Green vs. Brown Stocks: Climate Policy, Capital Costs, and the Battle for Market Returns

Since the 2015 Paris Agreement placed climate commitments at the center of the global agenda, a compelling new question has emerged for investors, policymakers, and academics: are “green” companies outperforming their emissions-intensive “brown” counterparts? The comparison may seem simple, but it hides a surprisingly intricate financial story of expectations, risk, politics, and the price of capital.

At first glance, the idea seems intuitive. If global concern about climate change grows and the transition to clean energy is embraced, low-carbon companies should benefit from more favorable growth prospects. Indeed, one reason green stocks may have outperformed brown stocks is simple: earnings prospects.

Investors may have underestimated the speed of growth in green technologies and the magnitude of the shift in demand. When earnings forecasts were revised upward, stock prices rose accordingly. Brown companies, such as oil producers, coal companies, and high-emissions heavy industries, may have experienced fewer positive surprises.

Focus on the cost of capital: Why green bonds are better

However, there’s another, more subtle mechanism at play that receives much less attention outside of university classrooms: the cost of capital. Essentially, it’s the expected return investors demand for holding a company’s stock. If this expected return increases, the stock price falls, even if the company’s business remains unchanged.

This is precisely where climate policy comes into play. When large institutional investors divest from fossil fuel-intensive sectors, they often justify this choice not only on ethical grounds, but also by weighing the risks. Carbon-intensive companies are exposed to more stringent regulations, stranded assets, volatile demand, and future liabilities.

These risks lead to a higher cost of capital for brown companies. As investors exit, share prices are pushed down, resulting in higher expected returns.

In other words, brown stocks may underperform simply because the market is less inclined to hold them, and not necessarily because of disappointing earnings. Paradoxically, once the higher cost of capital has been fully priced in, theory predicts the opposite effect: brown companies should end up earning higher returns , compensating investors for the increased climate risk. This is what some scholars call a carbon risk premium.

What really happened?

To find out, researchers have built increasingly sophisticated models that link stock prices to long-term growth expectations and changes in the cost of capital. When we estimate these models and verify the results, a clear picture begins to emerge.

Image containing text, screenshot, Character, numberAI-generated content may not be correct.
Since the signing of the Paris Agreement, the cost of capital, or expected return, for brown companies in the United States has increased by 0.55 percentage points compared to their green counterparts. Green companies represent the third-lowest carbon-intensive companies in each sector; brown companies, on the other hand, represent the third-lowest carbon-intensive companies.

This trend is illustrated by the blue bars in the previous chart. This represents a significant repricing in financial markets. Interestingly, this 0.55 percentage point differential between brown and green stocks has remained virtually constant until the November 2024 US presidential election.

Trump 2.0: The Dismantling of the Rules

Then the political landscape changed. Climate regulations were rolled back, the United States withdrew from the Paris Agreement, and clean energy subsidies were reduced. Pressure on polluting companies eased, and investors responded accordingly. Although Trump had already withdrawn from the Paris Agreement during his first term, his backtracking on climate policies was much more aggressive in his second.

Since then, the gap in the cost of capital between “brown” and “green” companies has narrowed, falling to 0.30 percentage points. This was positive news for investors in “brown” stocks. A lower cost of capital automatically boosts valuations. Indeed, the rethinking of US climate policies has boosted the returns of carbon-intensive “brown” companies.

Climate leaders versus laggards

At Robeco, we don’t particularly like the distinction between “green” and “brown” companies. Instead, we evaluate whether companies have credible plans to decarbonize their operations or develop new technologies to accelerate the transition to clean energy. We define “climate leaders” as companies with solid plans and “climate laggards” as those without.

While there is considerable overlap between the two categories, the distinction remains important as some “brown” companies are embarking on a credible green transition. But what happened to these climate leaders, these green or transitioning companies that should have suffered the consequences of these policy reversals? Have they been penalized for making the “right” choice?

The data suggests otherwise. Despite weakening US climate commitments, global climate leaders continued to report improving earnings prospects, driven by technological momentum, declining clean energy costs, and the accelerated adoption of climate-friendly policies in Europe and Asia. The orange bars in the chart demonstrate this. These positive earnings revisions led to rising stock prices, regardless of the U.S. policy shift.

Was it worth it?

So, has going green paid off? It all depends on how you measure it. “Brown” companies in the United States received a short-term boost when US climate policies reversed. However, global climate-leading companies continue to post stronger-than-expected growth.

One thing is clear: the market dynamics since the Paris Agreement are too complex to simply call it a triumph for clean energy. It’s a web of shifting expectations, geopolitical reversals, and repricing risks, reminding us that in financial markets, climate change is no longer a distant and abstract threat. It’s already moving prices today.

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(Featured image by Markus Spiske via Unsplash)

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First published in ESG NEWS. A third-party contributor translated and adapted the article from the original. In case of discrepancy, the original will prevail.

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