ABSTRACT This paper examines how the European Union Emissions Trading System allowance prices reshape the link between corporate environmental performance (CEP) and firms' growth expectations, measured by Tobin's Q. Using a panel of 1370 listed firms across 15 European countries from 2005 to 2024 and high‐dimensional fixed‐effects models, we first confirm a U‐shaped CEP–Q relationship: Initial emission cuts carry compliance costs, but beyond a threshold they deliver efficiency and reputational gains that boost valuation. We then show that allowance prices condition this pattern: Modest prices amplify CEP's upside, whereas very high prices erode—and, in extreme cases, reverse—its benefits through investment deferral, resource crowding out, and investor uncertainty. The erosion is economically substantial: Leakage‐exposed firms lose 65% of their CEP benefits as prices rise from low to very high levels, and high emitters lose 71%. Our findings highlight the nonlinear impact of carbon‐price stringency on investor expectations. For managers, we recommend hedging carbon‐price risk and prioritizing high‐impact abatement measures. For policymakers, establishing price corridors and providing targeted support to vulnerable firms can ensure carbon markets drive, rather than hinder, sustainable growth.
Adrián Ferreras (Thu,) studied this question.