© 2004 Kluwer Academic Publishers. Printed in the Netherlands.
The Relationship between the Environmental and
Financial Performance of Public Utilities
GREG FILBECK1 and RAYMOND F. GORMAN2,∗
1 Adjunct Professor of Finance, University of Wisconsin – La Crosse; Senior Vice-President, Schweser Study Program, 1905 Palace Street, LaCrosse, WI 54603, USA; 2 Miami University, School of Business Administration, Oxford, OH 45056, USA; *Author for correspondence (e-mail: firstname.lastname@example.org)
Accepted 11 December 2003
Abstract. A growing body of research has centered on the issue of the relationship between ﬁnancial and environmental performance. The lack of consensus in this literature can be attributed to several factors. The cost of complying with environmental regulation can be signiﬁcant and detrimental to shareholder wealth maximization. Conversely, a ﬁrm that can effectively control pollution might also be able to effectively control other costs of production and hence earn a higher rate of return. We utilize data from the Investor Responsibility Research Center as well as a proprietary database to investigate the relationship between environmental performance and ﬁnancial performance in electric utilities. Utilities, as producers and distributors of energy, produce substantial amounts of pollution. However, since public utilities are regulated, studying the ﬁnancial and environmental performance of utilities affords us the opportunity to see what role regulation plays in enhancing or diminishing the relationship between ﬁnancial and environmental performance. Our results differ from earlier studies in that we ﬁnd do not ﬁnd a positive relationship between holding period returns and an industry-adjusted measure of environmental performance nor do we ﬁnd that regulatory climate appears to explain returns. While there does not appear to be a clearly deﬁned relationship between regulatory climate and a compliance based measure of environmental performance, there is evidence of a negative relationship between ﬁnancial return and a more pro-active measure of environmental performance. We offer several possible interpretations of these results and extensions for future research.
Key words: environment, performance, public utilities, regulation JEL classiﬁcations: G38, L94, Q30
Until somewhat recently, the ﬁnancial markets and the ﬁnancial economics literature largely ignored environmental performance as a criterion to assess whether a company is a good investment. Typically, the market paid attention only in cases where the ﬁnancial analysts determined that poor environmental management would create liabilities that would adversely affect the ﬁrm value. As such, the focus had almost entirely been on the negative side of valuation, on risk and
GREG FILBECK AND RAYMOND F. GORMAN
exposure to environmental liabilities rather than on environmental performance as a success factor. The case for looking upon environmental cost drivers as creators of values, as opposed to treating them purely as potential liabilities, had not been effectively communicated to investors. This undoubtedly made it more difﬁcult for investors to identify, and then to evaluate, the ﬁnancial consequences of environmental activities.
More recently, the relationship between corporate environmental and ﬁnancial performance has attracted increasing attention in the empirical literature as well as in the business community. The traditional perspective viewed environmental expenditures, whether on waste treatment and removal or pollution prevention strategy, as a drain on ﬁrm resources and a commitment of funds to non-productive uses (Palmer et al. 1995). However, a growing movement argues that pollution prevention and the associated re-evaluation of a ﬁrm’s production processes creates opportunity for the ﬁrm to strategically alter production (e.g., to...