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Does environmental performance improve market valuation of the firm: evidence from Indian market

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Abstract

Current regulatory mechanism is costly and ineffective due to weak enforcement of environmental standards in India. Harnessing the capabilities of capital markets could be a better strategy for environment friendly economic growth. Therefore, the paper aims to examine a relationship between a firm’s environmental performance and its market valuation. The study uses market value as an indicator of the financial performance using the Ohlson (Contemp Account Res 11:661–687, 1995) model, which is a better indicator in an emerging economy compared to Tobin-q and is free from the biases that Tobin-q suffers from. The study finds a positive relationship between the number of voluntary environment program implemented by a firm and its market value and significant negative relationship between a firm’s market value and pollution index. However, the relationship between resource use index and market value is not found to be statistically significant. The study indicates that India could harness the power of capital markets for improving industrial environmental performance.

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Notes

  1. For improving industrial energy efficiency, Government of India launched a program known as PAT (Perform, Achieve and Trade) in 2012 which is a market based program wherein the industrial units are given the energy efficiency targets and are allowed to meet the targets using the markets for energy efficiency certificates. A program known as REC (Renewable Energy Certificate) was initiated in 2009 to meet renewable energy targets set for the electricity distribution companies. In the category of taxation, there is a cess on coal consumption in India.

  2. Accounting based measures reflect short term or past financial performance of the firm whereas market based measures reflect both current information as well as future prospects. Moreover, market based measures incorporate all relevant (financial and non-financial) information, unlike accounting base measures, and are not limited to a single aspect of firm performance. For details see, Gentry and Shen (2010) and Sarkar and Sarkar (2012).

  3. Both Tobin q and Market to Book Value Ratio (MBVR) could be used as indicators of market valuation in developed capital markets as measures of market performance. MBVR is a ratio of the product of the number of equity shares and the closing price of the share on the last day of the financial year to the book value of equity and reserves. Tobin q is defined as a ratio of market value of equity and debt to the replacement cost of assets. No specific computational adjustments are required to compute MBVR for developing economies like India. However the calculation of Tobin q is difficult in these countries primarily because a large proportion of the corporate debt is institutional debt that is not actively traded in the debt market. Moreover most companies report asset values to historical costs rather than at replacement costs. For details please see, Sarkar and Sarkar (2012).

  4. Porter and van der Linde (1995) suggest that pollution is a waste of resources and a reduction in pollution improves productivity through better use of resource. This is known as Porter hypothesis. Several studies have been carried out towards validating Porter hypothesis.

  5. Tobin q is defined as the ratio of market value to replacement cost and market value comprises both, tangible and intangible valuation. Tangible valuation is equal to replacement cost, thus Tobin q − 1 is the measure of intangible valuation.

  6. Gupta and Goldar (2005) uses the environmental rating produced and announced by Centre for Science and Environment (CSE), an NGO, as an indicator of environmental performance and related it with the stock prices on the firm with the declaration of environmental performance by the CSE.

  7. Since these studies have been mostly related to the developed economies like US, EU, Japan, where stock markets are well developed and accounting standards are well defined and stringent, hence Tobin q would have been appropriate.

  8. Accounting earning is also termed as abnormal earning in the accounting literature.

  9. For comparison between MBVR and Tobin q, please refer to footnote 2.

  10. Pollutant index is constructed by scaling down each observation of pollutant such as NO x , SO2 and SPM by its maximum value for the respective sector of the sample. Then the pollution index is defined as the geometric mean of the three relative indices of NO x , SO2, and SPM. The range of this index is from zero to one. It takes the value one for the firm with the least compliance and approaches zero for the firm with the maximum compliance or zero pollution. Similar kind of indexes were used by Gollop and Roberts (1983) and Murty and Kumar (2003).

  11. We could get information for 19 firms belonging to cement sector, 20 firms belonging to the steel sector and 10 firms belonging to the power sector.

  12. It may be suspected that the firms those who are doing better environmentally report to the pollution control boards, and the results would suffer from selection bias. But note that it is mandatory for all the polluting firms to report to the pollution control boards in India and we get the information from the pollution control boards rather than from the firms directly implying that the results are not suspect to selection bias.

  13. ACE Equity is a desktop based application which gives a comprehensive and analytical statistics for company information with user friendly navigation (http://www.accordfintech.com/ace-equity).

  14. The GRI was formed by the United States based non-profits Ceres (formerly the Coalition for Environmentally Responsible Economies) and Tellus Institute, with the support of the United Nations Environment Programme (UNEP) in 1997. The firm reports their sustainability performance, which includes the environmental performance using the GRI guideline. This report is independently verified by a third party approved by the GRI.

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Authors and Affiliations

  1. Department of Economics, Delhi School of Economics, University of Delhi, Delhi, 110007, India

    Surender Kumar

  2. ERM India, Gurgaon, India

    Shivananda Shetty

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  1. Surender Kumar
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  2. Shivananda Shetty
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Correspondence to Surender Kumar.

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Kumar, S., Shetty, S. Does environmental performance improve market valuation of the firm: evidence from Indian market. Environ Econ Policy Stud 20, 241–260 (2018). https://doi.org/10.1007/s10018-017-0192-7

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