Does the Carbon Premium Reflect Risk or Outperformance?

Prior research documents a carbon premium in realized returns, assuming they proxy for expected returns and thus the cost of capital. We find that the carbon premium partially reflects unexpected returns and thus outperformance. Companies with higher scope 1, 2, or 3 emissions enjoy superior earnings surprises and announcement returns; earnings announcements explain 20-40% of the annual premium. We find similar results for emissions changes but not intensities, consistent with earlier evidence on realized returns. Our results suggest that the carbon premium, where it exists, partially arises from an unpriced externality rather than the market pricing in carbon transition risk.