Research Paper.docx

Research paper

The Value Relevance Of Environmental Performance: Evidence From Pakistan

AUTHORS: FATIMA ZOHRA ANAM NOOR POOJA GOLANI

Abstract Purpose: this research papers aims to investigate the value relevance of environmental rating with the relationship between share prices of pakistani listed companies and their environmental rating. Design/methodology/approach: 35 companies comprise the sample and data is used for 8 years from 2008-2015. The total observations are 192. Ohlson (1995) model is used but environmental rating is added in the model. Findings: the findings are that environmental rating is not value relevant for Pakistani listed companies. Research limitations: the limitation is the missing values in the environmental rating data. Originality: This study addresses the gap in Pakistani market as now it give insights on how Pakistani investors value the environmental performance of firms. Also it is helpful for companies to make decisions about environmental initiatives. Keywords: Environmental rating, Share price, Value relevance, Pakistan.

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Introduction A large body of research confirms to the fact that stock markets react positively to the announcements of environmental performance of the firm in developed countries. This encourage companies to involve in pollution and disaster control and promote ecofriendly environment. This research is extended from developed stock markets and applied to the developing stock market of Pakistan. This study aims to examine the value relevance of environmental performance of Pakistani firms and to see that whether this helps in prediction of future returns. In order to test the relationship between stock prices of Pakistani listed firms and their environmental performance ratings, Ohlson(1995) model is applied Previous studies presented mixed results. Many of the prior findings were in support of the argument that investors value the environmental performance initiated by the firm as reflected by value relevance of environmental performance in Russia (Middleton, 2015) and increased stock returns (Bernal karali and Zsuzsanna Deak, 2014). However, some finding are not supporting the argument and is consistent with the idea that investors value the environmental friendly programmes as reflected by negative market value of firms due to environmental performance( Hassel, Nilsson and Nyquist, 2005). In this study, we used Bloomberg ratings which are considered most appropriate and suitable for this type of research. The main reason for using Bloomberg ratings is the easy availability of data as Bloomberg corporates with Robeco SAM (Sustainable Asset Management) to fetch the data. Our sample consists of 192 observations from 35 listed companies of Pakistan. As we aims to see the relationship between stock price and environmental performance, stock price is taken as independent variable and dependent variables are environmental rating, earning per share and book value per share. The results of this study show that the accounting information that is book value per share and earning per share are value relevant to the stock price. However the environmental performance is not value relevant to the stock price. The results differ from most of the developed world and this study is not supporting the argument that investors value the environmental performance. The major implication of this study is that this will help corporations to decide the amount of resources that they should invest in environmental initiatives.

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Literature review: The study by Marco Fazzini Lorenzo Dal Maso, (2016) investigated the value relevance of nonfinancial information, also he examined that independent assessment of environmental policies affect the value relevance of environmental disclosure. He found that environmental disclosure is value relevant and positively correlated with market value of company, but assured disclosure does not provide additional relevance. Eli Amir, Baruch Lev was interested to know the value relevance of non-financial information in cellular industry and conclude that just financial information is not enough to determine firm’s value but along with non-financial information, it is value relevant in cellular industry. Because financial information does not let investors know about commissions and churn rate in cellular companies. Guy Dresser, (1997) concluded that market will reflect the importance of non-financial indicators, because companies which demonstrate better research and development, better management and better customer/supplier relationships deliver superior results in the long-term. He also considered environmental behavior and community involvement in non-financial indicators. Youchao Tan, Yuyu Liu, (2017) tested that FNFI (future non-financial information) can reduce information asymmetry between firms and external suppliers of capital. The results showed that excellent and good firms tend to publish information with high quality to gain the trust of investors and get investment, which reduces the corporate financing constrains to a larger extent than firms rated low. Shihping Kevin Huang Chih-Lung Yang, (2014) inspected the link between corporate social performance and corporate financial performance. The conclusion was that these two are positively linked and it is positive even after R&D and industry type are controlled. It means a corporation which attain more social responsibility enjoys good financial condition. It also investigated hat non-manufacturing firms have strong CSP-CFP relation than manufacturing firms. Michel T.J. Rakotomavo, (2012) investigated the investment in social responsibility versus dividends and concluded that the companies which are in maturity stage are more indulge in CSR and are larger, profitable and more earned equity and pay more dividends. The investment in CSR is not cut from dividends. It means the investment in CSR ultimately increase the stock price.

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The study (Frank H.M. Verbeeten Ramin Gamerschlag Klaus Möller, (2016)) suggests that separate CSR report in positively related with share prices but provision for CSR is not related with share price. Even the provision for environment disclosure is not related or negatively related. Also, it suggests that there is a positive relation between social CSR disclosure and price of share. It is so because CSR disclosures are risk management strategy and provide positive economic returns. And companies provide these disclosures to have good financial performance in future. Bernal karali and Zsuzsanna Deak 2014 investigated the effect of company environmental news on shareholder value which appeared in media. The companies selected were in the food industry only. They concluded that environmental improvements increased the stock returns while environmental violations hurt the stock returns. Furthermore, they found that stockholders and other participants valued those environmental actions more which were started by the firms themselves. Hamilton 1995 studied the effect of TRI (Toxic Release Inventory) data which is released by Environmental Protection Agency (EPA) in June 1989, on market value of firms. He found that stockholders faced negative significant abnormal returns on the news of the pollution figures. The firms experienced loss of $4.1 million in stock value when the news of TRI was out. Guenther Cappella Blanchard abs Marie Audi Laguna examined the effect of industrial disasters on stock market reactions. A quarter of the accidents were related to toxic release and 50 percent of them caused at least one death. They concluded that after every accident, stock market reacted negatively. It was found that stockholders suffered loss of 1.3 percent over two days after the occurrence of disaster. It was also observed that those firms which had bad records of safety and environment suffered more stock market losses. Hendricks and Singhal investigated the effects of winning of quality awards on firm’s market value by estimating change in stock prices in the sample of firm whose data were available publicly. The results showed that stock market positively reacts to quality winning awards. Dale Miller Bill Merrilees, (2013) researched that there exists association between customers’ perceptions of retailer sustainability practices and the customers’ brand attitudes towards the retailer corporate brand. So, the corporations are striving to have substantial sustainability of their environmental management. White, Mark A, 1996 tested the relationship between good reputation for environmental responsibility and risk-adjusted shareholder returns and concluded the positive relationship. It 4|Page

means a shareholder gets great investment returns in the periods when the corporation is rated “green”. Caroline Flammer (2012) studied the sensitivity to corporation’s environmental work of investors. After conducting the event study of the environmental news of all the U.S. publicly traded corporations from the time of 1980 to 2009 found that shareholders are sensitive to ecofriendly and Eco harmful initiatives of companies. The study found that shareholders positively reacted to environmental friendly initiatives and responded negatively to Eco harmful behaviors of companies. Second, they found that Environmental corporate social responsibility is a resource with decreasing marginal returns for firm. Shreekanth Gupta and Bishwanath Golda examined the effects of environmental performance on stock prices of the firms. The firms included in the sample were large pulp and paper, automobile and Chloe alkali firms in India. The findings showed that the firms with weak environmental performance as per the environmental rating programs lowered the returns of investors who hold stocks of those companies. Robison, muoghalu and Glascock (1990) investigated the effects of harmful and dangerous waste malpractice and mismanagement lawsuits on capital markets. They found that firms in the sample suffered major losses in their market values. Nicolau and Sellers (2002) examined the effect of quality certification on market value of the company. Companies selected were trading on Spanish stock market. They analyzed that on announcements of quality awards, the share prices saw the abnormal returns. The market positively reacted to these quality awards. Amy j. Hillman* and Gerald d. Keim, (2001) concluded that Building better relations with primary stakeholders like employees, customers, suppliers, and communities could lead to increased shareholder wealth and can be a source of competitive advantage in this world of globalization. The results showed that investing in stakeholder management may be complementary to shareholder value creation and may indeed provide a basis for competitive advantage. Susmita Dasgupta, Jong Ho Hong, Benoit Laplante, Nlandu Mamingi, 2005 examined the investor’s reaction on publication of list which shows the firms which did not comply national environmental laws and regulations. It came up with the strong reactions. It also mentioned that the intensity of reaction depends upon the intensity of coverage by media about these firms. But

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this did not examine that whether these reactions effective enough to change the environmental performance of firms. Gilley, Worrell and Abuzar El-Jelly examined the effect of greening initiatives on the stock returns. They included both manufacturing and service firms in the sample. The results showed that there is not any overall effect of corporate environmental initiatives’ announcements on the firm’s anticipated performance. But these initiatives influenced the perceptions of investors of the future performance. Investors responded positively towards the introduction of environment friendly products which increased the firm’s reputation and it enabled organizations to involve in environmental sustainable strategies. Joaquín Cañón-de-Francia · Concepción Garcés-Ayerbe, (2009) Investigated that how ISO 14001 certification affects the market value of firms and the results showed that ISO 14001 certification has a negative effect on the market value of certain firms. The results also showed that the market negatively views the allocation of resources to ISO 14001 certification in the case of less polluting and less internationalized firm. The results also suggested that the firm following these ISO standards voluntarily don’t have an edge over its competitors. According to a study by Maria Federica Izzo Barbara Sveva Magnanelli, (2017) investigated the relation between the cost of debt and the CSR performance, which resulted that CSP does not play a pivotal role in determination of cost of debt. That was because banks don’t consider CSP while granting loans as an important factor in reducing the operational risk that firms face. The research on value relevance of environmental performance in India, brazil, Indonesia, Italy, US and European countries was done in different industries with different non-financial environmental variables. Most of the studies conclude with the findings that non-financial environmental variables are value relevant and related with share price. Some of the studies conclude with non-relevance and some with mixed findings. Environmental performance in Pakistan can be value relevant when provide added information to financial variables and assist investors in decision making in stock market of Pakistan. The hypothesis formulated to conduct this research is: H1: Environmental performance ratings are value relevant to the market.

Research Design and Method 6|Page

Sample and data selection: This research aims to test the relationship between shares prices of Pakistani listed companies and the environmental performance ratings. It is expected that the share prices that are determined by the investors or general public are affected by environmental ratings of a companies and other factors. All the data of financial factors which includes historic share prices, EPS and BV per share are collected from Bloomberg software. Other than this, nonfinancial factor affecting share prices that is environmental rating of the companies is also taken from Bloomberg terminal (which basically fetches the environmental data from RobecoSAM (Sustainable Asset Management)). The initial sample consist of 37 companies Pakistani publically listed companies whose environmental rating by Bloomberg were available from the period of 2008 to 2015. This makes 197 observations of all 37 companies over the 8 years period. The sampling method for this study is the availability of data, excluded the companies whose environmental data is not available on Bloomberg of 3 or less years has been excluded. After the exclusion a sample of 35 companies, making firm yearly observation equal to 192.Our final sample in which data of all financial and non-financial variables is available is making a sample of 192 observations from 35 unique companies.

Research model: Accounting information no doubt plays a very significant role in analyzing the impact on share prices of a company this idea has been proven by Ohlson (1995) which is basically a valuation framework that investigated the relation between accounting book value, equity value and future earnings. Further in order to check the impact of other non-financial information that is environmental ratings on share prices of a company, an additional independent variable as rating has been added.

SPxy =β0+β1BVxy+β2EPSxy+β3RATINGxy+µxy Where: SPxy

= Company x share prices at year y

BVxy

= Company x Book value at year y

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EPSxy

= Company x Earning per share at year y

RATINGxy

= Company x environmental rating RobecoSAM at year y

Here share prices of x company at y period is taken as a dependent variable whereas book value per share, earning per share and environmental ratings of x company at y period are considered as independent variables. Here the share price that is taken is the year end last price of the company stock in a particular year. Whereas book value per share can be defined as total common stockholder’s equity divided by number of common shares outstanding here the taken book value of each company at year end. EPS is defined as earnings per share which has been taken as the last EPS of the year. Both of these financial variables contain useful information that is helpful in determining the share prices of a company. Other than this, environmental rating has been taken from Bloomberg terminal using ESG that is (Economic Social and Governance). Basically, Bloomberg fetches the ESG from RobecoSAM that is an independent investment specialist focused exclusively on Sustainability Investing. It offers many services including sustainability assessments and benchmarking services. RobecoSAM and Bloomberg band together to make the results of the Corporate Sustainability Assessment (CSA) readily available to the global investment community. RobecoSAM makes the percentile ratings of the scores of the CSA available to all licensed Bloomberg users. The information shared by RobecoSAM on Bloomberg are: 1. Relative rating of companies within their industry (percentile ranks) 2. Percentile ranks at total dimension as they appear on Company Benchmarking Scorecards. 3. Additional research by RobecoSAM The company additionally in order to maintain privacy and their own integrity will not share Company answers, data points, comments, documents or any other confidential information collected through the CSA. Together RobecoSAM and Bloomberg has taken this initiative due to following reasons that are advantageous to investors especially those who are licensed Bloomberg users: 1. To be more transparent about the results of the CSA and helping to improve the credibility and utility of the CSA to creditors and companies.

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2. Companies are positive toward the disclosure of the results of the CSA to be more visible to investors. A survey conducted by RobecoSAM in the fall of 2015 showed that the vast majority of companies favored increased disclosure around CSA results 3. Investors increasingly would like to know more about the CSA. Corporate Sustainability Assessment that is CSA is an annual assessment of companies’ sustainability practices. Around the world over 3400 listed companies are assessed by asking 80120 industry-specific questions that focus on economic, environmental and social indicators that are relevant to the company’s profile and investment decisions, but that are under-researched. The highest score for each question is 100. Based on the value and relevance of questions the weight is assigned to over all questions and final rating is obtained of each indicator. In order to assess the dimension of environment there are various factors that are judged which include:       

environmental and social reporting operational eco-efficiency direct greenhouse gas emission, indirect greenhouse gas emission energy consumption waste water consumption

Results and Discussion Descriptive Statistics The total observations are different for share price, book value per share, earning per share and environmental rating. The Descriptive Statistics of these observations are given in table 1. The average share price of all companies in the sample is Rs.314.5301 with minimum of Rs.1.4559 and maximum of Rs.11203.8. it shows the wide range of sample. The average earning per share is Rs.20.6515 and book value per share has average of Rs.126.2526. It can also be noted that some companies have negative earnings and negative book values per share which may affect the analysis. The environmental rating is around 10.58572 in which the average sample has very low rating. The companies in sample have environmental rating as low as 1.5504 and as high as 45.7364. Table 1 Descriptive Statistics 9|Page

Variable SP E BV RATING

Obs

Mean

Std. Dev

Min

Max

274 266 264 187

314.5301 20.65195 126.2526 10.58572

1053.873 46.42205 184.7081 11.3831

1.4559 -188.22 -0.4192 1.5504

11203.8 354.59 1263.885 45.7364

Notes: SP: share price; E: earnings per share; BV: book value per share; RATING: environmental ratings.

Regression Results The very initial regression was conducted on the original Ohlson model. The results in table 2 depict that the assumption that accounting information is value relevant is true (Model 1). In model 2, the hypothesis that environmental performance is value relevant is tested. In these results, the accounting information is still value relevant but environmental rating is not value relevant (pvalue=0.4148). Table 2 Regression Results on Original Ohlson (1995) Model and Panel Data

1 VARIABLES E BV RATING Constant N R-squared Adj. Rsquared F Prob>F

2

Original Ohlson Model Coefficients P>t

Panel-Samples Coefficients P>t

13.29999*** 1.851235***

0.0000 0.0000

-185.8383

0.0000

12.00239*** 2.493111*** 3.97951 -261.656

264 0.699165

179 0.717632

0.69686 303.2925 0.0000

0.712792 148.2532 0.0000

0.0000 0.0000 0.4148 0.0012

Legend: *p<0.05; **p<0.01; ***p<0.001

Based on the statistical tests we conclude that environmental performance does not seem to have value relevance for the market value of Pakistani listed companies.

Conclusion This research paper explores that environment disclosure of Pakistani listed companies is value relevant or not. Previous studies were taken place with different financial and non-financial variables and came up with mixed findings. For this paper’s purpose, the data of financial variables; BV per share, Share price, Earnings per share and environmental rating is taken from 10 | P a g e

Bloomberg. For non-financial variable environmental rating, it fetches data from RobecoSAM (Sustainable Asset Management). This study uses data from a final sample of 35 Pakistani listed companies for 8 years from 2008 to 2015. Ohlson (1995) model was used and share price is regressed with earnings per share, book value per share, and environmental ratings. The results are not significant for environmental rating showing that environmental rating is not value relevant in Pakistan stock exchange.

There are some limitations of this research. First, the data was limited for Pakistani listed companies. The data of environmental rating was not available for many years of many companies, so our data was unbalanced panel, and this may influence our findings. Second limitation was of being an undergraduate student as we did not have access to all sources during our research like paid soft wares and paid research studies for reference. Third, we, as students did not have experience of research work. These limitations were not controlled during study and may impact the work. The research on this subject mostly needs secondary data so the field is open to further work upon. The practical implications are that Pakistan should also an independent institute like PROPER program in Indonesia by Indonesian Ministry of Environment which rate companies on the basis of their environmental performance and categorize as good performers and bad performers. Our findings show that Pakistani stock market does not value the environmental performance. It can be implied that there is no such rules and regulations in Pakistan which enforce companies to comply as these are in other countries like European countries and US.i

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