In recent decades, business practitioners and academic researchers have paid a great deal of attention to climate change concerns. Notably, alongside the surging greenhouse gas (GHG) emissions, many countries have attempted to control GHG emissions since the 2005 adoption of the Kyoto Protocol. Moreover, consumers are becoming increasingly concerned about rapid climate changes. In response to institutional and social demands for GHG reduction, firms have devoted considerable resources to corporate environmental responsibility (CER) in order to comply with relevant regulations and satisfy customer expectations (Hoffman, 2005). Additionally, existing studies investigate the effects of CER on firm value (e.g., Reinhardt, 1999; Sen et al., 2015). However, relatively less focus has been placed on the factors that influence CER activities.

Institutional investors have acted as firms’ major shareholders by gradually increasing their ownership (Barber et al., 2008; Bolton and Kacperczyk, 2020; Dyck et al., 2019; Ilhan et al., 2021; Mehrani et al., 2017). Chen et al. (2007) show that institutional ownership of the US stock market exceeded 50% in 2004. In addition to their substantial ownership, they have had a significant impact on corporate policies and decisions (Aghion et al., 2013; Neubaum and Zahra, 2006). Particularly, institutional investors are tend to have incentives to pay more attention to CER activities because these activities can lead to an increase in the long-term value of firms (e.g., Deng et al., 2022; Dyck et al., 2019; Holm and Rikhardsson, 2011; Krueger et al., 2019; Miles and Covin, 2000).

This study examines the impact of institutional investors on CER activities. Among various dimensions of CER, we focus on a firm’s GHG emissions because they have a direct impact on climate change and are widely recognized as the determining factor for CER activities. CER can enhance a firm’s long-term value through two channels. First, CER can enhance a firm’s reputation by fulfilling stakeholders’ demands and boosting its value (Dangelico and Pujari, 2010; Hill and Jones, 1992). Second, CER can reduce a firm’s risks, including those associated with uncertain explicit claims, litigation, and sanctions (Agle et al., 1999; Waddock and Graves, 1997). Institutional investors have strong incentives to encourage managers to invest in more environmental activities because these channels are likely to induce higher firm valuation. In line with this discussion, we hypothesize that an increase in institutional ownership will reduce a firm’s GHG emissions.

To test this hypothesis, we collect data from various sources, including Trucost, Compustat, the Center for Research in Security Prices (CRSP), and the CDA/ Spectrum 13F database of Thomson Reuters. Particularly, we obtain the GHG emission data from Trucost and measure a firm’s GHG emissions. By merging this measure with data on institutional ownership and accounting and financial information, we eventually have 8,268 US firm-year observations over the 2002-2019 period. Using this sample, we conduct multivariate regressions to examine the relationship between institutional ownership and a firm’s GHG emission rate while controlling for various factors that affect GHG emissions. We find that institutional ownership is negatively related to a firm’s direct and indirect GHG emissions. This finding indicates that institutional investors are more likely to monitor their firm’s CER. To alleviate endogeneity concerns, such as reverse causality and omitted variable bias, we conduct additional tests, including two-stage least squares (2SLS) regressions, change regressions, and regressions with firm fixed effects. Even when we address endogeneity issues, our primary findings still hold.

Our paper contributes to the literature on determining a firm’s GHG emissions. Earlier studies identify a few determinants of GHG emissions including institutional pressures and firm characteristics (Comyns, 2016; Faisal et al., 2018). We complement these studies by investigating the impact of institutional investors on a firm’s GHG emissions. We also contribute to the literature on the positive role of institutional investors in a firm’s long-term investments (Aghion et al., 2013; Bushee, 1998; Eng and Shackell, 2001) because a firm’s environmental performance is highly associated with its long-term value. Furthermore, we contribute to the extant literature regarding the association between institutional investors and climate risks. Recent studies (e.g., Krueger et al., 2020; Bolton and Kacperczyk, 2021) have explored the relationship between institutional investors and climate risks in the context of asset pricing and investment. However, we examine this relationship from the perspective of corporate finance.

Moreover, using data on the actual amount of a firm’s GHG emissions, this study adds to the literature by providing direct evidence of corporate environmental performance. For example, Krueger et al. (2020) use survey data on climate risk perceptions. In addition, Ilhan et al. (2021) construct an indicator variable that measures whether a firm discloses the quantity of its carbon emissions. On the contrary, we employ the firm’s actual quantity of direct and indirect GHG emissions, allowing us to precisely investigate corporate environmental performance.

The rest of this paper is structured as follows: Section 2 reviews relevant literature and fully develops the hypothesis. Section 3 outlines the data and describes the primary variables that were constructed. Section 4 presents our empirical findings, while Section 5 concludes the paper.

In recent decades, environment protection has become a global concern; hence, studies on a firm’s CER activities have become more critical. In particular, there are two prominent strands of research on CER. The first one focuses on how CER affects a firm’s performance (Elsayed and Paton, 2005; Miles and Covin, 2000). Some studies argue that CER activities may be regarded as unnecessary costs that have negative short-term effects on a firm’s profitability and shareholder wealth (Waddock and Graves, 1997). However, from a long-term perspective, CER can have a positive effect on the firm’s value (Jo et al., 2015; McGuire et al., 1988). This positive relationship between CER and a firm’s long-term value can be supported by two main views on CER: reputation-building and risk mitigation.

First, a firm that engages in more CER activities by reducing GHG emissions can increase its long-term value by building positive reputation (Hill and Jones, 1992; Hoffman, 2005). The firm with more CER activities is likely to attract greater attention from a diverse range of stakeholders, such as shareholders who place a high premium on environmental performance and customers who prefer environmentally friendly products. Liedong et al. (2017) show that pursuing CER activities strengthens a firm’s relationship with the local community. Second, CER enables a firm to mitigate risks, such as sanctions and litigation (Agle et al., 1999; Hoffman, 2005; Waddock and Graves, 1997). For instance, if firms exceed the international limit for GHG emissions under mandatory emissions mitigation schemes, they may be subject to sanctions, such as substantial penalties and suspension of business. On the contrary, firms with better environmental policies can avoid unnecessary costs associated with environmentally irresponsible activities (Sharfman and Fernando, 2008).

The second strand of literature explores the determinants of firms’ CER activities. Cowen et al. (1987) show that firm size and industrial characteristics are positively associated with the disclosure of a firm’s social activities. Freedman and Jaggi (2005) place greater emphasis on a firm’s environmental performance and find that firm size relates positively to GHG pollution disclosures. Meanwhile, given that the government regulates GHG emissions, previous literature has examined the relationship between national legislation changes and a firm’s GHG emissions. Kumar and Sharma (2014) suggest that various governance regulations for environmental protection induce firms to implement environmentally friendly policies, including the construction of new facilities and the introduction of innovative technologies, resulting in a reduction in GHG emissions.

Meanwhile, because managers implement corporate decisions and policies, managerial risk-taking behavior can significantly affect a firm’s environmental policy. Although there is a growing demand from society for environmentally responsible activities, managers’ decisions may not reflect this demand. Thus, it is essential to investigate the impact of corporate governance on a firm’s environmental performance because corporate governance designs managerial incentives to implement corporate policies (Sommer, 2019). Existing studies show that institutional investors have become major shareholders and have played critical roles in establishing corporate governance (Barber et al., 2008; Cao et al., 2020; Chen et al., 2007). In line with these studies, institutional ownership can be the primary determinant of a firm’s CER, particularly GHG emissions, by influencing managerial risk-taking incentives.

Institutional investors comprise various types of investors, such as investment companies, pension funds, investment advisors, bank trusts, and insurance companies (Bushee, 1998; Carey et al., 1998). Compared with retail investors, institutional investors are more motivated to participate in the corporate decision-making process because they tend to hold substantial ownership and remain in the firm as shareholders over longer periods (Aghion et al., 2013; Gaspar et al., 2005). Aghion et al. (2013) document that improved monitoring by institutional shareholders can precisely capture the ability of managers and, thereby preventing managers from being dismissed because of stochastic reasons. Consequently, the presence of institutional investors as better monitors shields managers from the reputational risk of poor performance resulting from stochastic circumstances, such as industry shocks and regime or regulation changes, mitigating managers’ career concerns. Thus, when institutional investors monitor managers more closely, these managers are likely to pursue corporate policies that enhance the firm’s long-term value. Consistent with this reasoning, Aghion et al. (2013) show that institutional investors induce firms to invest in long-term intangible assets by increasing their innovative activities. Similarly, Kim et al. (2019b) find that long-term institutional investors positively affect corporate innovation.

As we have discussed, CER can increase a firm’s long-term value by fostering a favorable reputation and mitigating risk. Therefore, managers in firms with greater institutional ownership are more likely to engage in CER to enhance the firm’s long-term valuation. In particular, among the various dimensions of CER, a firm’s GHG emissions have a significant impact on climate change and are widely regarded as the critical component that measures the firm’s environmental performance (Hatakeda et al., 2012). Thus, focusing on corporate GHG emissions, we propose the testable hypothesis that an increase in presence of institutional investors will reduce a firm’s GHG emission rate.

Research on corporate environment activities has grown along with an emphasis on the environment in the business area. In particular, among various dimensions of CER, a firm’s GHG emissions attract much attention from researchers because they have a direct impact on climate change and are widely recognized as the key factor in determining CER activities. Meanwhile, institutional investors have increased their ownership and become US firms’ largest shareholders, significantly affecting corporate decision-making. Because they place considerable emphasis on the long-term value creation of their firms, institutional investors are likely to exert pressure on managers to invest in more CER activities, especially to reduce GHG emissions. Thus, this study examines how institutional ownership influences a firm’s GHG emissions.

We find that institutional ownership is negatively related to firms’ direct and indirect GHG emissions. Moreover, we conduct additional tests to address endogeneity concerns. The results of 2SLS regressions, change regressions, and regressions with firm fixed effects indicate that our main findings remain consistent when endogeneity is controlled for. Overall, our results suggest that institutional ownership encourages firms to enhance their CER performance by reducing GHG emissions.

This study contributes to the literature on determining a firm’s GHG emissions. Existing studies have found a few factors of GHG emissions, such as institutional pressures and firm characteristics (Comyns, 2016; Faisal et al., 2018). We complement these studies by providing empirical evidence that the presence of institutional investors affects a firm’s GHG emissions through enhanced monitoring. In addition, our study adds to the literature on the positive role of institutional investors in a firm’s long-term investments because the reduction in GHG emissions induced by the presence of institutional investors can increase the firm’s long-term value. Further, we contribute to the existing literature on the relationship between institutional investors and climate risks. Recent studies (e.g., Krueger et al., 2020; Bolton and Kacperczyk, 2021) have examined the relationship between institutional investors and climate risks in the context of asset pricing and investment. In contrast, we examine this relationship from the perspective of corporate finance.