The value relevance of environmental performance

Abstract

This paper provides insight into how environmental information is reflected in the market value of listed Swedish companies. Using the residual income valuation model, we express market value of equity as a function of book value of equity, accounting earnings, and environmental performance, where the last variable is used as a proxy for other value-relevant information. Our research is motivated by the recommendation of the Swedish Society of Financial Analysts regarding environmental reporting. This recommendation assumes that environmental information has value relevance, since it is likely to affect the expected future earnings of listed companies. We contribute empirical findings to current debate on the relationship between environmental performance and shareholder value. The cost-concerned school argues that environmental investments represent only increased costs, resulting in decreased earnings and lower market values. The value creation school regards environmental efforts as a way to increase competitive advantage and improve financial returns to the investors. The current research finds support for the cost-concerned school, because the results indicate that environmental performance has a negative influence on the market value of firms.

Acknowledgements

We gratefully acknowledge CaringCompany in Stockholm for providing us with environmental performance data and Jan Wallanders och Tom Hedelius Stiftelse for providing financial support. Valuable comments have been received from Xavier de Luna, Rickard Olsson, Tim Wilson, and participants at the accounting and finance research workshop in Umeå, the Asian-Pacific Conference on International Accounting Issues in Brazil, and the EAA Conference in Greece 2001. This paper was awarded The Vernon Zimmerman best paper award at the Thirteenth Asian-Pacific Conference on International Accounting Issues in Brazil.

Notes

¹See also Appendix.

²Also note that the intercept allows for the non-zero mean valuation effects of other valuation-relevant information, besides environmental performance which is picked up by the error term.

³Five of the companies studied did not use SEK as a reporting currency. For these companies, we translated the accounting numbers into SEK using the relevant exchange rate as of the last trading day of the quarter. The exchange rates were collected from the Trust Database.

⁴In a few cases NI was not available on a quarterly basis. To avoid a further reduction of the sample size, we used profit after financial items or operating profit adjusted for proxy tax for those firms.

⁵Forty-two firm quarters were deleted because no available stock prices and/or total number of stocks figure appeared in the Trust Database.

⁶As a robustness check, we reran all the tests deflating equations 3–5 by sales instead of opening book value. The results obtained were very similar to those reported in the paper.