Corporate environmental performance and its impact on financial performance and financial risk: Evidence from Australia

Abstract

This thesis consists of four essays on Corporate Environmental Performance (CEP) and its impact on Corporate Financial Performance (CFP). The first essay is entitled “Emission Indices for Hazardous Substances: An Alternative Measure of Corporate Environmental Performance”. This essay reviewed significant interdisciplinary research and concluded that firm chemical release/emission can be used as a proxy for a firm measure of environmental performance. It also proposed that due to the variety of chemicals and different levels of toxicity, a risk factor should be calculated for all chemicals on the basis of human health risk, environment risk and risk of exposure. Once a single risk factor is calculated for each chemical, then it should be multiplied by the level of each company chemical release that is reported to National Pollutant Inventory in order to calculate the weighted average risk factor for each company. Thus, the weighted average risk is a robust measure having the combined effect of level of toxicity and volume of chemical emissions. Once the environmental performance index is formulated, the second essay investigated the nature of the relationship between environmental performance and financial performance of publicly listed companies in Australia. The second essay provided evidence that the nature of the relationship between environmental performance and financial performance is positive. Further, this study divided the sample into a period of economic growth (2001-2007) and a period of economic contraction (2008-2010). The multivariate regression estimation shows a positive relation between CEP and CFP in the period of economic growth but during the extra ordinary circumstances like the financial crisis this relationship is insignificant. This research is of great relevance for managers, academics and society at large. The third essay investigates the relationship between Corporate Environmental Performance (CEP) and financial risk for Australian listed companies from 2001-2010. Three financial risk measures including firm market risk, systematic risk and downside risk were used. The analytical procedure based on fixed effects estimation provides strong evidence that environmental performance is negatively and statistically associated with market volatility and to different measures of downside risk. The third essay results show that downside risk is a better measure of firm risk especially when investors are not showing linear sensitivity to changes in prices. Therefore, this study concludes that environmental performance (reduction in toxic emissions) provides a wealth protection effect. The results are robust after controlling for several moderating effects including financial, institutional and environmental management. The fourth essay analyses the causal relationship between firm financial performance and environmental performance. The results provide convincing support for the idea that there is a bi-directional relationship between CEP and CFP in both the short and long run. These results support the Hart and Ahuja (1996) hunch that a ‘virtuous circle’ exists with regard to the relationship between pollution prevention and CFP, that is, firms can realize cost savings and plough these savings back into further emission reduction projects for a number of years before the benefits balance turns negative.