Ebook Environmental and Financial Performance: Are They Related?
Prior research has been contradictory on the relationship between financial and environmental performance. There are both theoretical and empirical reasons for this lack of consensus. Complying with environmental regulation is costly and thus might hurt a firm's bottom line. On the other hand, a firm that is efficient at pollution control might also be efficient at production. Moreover, a firm that does well financially can afford to spend more of its resources on cleaner technologies. Among the reasons for the past discrepancy in empirical findings is the lack of objective criteria to evaluate environmental performance.
Some authors have looked at subjective rankings by public interest groups, others have examined pollution control expenditures across industries, while others have compared the market returns of socially conscious mutual funds to overall market trends. This study reports on a new objective data set detailing the environmental performance of the Standard and Poor's 500 companies. We construct two industry-balanced portfolios and compare both accounting and market returns of the "high polluter" to the "low polluter" portfolio. Overall, we find either no "penalty" for investing in the "green" portfolio, or a positive return from green investing. We also examine the stock market reaction to new information on the environmental performance of individual firms, and provide a preliminary analysis of which comes first good financial performance or good environmental performance.
The subject of corporate environmental performance what it means, how to measure it and why it matters is rapidly gaining prominence among business leaders, academics and investors. A key element in this debate is the question of how an individual firm's environmental performance impacts its financial performance. Does a company that strives to attain good environmental performance gain advantages over competitors, or is environmental performance just an extra cost for these firms? Answers to these questions have important implications for the role that corporations can be expected to play in promoting pollution reduction efforts and the use of cleaner technologies.
Historically, investments by corporations in environmental protection measures have tended to be viewed as a drag on financial performance. For the U.S. economy as a whole, the EPA estimates that total annualized costs for all pollution control activities in the United States amounted to $115 billion in 1990, or about 2.1 percent of the nation's GNP. Moreover, EPA expects this annual cost to increase to $171 billion (in 1990 dollars) by the year 2000, or 2.6 percent of estimated GNP (U.S. EPA, 1990). Environmental investments were often viewed by business as a necessary evil: necessary to meet societal standards for controlling pollution and protecting public health, but evil because they resulted in lower overall profitability by diverting resources to a fundamentally non-productive use.
In recent years, this premise has come under increasing attack, however, not only by environmental advocates, but also by important business and academic leaders and investors. Perhaps this is not surprising, since until recently firms had looked towards end-of-pipe treatment as the main method of pollution control. More recent trends toward pollution prevention may have shifted some of the debate away from compliance costs toward competitiveness.
The notion that environmental performance is an important component of competitive advantage has found acceptance by a growing number of corporate leaders over the last several years. For example, Ben Woodhouse, director of Global Environmental Issues at Dow Chemical, states that "the degree to which a company is viewed as being a positive or negative participant in solving sustainability issues will determine, to a very great degree, their long-term business viability" (Schmidheiny 1992, p. 11). "Monsanto's ability to develop new products, enter new markets, sell our current products and operate our manufacturing facilities profitably depends upon continuous improvement in environmental performance," adds Richard J. Mahoney, Chairman and CEO of Monsanto Co. (Monsanto, 1991). Finally, according to Richard Druckman, Vice-President for Strategic Planning for Bristol-Myers Squibb Co., "continuous improvement of environmental management throughout the organization is a key factor for our competitiveness in the 1990s. Each business group and division now incorporates strategies to address environmental management improvement in its strategic plan," (Bristol-Myers Squibb Co., May 1993.)
This paper offers new evidence on whether or not firms that perform well on environmental criteria also perform well financially. Previous research on this issue has been limited in scope due to lack of data availability. Unlike previous research, our analysis is based on a relatively comprehensive list of companies the Standard and Poor's 500. In addition, the environmental performance measures are based on actual government records or government-mandated securities filing disclosures. Unlike previous studies, we do not rely on subjective or anecdotal analysis to characterize environmental performance. The primary source of data was published by Investor Responsibility Research Center (1992). Although these environmental performance measures are based on publicly available information, they have not previously been available to researchers in an accessible format.
Although there are many ways in which one could compare environmental and financial performance, this paper is concerned with whether or not "green investing" provides a positive financial return relative to a more neutral investing strategy. Unlike previous authors, we define green investing to be investing in companies that are the environmental leaders in their respective industries. This would allow for investing in oil and chemical companies and firms in other heavy polluter industries. We construct two “portfolios” consisting of the “low pollution” and “high pollution” firms in their respective industries. Our main finding is that the “low pollution” portfolio does as well as - and often better than the “high pollution” group.
It is important to state at the outset, however, that any relationship that is found does not necessarily imply the direction of causation. For example, a finding that good environmental performance is correlated with high earnings does not necessarily mean that firms who improve their environmental performance will also improve their earnings. It is possible that causation runs the other way that firms are good environmental citizens because they are strong financially and are able to afford to be good citizens.
Section II provides a brief literature review and some background into the empirical evidence on the relationship between financial and environmental performance. Section III describes the IRRC and financial performance data used in the analysis, as well as the empirical tests employed. Section IV presents the main results of the paper, comparing the financial performance of "low polluter" portfolios to industry-matched "high polluter" portfolios . Section V considers the question of which comes first good environmental performance or good financial performance. Some concluding remarks and suggestions for further research are reserved for Section VI.
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