One of the greatest failings of the Efficient Markets Hypothesis (of which there are many) is its failure to account for the phenomenon of herd behavior. Dartmouth professor Karin S. Thorburn has an article on VoxEU arguing that U.S. companies' failure to voluntarily reduce their carbon footprints (I hate that term) is the result of herd behavior among investors. Yves Smith gets at the heart of Thorburn's article:

Apparently, investors do not buy the idea that investing in greater energy efficiency in an era of of $115 a barrel oil is compelling (and note that despite all the brouhaha about alternative fuels, using less energy will have a far greater impact). How could investors be so ill informed? One possibility: socially responsible investing has gotten consistently bad press. It's generally depicted as a soft-headed way to guarantee inferior investment performance. Thus, being a skinflint about energy use, which like other types of cost-cutting is good for profits, is instead treated as naive do-gooderism and punished.
So yet again, the Efficient Markets Hypothesis becomes a self-fulfilling prophecy: investors think that investing in energy efficiency is bad for companies because that's what other investors think; when a company announces that it's investing in energy efficiency, investors flee the company's stock, and the stock price falls; investors then use the fall in the company's stock price as evidence that energy efficiency is bad a investment for companies. This is the main reason I think the massive global warming PR campaigns, while overly moralizing and extremely grating, are nevertheless beneficial in the long-run.


Gabriel M said...

Is there a set of observations that will infirm or confirm your claim?

Anonymous said...

I meant it more as an observation than as a positive claim. The whole "energy efficiency" movement is a relatively recent phenomenon, and since it takes a while to realize the returns on investing in energy efficiency, there's not nearly enough data to render a decisive verdict on whether energy efficiency is a good investment. The February 2008 McKinsey Institute study is the closest thing we have to an objective, comprehensive study of energy efficiency investments, and it concluded that there are loads of energy efficiency investments that are going unexploited. There's no shortage of anecdotal evidence though, as Yves Smith notes in the post I linked to. And the great weight of the anecdotal evidence certainly suggests that energy efficiency investments are profitable for some companies (depending on the industry, of course).

I was really just extrapolating from the Thornburn article, which said that companies' seemingly irrational failure to invest more in energy efficiency is a case of market failure that can be corrected by the government. (It's hard to say whether I agree with Thornburn though, since she doesn't say what kind of "regulation" she has in mind.)

My point about the Efficient Markets Hypothesis and herd behavior was that it could explain why this alleged market failure exists in the first place. Again, it's way too early to have reliable data showing that this kind of herd behavior is causing the underinvestment in energy efficiency.

I don't think you were, but if you were asking whether there is a set of observations that confirms my claim that the Efficient Markets Hypothesis doesn't hold, then the answer is yes. There are too many empirical studies to even count. The collapse of Long-Term Capital Management, for example, immediately comes to mind.

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