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ABSTRACT This paper investigates how carbon emissions create trading costs in stock markets and why executive psychology matters for this relationship. Using 387 U.S. firms from the S&P 500 index over 2010–2021, we find that carbon emissions reduce stock liquidity by increasing information asymmetry, inducing stakeholder divestment, and threatening corporate legitimacy. Direct emissions (scope 1) create the strongest liquidity penalties because they signal immediate regulatory exposure and operational carbon intensity. However, overconfident CEOs mitigate these negative effects through enhanced environmental communication, credible innovation signaling, and proactive stakeholder engagement—mechanisms that reduce market uncertainty despite high emission levels. Our analysis of international climate agreements reveals that during the Kyoto Protocol's first phase (2010–2012), markets primarily penalized direct emissions, while the second phase (2013–2020) saw broader investor pricing across emission types. During the Paris Agreement's pre‐commitment phase (2010–2015), regulatory uncertainty led to negative market reactions, but the commitment phase (2016–2019) transformed emissions from risk factors into operational concerns as regulatory clarity emerged. Finally, high‐emission industries show more pronounced liquidity effects, confirming that carbon risk pricing varies with sectoral environmental exposure.
Bargaoui et al. (Fri,) studied this question.