RESEARCH ARTICLE Investors' carbon risk exposure and their potential for shareholder engagement Lukas Benz 1 | Stefan Paulus 1 | Julia Scherer 1 | Janik Syryca 1 | Stefan Trück 2 1 Chair of Finance and Banking, University of Augsburg, Augsburg, Germany 2 Centre for Financial Risk, Macquarie University, Sydney, New South Wales, Australia Correspondence Lukas Benz, University of Augsburg, Chair of Finance and Banking, Universitätstr. 16, 86159 Augsburg, Germany. Email: lukas.benz@wiwi.uni-augsburg.de Funding information Bundesministerium für Bildung und Forschung Abstract This article examines the exposure to and management of carbon risks of different investor types. Considering the dual role as portfolio manager and partial owner, we analyze carbon risk for investors both in terms of exposure to portfolio values and in terms of responsibility as shareholder of carbon-intensive firms. We show that among various investor types, the preference for holding carbon-intensive stocks dif- fers substantially, even when considering traditional investment decision parameters. In particular, it is governments whose portfolio values are most threatened by a car- bon risk exposure of 49%, but at the same time, they prefer larger ownership shares in polluting firms. In contrast, individual investors, investment advisors, and mutual funds avoid holding stakes in these firms, while revealing only a moderate exposure of their assets to carbon risk. In view of the Paris Agreement, which includes the con- sistent steering of financial flows towards a low carbon transformation of the econ- omy, our study provides policymakers with important implications regarding the coverage and effects of respective regulations. By identifying the ownership struc- tures of carbon-intensive firms and respective owners' portfolio compositions, we also offer implications for further research on portfolio decarbonization and share- holders' influence of corporate carbon management. KEYWORDS carbon risk, corporate carbon emissions, decarbonization, institutional ownership, investor behavior, shareholder engagement 1 | INTRODUCTION According to the Intergovernmental Panel on Climate Change (IPCC), Carbon Dioxide (CO 2 ) accounts for about three quarters of global greenhouse gas (GHG) emissions and is likely to be the main driver for anthropogenic global warming (IPCC, 2014). As a result, policymakers around the world are considering various plans for reducing carbon emissions and aim to mitigate the detrimental con- sequences of rising temperatures for business and society. Even though there have been some significant achievements, such as the Paris Agreement (UNFCCC, 2015), the implementation process of the agreed measures for carbon emission reductions is rather lengthy, difficult to enforce, and subject to regular changes. Espe- cially due to the discrepancy between the primary emitters and those who are already suffering from climate change, combating cli- mate change is one of the most difficult ethical issues facing today's economy and society (Dahlmann, Branicki, & Brammer, 2019). Fur- thermore, the cost of carbon as well as the decarbonization of key [Correction added on August 31, 2020, after first online publication: Projekt Deal funding statement has been added.] Received: 11 February 2020 Revised: 27 July 2020 Accepted: 8 August 2020 DOI: 10.1002/bse.2621 This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited. © 2020 The Authors. Business Strategy and The Environment published by ERP Environment and John Wiley & Sons Ltd 282 Bus Strat Env. 2021;30:282–301. wileyonlinelibrary.com/journal/bse