factors. In other words, a positive or negative α indicates that the events are deemed unexpected. The goal of this event study was to test out various scenarios that represent the impact of environmental risk and to use Fama-French's residual return over an average time frame in order to find the CARs.

Events: The time frame for the events we collected was 2007-2017. The study included events that related to potential environmental risks in general and to events related to potential environmental risks specific to each of the companies selected. We also filtered the events further by focusing on one industry group: the food industry. We collected over 310 events and news (Excel file) related to climate change and environmental risk that were specific to the top 14 companies in the food industry listed on the S&P 500. For a full list of our companies, see Appendix A.

WRDS: We leveraged the Wharton Research Data Service ((WRDS)) in order to analyze the various events and news and see if there was a residual return based on these events. The residual returns, measured by the cumulative abnormal returns derived on the WRDS platform, applied Fama-French. Each event was analyzed 10 days before and after for evaluation. The results then were averaged out for the certain number of events, which produced the CARs. In the analysis section below, a summary of the findings is presented for each event study with recommendation for further research.

The Food Industry

The Direct Impact of Environmental Risk

The food industry is a sector in which climate change creates a prominent risk in each company's supply chains. A company in the food industry relies heavily on agriculture , namely crops, livestock and land, in order to produce their products. In recent times, environmentally conscious investors seem to be heavily concerned with the food industry due to its short-term as well as long-term impact. On the one hand, the industry impacts natural resources for the future depending on the process of production of food; on the other, it impacts the short-term profitability of the company and also the health and lives of current population. For example, when a drought in the U.S. Midwest hit grain production, the earnings of Archer-Daniels-Midland ( ADM ), a U.S. processor of crops, took a hit, even months after the drought broke: Its second-quarter earnings falling by 21% in 2013 due to lower grain-handling profits (See here , here and here ). Below is the general supply chain of our companies. See Appendix B for each web page of our selected company's descriptions about their supply chains.

Exhibit 1: Example of Food Industry Company Supply Chain

This upstream portion of the supply chain is threatened by the negative effects of climate change. For these reasons, we decided to analyze the financial returns correlated to events relating to climate change, GHG emissions, deforestation, etc. of companies in the food industry.

Hypothesis and Data sets

Mega- and Large-Cap Food Stocks

For the purpose of this research, we selected the largest food companies by market cap in the US for the period 2007-2017. Our hypothesis was that the CARs of our selected basket of food industry stocks would be negatively affected by unexpected negative news and events in which a company's contribution to climate change was clearly evident and, conversely, positively affected by positive news and events. We defined contribution to climate change to include a company's direct contribution to actions such as deforestation and the emission of higher GHGs. In total, we identified a total of 310 news/events. Almost all of these (300) were regulatory or compliance or company-specific sustainability news, with the remaining 10 industry-wide physical news.

We also identified two types of news and events: (a) corporate governance, policy and regulatory events, and (b) physical events, as described below.

Corporate Governance, Policy and Regulatory Events: We expected changes in climate-related regulation will impact the share prices for the selected basket of stocks. Positive news, such as a company initiating a carbon-sequestration project, should have a positive effect on the select basket of stocks because projects that reduce greenhouse-gas concentration in the atmosphere would help ensure the agricultural sustainability, and crop sourcing would not be disrupted in the medium and long term. Negative news, such as Trump withdrawing the U.S. from the Paris Accord, is expected to have a negative effect on valuation because the long-term consequence of climate change would have an adverse impact on the viability of the food producers in general.

The majority of the news we found (190 out of 300 events) were items that an ESG-focused investor would have considered positive. Positive regulatory or compliance-related news were the most common, in part because companies are incentivized to broadcast the positive news to boost their public images. Our hypothesis would also suggest that this type of positive news would be common, as companies would endeavor to undertake climate-change-averse programs, as it affects their supply chain. The second-biggest type of news found was negative regulatory or compliance-related news (110 out of 300 events). The negative news is usually the consequence of bad operational practices, such as fines or reputational damages.

Physical Events: Physical Events include known natural disasters that hit the United States. One challenge of this specific event study was to pinpoint the exact date for the event of natural disaster. For example, a drought in California happened from 2013 to 2015. The date identified as the most extreme point of the drought occurred in January 2014. Hurricanes, on the other hand, are events that are well recorded by weather-data-collecting agencies. During this study, we reviewed and analyzed a total of nine physical events.

Analysis: Palm Oil

The Burning Issue For More Than A Decade

Background and Hypothesis: An example of the various climate-change-related events and news that we tested was news relating to palm oil. Several of the companies we studied are linked to the sourcing of palm oil for the purposes of producing their products. Palm oil sourcing has become a heated topic, as its sourcing leads to deforestation, which is a major contributor to climate change .

We analyzed the CAR of companies that were mentioned in various stories related to the negative effects of palm oil sourcing, announcements from these companies related to their plans to fight "dirty" sourcing of palm oil, and other related news. We theorized that news related to palm oil, and by extension to deforestation, would be unexpected, as investors might underestimate this type of news as irrelevant to their earnings.

Findings: The WRDS event study on palm oil yielded the graph labeled Exhibit 2.

Exhibit 2: CAR for Palm Oil Event Study

Source: Wharton Research Data Service

Our basket of the largest 14 stocks had a number of events related to palm oil. We studied 25 of those events and news items. In this case, we saw a positive return. The event study reported a positive CAR of approximately 2% on average 10 days after the first trading date. Generally, the 25 news items were negative regarding the palm oil problem; however, they depicted our companies in a positive light. The uptrend in CAR can be explained by the unexpected nature of the impact of palm oil on the food industry. In analyzing the 10-Ks of the various companies, the reports include content in which the companies indicate that they disclose the sourcing and use of palm oil. The companies also disclose the knowledge of the adverse effects of climate change on a company's reputation, earnings, etc. See, for example, excerpts from Mondelez's ( MDLZ ) 10-K:

Exhibit 3: Excerpts from Mondelez International's Form 10-K

Our analysis of the 10-Ks suggests that investors are less concerned about the long-term implications of sourcing palm oil and more concerned about the short-term returns that occur from having a consistent and non-volatile sourcing of palm oil. Therefore, the various events and news that we used to calculate the CAR are deemed unexpected.

Analysis: Hurricanes

A Recurring and Critical Supply Chain Factor

Background and Hypothesis: According to NOAA, sea-surface temperature and the strength of the hurricane are statically correlated. By the end of the 21st century, the increase in sea-surface temperature would imply a 300% increase in the power intensity of hurricanes, which would translate into an increase in the intensity and frequency of hurricanes . We have studied all hurricanes (Appendix A) that have made landfall in the US for the past 10 years in order to assess the valuation effect on the food industry due to severe weather events. In the past decade, 12 hurricanes made landfall in the US. Four hurricanes made landfall in 2017, three of them Category 4 hurricanes. The increase in intensity and frequency is apparent based on the most recent 2017 data. We expect more severe hurricanes with heavier rainfall moving forward. We hypothesize that the hurricane will unexpectedly disrupt the supply chain for our basket of large-scale food producers within the US and that the stock price of the selected basket may be negatively affected by the events.

Findings: The WRDS event study yielded the graph labeled Exhibit 4.

Exhibit 4: CAR for Hurricane Event Study

Source: Wharton Research Data Service

The basket of 14 stocks with 12 hurricane landfall events yielded a sample size of 168. 121 of the 168 events are analyzed in this event study because some events in 2017 hurricane season are excluded from this study by the WRDS due to insufficient data.

Contrary to our hypothesis of negative return, the event study reported a positive CAR of 1.36% at the first trading date at or after a hurricane landfall. A positive uptrend in CAR is observed leading up to the landfall and a downtrend shortly after. We hypothesize that the uptrend can be explained due to the unexpected nature of the hurricane. The downtrend of the CAR signals that the returns of the food producers can be explained by market force after the landfall. The event studies concluded that the investors are not concerned about the supply chain disruption during a major hurricane event.

Further research: Further event studies can be conducted in the future to test if the CAR found in this study is related to the fear about food shortage. If food storage is anticipated, other retailers should expect a higher return when food supply decreases while demand increases. Future event studies should include other players in the food distribution industry, such as Sysco ( SYY ), food retailers such as Kroger ( KR ), and wholesale clubs such as Costco ( COST ), to test if fear of food shortage is a factor in the CAR.

Analysis: Positive Vs. Negative News and Company Size

Does the Market Even Differentiate?

Background and Hypothesis. In the first part of this hypothesis, we expected the market to reward all stocks in our data set for positive news and to penalize them for negative news. This should hold true if we expect the market to be conscious of environment-related factors and the relative cost of these events on society and their investments.

In the second part, we expected market to react similarly to the companies of all sizes in our data sets, i.e., the news type (positive/negative) will lead to respective price movement (increase/decrease) for all companies, whether they are small or large.

Findings: For the first part, we found that for all positive news, the market provided quite insignificant but nevertheless positive price movement. Even though the size of the return was small, the direction of it was the complete opposite of that for negative return.

Exhibit 5: CAR for Positive News/Events in Food Industry

Source: Wharton Research Data Service

Exhibit 6: CAR for Negative News/Events in Food Industry

Source: Wharton Research Data Service

That exact opposite reaction - i.e., the increase and decrease in return to positive and negative news, respectively, for 157 and 95 non-missing return events - signifies that even though the impact of such news may be only a few basis points for a basket of 14 stocks in one particular industry, it could be significant for a larger portfolio. At the very least, investors appear to follow such news, albeit at a very small value scale (in our research), as per the sentiment of the news.

The more interesting insights were found when we divided the set of 14 companies into two subsets - the top seven and the bottom seven. Respectively, these were the top seven companies by market cap in the sector (average of $34 billion) and the next seven by market cap (average of $13 billion). The reaction for each type of news (positive or negative) was larger in smaller companies than in larger companies.

Exhibit 7: CAR for Positive News/Events in Food Industry - Top 7 in the Basket

Source: Wharton Research Data Service

While the CAR for the top seven companies was more or less around 0%, the same for bottom seven companies was around 1.5%, with the upper-range confidence interval going as high as 3%. Such a gap could have been attributed to randomness, but similar pattern was also observed for negative news, also on a larger scale.

Exhibit 8: CAR for Positive News/Events in Food Industry - Bottom 7 in Basket

Source: Wharton Research Data Service

With regard to negative news, while the top seven companies had a CAR around 0% in general with +1% confidence interval, for the bottom seven, the return went as low as -2.5% 10 days after the news event, with the lower range of confidence interval going up to -5% at the end of that period. The gap in returns for negative news between top and bottom companies is much wider than that for positive companies.

Exhibit 9: CAR for Negative News/Events in Food Industry - Top 7 in the Basket

Exhibit 10: CAR for Negative News/Events in Food Industry - Bottom 7 in Basket

One of the reasons for this could be that investors tend to punish larger corporations relatively less for negative news due to a higher level of trust in them, or because of extensive public relations activities conducted by the larger companies. There could be other reasons as well, such as larger companies tending to be good at resolving such negative news more quickly as compared with smaller companies.


The Market Cares About the Environment, but Investors Should Focus on Mega-Cap Stocks

In summary, we have found strong results with regard to the impact of unexpected ESG events or news on the stock performance of major companies in the food industry. Firstly, investors in general do identify and separate environment-related positive news from negative news and seem to give a similar push in respective direction, even if it's marginal on a macro scale. Secondly, investors are giving positive indications for palm-oil-related news. Perhaps this is because they are seeking more stability about the issue rather than necessarily taking an environmentally conscious approach to it - though having an environmentally positive resolution seems to be perceived better than the inverse is. Thirdly, investors seem to be less concerned with sustainability related to the largest companies than that for the smaller companies, and they even seem to punish the smaller firms for negative news more than they reward those companies for positive news. Lastly, the impact of hurricanes on the supply chain needs to be studied further in order for us to have more conclusive evidence, as there may be an indication of investors reacting to anticipation of a food shortage.

Looking at the research from an investment-selection lens, investors should understand that the stock market in general does react to ESG news and gives mega-cap food companies more leeway in terms of correcting the issue than it does for large-cap companies. While this research does not focus on smaller companies, it would not be surprising to see an even bigger negative impact for small- and mid-cap food stocks as compared with large-cap food stocks. Investors concerned about ESG factors could relatively safely invest in mega-cap food stocks, as both in the short term as well as long term, investors seem to put much more faith in the capabilities of mega-cap companies to resolve the issue. Investors should pay attention to ESG and take the factor more seriously when making investment decisions, as this is no longer a temporary trend. At the same time, investors should not hurry to sell food stocks, be they large or mega cap, based on negative palm-oil news, as the market in general does not seem to punish such stocks in the short or long term.


Note: Please let us know through a direct message on Seeking Alpha or email (email address in bio) if you plan to use or reference this research for other research or publications purposes. Thank you.


Appendix A: List of Companies Studied



Market Cap (( USD ))

Mondelez International, Inc.


63.2 B

Constellation Brands, Inc.


42.3 B

General Mills, Inc.


30.5 B

Tyson Foods, Inc.


31.1 B

The Hershey Company


23.0 B

Archer-Daniels-Midland Company


22.0 B

Kellogg Company


22.6 B

Hormel Foods Corporation


17.5 B

Campbell Soup Company


14.9 B

Conagra Brands, Inc.


14.6 B

McCormick & Company, Incorporated


13.0 B

The J. M. Smucker Company


13.0 B

Bunge Limited


8.6 B

Ingredion Incorporated


9.8 B

Appendix B: Company Supply Chain Dependence on Agriculture References

1. Agricultural Supply Chain , Mondelez International

2. Sustainability , Constellation Brands

3. How General Mills is advancing a sustainable supply chain , General Mills

4. About Tyson Foods , Tyson Foods

5. Good Business , The Hershey Company

6. Sustainability Progress Tracker , ADM

7. Our Business Sustainability , Kellogg Company

8. Supply Chain , Hormel Foods

9. Responsible Sourcing , Campbell Soup Company

10. Corporate Social Responsibility , Conagra Brands

11. Our Commitment , McCormick & Company

12. Smucker's Corporate Responsibility , J.M. Smucker Company

13. Sustainability , Bunge Limited

14. Sustainability , Ingredion Inc.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of NASDAQ, Inc.


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