The price of pollution: examining carbon emissions’ effect on stock liquidity

Purpose This study aims to investigate the relationship between carbon performance and stock liquidity. Design/methodology/approach Based on a sample of 3,386 firm-year observations from the S&P 500 index over the period 2011–2023, the authors use regression models on panel data estimated with robust standard errors. Findings The authors show that carbon performance improves stock liquidity. The results are robust to endogeneity concerns, as shown by the use of advanced econometric methods, including two-stage least squares (2SLS) and propensity score matching (PSM). Additional analyses show that the positive impact of carbon performance on stock liquidity is amplified in firms with stronger corporate social responsibility (CSR) engagement and lower levels of information asymmetry. However, the positive association is attenuated during the COVID-19 pandemic period, suggesting a dampening effect of crisis conditions. Finally, subsequent analyses indicate that stock liquidity contributes positively to firm value, particularly among firms with superior carbon performance. Research limitations/implications The findings offer several important practical implications. First, governments should actively encourage firms to reduce carbon emissions by implementing financial incentives such as tax breaks, grants for adopting green technologies and subsidies for renewable energy projects. Second, investors are advised to integrate carbon performance criteria into their investment analyses to better identify companies with superior stock liquidity and greater potential for long-term value creation. Last but not least, regulators should enhance requirements for carbon emissions disclosure and sustainability reporting to promote greater transparency and accountability among firms. Lastly, managers should view effective carbon management not only as a compliance obligation but also as a strategic opportunity to enhance stock liquidity. Social implications This study carries profound social implications. Companies with lower carbon footprints are more valuable and have stocks that are easier to trade. This insight encourages investors to reallocate their capital toward environmentally responsible companies, rewarding them for their sustainable practices and contributing to the development of a more sustainable economy. Overall, our study positions sustainability not merely as an ethical obligation but also as a strategic driver of shared value for firms, investors, and society. Originality/value This study makes a novel contribution by demonstrating that carbon performance – beyond traditional financial indicators – significantly influences stock liquidity. By revealing how carbon performance enhances stock liquidity, this paper extends the discourse on carbon performance from a focus on corporate reputation to tangible market outcomes. Furthermore, it explores multiple channels – such as CSR, information asymmetry and the impact of COVID-19 – through which carbon performance affects liquidity.