Does the Carbon Premium Reflect Risk or Outperformance?

Prior research has documented a carbon premium in realized returns, which have been assumed to proxy for expected returns and thus the cost of capital. We find that the carbon premium partially represents unexpected returns and thus outperformance. Companies with higher scope 1, scope 2, or scope 3 emissions enjoy superior earnings surprises and earnings announcement returns; quarterly earnings announcements account for 30-50% of the premium. When adding in announcement returns to events related to earnings calls, earnings guidance, dividends, and buybacks, this proportion rises to 40-65%. We find similar results for changes in emissions but not scaled emissions, consistent with earlier findings on realized returns. Our results suggest that the carbon premium, where it exists, partially results from an unpriced externality, highlighting the need for government action.