The Economic Value of Corporate Eco-Efficiency

Nadja Guenster

RSM Erasmus University

SRI in the Rockies

September 27, 2005

CONTRIBUTION

We investigate the relationship between eco-efficiency, operating performance (Return-on-Assets) and valuation (Tobin’s q)

• Eco-efficiency is a closely defined and comprehensive measure• Eco-efficiency data are available on a monthly basis from

December 1996-2002• Relate eco-efficiency to accounting-based and market-based

financial performance criteria• Investigate the relation between these criteria and eco-

efficiency over time• We relate our current results to prior research on SRI

FRAMEWORK

Eco-Efficiency

Risk-adjusted long-run stock returns

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Operating Performance:Return-on-Assets (ROA)

Valuation: Tobin’s q

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Eco-efficiency is positively related to operating performance (ROA)

Eco-efficiency is positively related to firm valuation (Tobin’s q)

Portfolios of most eco-efficient companies outperform portfolios of least eco-efficient companies by about 6% annually (Derwall et al., FAJ, 2005)

These abnormal long-run stock returns should over time translate into a higher valuation for more eco-efficient companies

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DATA

• Financial data are obtained from the Compustat US Research Database

• Monthly “Eco-efficiency Ratings” for 154 to 408 US firms (1996-2002) provided by Innovest

Innovest defines eco-efficiency along 5 dimensions:

• Historical liabilities: involves risk resulting from preceding actions

• Operating risk: risk exposure from recent events

• Sustainability and eco-efficiency risk: future risks initiated by the weakening of the company’s material sources of long-term profitability and competitiveness

• Managerial risk efficiency: the ability to handle environmental risk successfully

• Environmentally-related strategic profit opportunities: business opportunities, such as a competitive advantage

METHODOLOGY: FAMA-MACBETH (1973, JPE)

We estimate 24 quarterly regressions from 1997-2002:

Performance measurei1 = 1 + 1 Eco-efficiencyi1 + 1Xi1+ i1

.

.

.Performance measurei24 = 24 + 24 Eco-efficiencyi24 + 24Xi24+ i24

Time-series statistics

This approach allows us to investigate the time-variation of the effects of eco-efficiency on firm performance

ECO-EFFICIENCY AND ROA

Fama-MacBeth regressions of a firm’s ROA on a set of independent variables, using:

• The firm’s eco-efficiency score• Controls: Firm size, Debt/Assets, Total sales• Several measures of ROA: regular & industry-neutral

Our results indicate that there is a positive and significant association between eco-efficiency and ROA

A one-point increase in the eco-efficiency rating corresponds to a 2.1% increase in ROA

Asymmetric effect: least-eco-efficient firms display significant operational underperformance relative to the remainder of firms; most eco-efficient firms do not display significant operational outperformance

*** significant at 1% level** significant at 5% level* significant at 10% level

(-1.74) (-1.35)   

-6.36 E-6 *-8.44 E-6SALES

(-5.95)(-6.93)(-5.95)(-6.84)

-2.39***-4.04***-2.33***-3.99***DEBT / ASSETS

(-4.64)(-8.98)

-2.62 E-6 ***-4.98 E-6 ***SIZE

(0.10)(0.69)(0.19)(0.87)

0.010.060.010.07ECO HIGH

(-7.69)(-6.72)(-7.91)(-7.53)

-0.38***-0.37***-0.39***-0.39***ECO LOW

(7.30)(24.10)(7.66)(25.03)

0.55***4.71***0.56***4.77***Intercept

Ind.- adj. ROA ROA Ind.- adj. ROA ROA 

EXAMPLE OF RESULTS

We find a positive and asymmetric relation between eco-efficiency and ROA

ECO-EFFICIENCY AND TOBIN’S Q

Fama-MacBeth regressions of a firm’s Tobin’s q on a set of independent variables, using:

• The firm’s eco-efficiency score• Controls: Firm size, Age, R&D, Advertising, Nasdaq Dummy• Several measures of Q: regular, log, trimmed, industry-neutral Q

Results indicate that there is a positive and significant association between eco-efficiency and Tobin’s q

A one-point increase in the eco-efficiency rating corresponds to a 3.4% increase in Q

Asymmetric effect: especially low-ranked companies have lower Q values; high-ranked firms did not display a significant positive association with Q over the whole period.

-3.11E-6*** -1.25E-6*** -1.31E-6*** -3.21E-6***Size

11.01*** 3.02*** 4.48*** 11.27***R&D

0.01 0.01***-0.00-0.02AGE

1.39*** 0.36*** 1.26*** 1.49***SG

-0.020.02-0.030.02ECO HI GH

-0.32*** -0.10*** -0.32*** -0.31***ECO LOW

1.79*** 0.45***0.12 1.81**Intercept

Trimmed QLog(Q)Q Ind. Adj.Q

EXAMPLE OF RESULTS

We find a positive and asymmetric relation between eco-efficiency and Q

*** significant at 1% level** significant at 5% level* significant at 10% level

The Eco-Efficiency Premium Puzzle (FAJ, 2005)

Derwall et al. compose two equity portfolios. One consists of the most eco-efficient companies while the other one consists of the least eco-efficient companies.

They compare the returns on these portfolios using performance attribution models and find:

• The most eco-efficient portfolio earns an abnormal return of 6% p.a. compared to the least eco-efficient portfolio

• The performance differential between the portfolios is due to the outperformance of the most eco-efficient companies. The least eco-efficient companies hardly underperform compared to a benchmark

These abnormal returns should over time translate into higher prices for the most eco-efficient firms compared to least eco- efficient firms.

ECO-EFFICIENCY AND TOBIN’S Q: A time-varying relation (I)

ECO-EFFICIENCY AND TOBIN’S Q: A time-varying relation (II)

-3.59E -6*** -2.87E-6***Size

8.46** 14.09***R&D

-0.03 0.04*AGE

1.36***1.62***SG

ECO HI GH

ECO LOW

2.27*** 1.36***

Intercept

Period 2Q

Period 1Q

-0.42***

-0.24***

-0.20

0.21***

During the first half of our sample period, we find that the least eco-efficient and the most eco-efficient companies trade at a discount.

During the second half, the most eco-efficient companies trade at a significant premium.

ECO-EFFICIENCY AND TOBIN’S Q: A time-varying relation (III)

The valuation differential between the most eco-efficient and the least eco-inefficient companies increases over time

Value of most eco-efficient companies versus least eco-efficient companies

-0.50

-0.30

-0.10

0.10

0.30

0.50

0.70

0.90

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

SUMMARY (I)

Eco-efficiency and operating performance (ROA):

• Significantly positive relation

• While most eco-efficient firms don’t outperform, least eco-efficient firms perform much worse

Eco-efficiency and valuation (Tobin’s q):

• Significantly positive relation

• While the most eco-efficient firms don’t have a higher valuation, the least eco-efficient firms trade at a substantial discount

During our complete sample period, the benefits of eco-efficiency at least outweigh the costs

SUMMARY (II)

Eco-efficiency and valuation (Tobin’s q) over time: • The most eco-efficient firms traded at a discount at the beginning of our sample

period. Over time a premium arises• The least eco-efficient firms traded at a discount during the first half of our

sample period. During the second half, the discount is not statistically significant

• This evidence is in line with the abnormal returns on portfolios of eco-efficient companies reported by Derwall et al.

While investors used to punish the least eco-efficient and most eco-efficient firms at the beginning of our sample, they reward the most eco-efficient firms towards the end of our sample period

The financial market increasingly values the benefits of eco-efficiency during our sample period