How does pollution monitoring shape analysts’ pricing of environmental risks?

Environmental externalities such as pollution and climate change impose substantial costs on the global economy. When financial markets accurately price firms’ exposure to these risks, capital can shift away from highly polluting (“brown”) firms and toward environmentally friendly (“green”) firms, strengthening firms’ incentives to internalize their environmental externalities. But what causes sophisticated market participants to pay greater attention to environmental risk and incorporate it into firm valuations?

In our paper, we examine whether making local pollution more salient changes financial analysts’ beliefs and valuations and, ultimately, the incorporation of environmental risk into stock prices.

Why might pollution monitoring affect analysts’ valuations? Our prediction builds on a simple insight from the economics and psychology of salience: information that becomes more prominent can receive greater attention and weight in decision-making, even when it is not new. When pollution becomes more salient in an analyst’s local environment, environmental risks that were already publicly known (e.g., the possibility of tighter environmental regulation or shifts in consumer demand) may become more important in the analyst’s assessment of the firms she covers. Greater salience may also motivate analysts to collect additional firm-specific information to understand how these risks affect future cash flows. We therefore expect pollution monitoring to change analysts’ assessments most strongly for firms whose value is particularly sensitive to environmental risks: negatively for high-polluting firms and positively for environmentally friendly firms.

We test these predictions using the staggered rollout of China’s ambient air quality monitoring program. Beginning in 2012, China established a nationwide network of monitoring stations that reported real-time concentrations of six major air pollutants to the public. We first confirm that the program made pollution substantially more salient: newspaper coverage of air pollution rose by 160% in treated cities, while pollution-related internet searches increased by 37%. Because the network expanded gradually across cities, its rollout generates plausibly exogenous variation in the salience of pollution to analysts based on their city of residence.

This setting allows us to compare analysts covering the same firm at the same time but residing in cities where pollution monitoring was introduced at different times. Importantly, the rollout does not differentially change analysts’ access to publicly available pollution or firm-specific information. Rather, it changes the salience of pollution: environmental risks become more prominent to analysts living in treated cities, even though analysts elsewhere can access the same underlying information.

Treated analysts increase air pollution discussions in their reports: We find that when the ambient air quality monitoring program is introduced in a city, analysts based there become more than twice as likely to discuss air pollution in their reports relative to analysts in cities where monitoring has not yet been introduced. Importantly, these discussions focus on channels through which environmental concerns can affect firms’ cash flows. Analysts devote greater attention to both current and anticipated future environmental regulation, as well as shifts in consumer demand, with particularly pronounced increases in discussions of future regulatory and demand-related risks. By contrast, we find little change in discussions of physical environmental risks. These findings suggest that making pollution more salient leads analysts to think more broadly about how environmental concerns may affect the current and future profitability of the firms they cover.

Stock prices respond to analysts’ reassessments of environmental risk: We next examine whether these changes in analysts’ assessments are reflected in stock prices. We use a large language model to classify firms, based on their business descriptions, as green (e.g., low-emission firms or producers of environmentally friendly products such as electric vehicles), brown (e.g., high-emission firms such as coal-fired power plants), or environmentally neutral. We find that the market reacts more positively to treated analysts’ reports on green firms and more negatively to their reports on brown firms, while there is no corresponding change for neutral firms. The economic magnitudes are substantial: aggregated across our sample, treated analysts’ coverage is associated with approximately $43 billion in cumulative market value gains for green firms and $160 billion in cumulative market value losses for brown firms.

One concern is that these price movements could reflect analysts or investors overreacting to environmental risks simply because pollution has become more salient. Our evidence points instead toward improved pricing. First, the initial price responses do not reverse over the following month or year, as we would expect if they reflected temporary overreaction. Second, subsequent earnings announcements generate smaller price reactions when a larger share of the analysts covering green and brown firms have been treated. This suggests that information relevant to firm value is being incorporated into stock prices earlier, through analysts’ research. Together, these findings indicate that heightened pollution salience helps financial markets incorporate environmental risk into prices rather than simply generating temporary shifts in sentiment.

How do analysts change their assessments? We next examine what underlies these changes in stock prices. First, we find that heightened pollution salience changes analysts’ assessments in ways that depend systematically on firms’ exposure to environmental risk. Treated analysts issue more pessimistic earnings forecasts, lower target prices, weaker stock recommendations, and more negative reports for brown firms. For green firms, we find the opposite: forecasts, target prices, recommendations, and report tone all become more favorable. We find little change for environmentally neutral firms. These patterns closely mirror the stock-price responses documented above, suggesting that investors respond to analysts’ revised assessments of how environmental risks affect firm value.

Analysts also acquire more information: Heightened pollution salience does more than change the weight analysts place on existing information. It also motivates analysts to learn more about how environmental risks affect the firms they cover. Treated analysts become substantially more likely to conduct site visits to green and brown firms, but not to environmentally neutral firms. Moreover, when a larger share of analysts attending a site visit are treated, air pollution is more likely to be discussed during the visit. Finally, treated analysts produce more accurate earnings forecasts, with the improvements concentrated among green and brown firms. Together, these findings suggest that making pollution more salient prompts analysts to devote greater effort to understanding financially material environmental risks, resulting in more informative assessments of firm value.

Our findings suggest that ambient environmental monitoring can affect financial markets through a channel that extends well beyond informing people about the air they breathe. By making pollution more salient, monitoring changes how sophisticated market participants assess environmental risks that were already publicly known, motivates them to acquire additional firm-specific information, and ultimately helps incorporate those risks into asset prices. The resulting price changes favor environmentally friendly firms and penalize high-polluting firms, potentially shifting capital toward firms with lower environmental externalities. Thus, even without directly regulating emissions or requiring new firm-specific disclosures, environmental monitoring can complement traditional environmental policies by strengthening the market incentives for firms to internalize the costs of their emissions.

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Nemit Shroff is the School of Management Distinguished Professor and a Professor of Accounting at the MIT Sloan School of Management.

This blog is based on a paper presented at the Lisbon Sustainability Week 2026, held at Católica-Lisbon School of Business and Economics and organised with Santander Central Services and ECGI. Visit the event page to explore more conference-related blogs.

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