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Does the market reward firms for being more green or less brown?

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Abstract

This paper examines whether the market rewards firms for superior green performance or for being less brown. It finds that the market punishes brown firms and rewards them for improving environmental performance but does not pay a premium for green firms and does not punish green firms for deteriorating environmental performance. Brown firms have greater extreme losses due to elevated environmental risks. Increasing environmental related investments is associated with reduced risk, increased firm value for brown firms but decreased firm value for green firms. Overall, results in this paper indicate that market reward firms for reducing exposure to environmental risks but not for being green.

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Data availability

The datasets generated during and/or analyzed during the current study are available in the WRDS and Bloomberg.

Notes

  1. Since these environmental performance rankings are based on the firm environmental performance in the previous year, to examine the contemporaneous relation between environmental performance and firm returns (excluding the announcement effect), returns from one year before the rankings are employed. As these environmental rankings are publicized, they become available to the public and retail investors and attract investors attention. To factor in the market response from the public and retail investors as well as market attention, this study also examines the excess returns after the rankings are announced.

  2. Newsweek has been ranking SP 500 firms every year since 2009 except in the year 2013 due to a change in editorship in that year.

  3. Since Newsweek use different metrics for environmental scores over time, therefore, environmental rankings are the more relative informational measure for environmental performance. Hence, we do not present the summary statistics for environmental scores.

  4. GICS industry groups have 24 different industries. They are used in this study because firms are more evenly distributed in GICS sectors than other classification systems such as SIC one digit or two digits codes.

  5. The adjusted market model uses abnormal returns defined in excess of CRSP value-weighted market return, instead of SP 500 return. The market model uses abnormal returns defined according to the CAPM.

  6. The adjusted market model shows positive excess returns for all ranking portfolios except portfolio 10, and the four-factor model indicates negative excess returns for all ranking portfolios. This difference is mostly due to the size factor in the four-factor model. Since our sample covers SP 500 firms, which are large firms and tend to have lower returns than small firms. Hence, the excess returns from four-factor model after adjusting for size are negative for these large firms. However, our focus here is on the variation pattern of excess returns, which is qualitatively similar between the two models.

  7. We focus on environmental rankings since their values are more consistent than environmental scores. Environmental scores are calculated using different metrics over the sample period.

  8. We have tried the top(bottom) 25/50/75/100/125/150 firms and find that the top 25 and 50 firms have significant results, but not the top(bottom) 75 or higher numbers. Hence, we use the top and bottom 50 firms as proxies for green and brown firms.

  9. Examining excess returns over one year before the announcement dates reflects the contemporaneous relation between environmental performance and firm performance per se, excluding the announcement effect. Employing excess returns over the event year incorporates the investor attention effect and responses from small investors. Examining excess returns over the event year also reduces the contamination effect from environmental rankings in previous year or the next year. To investigate market reaction to the announcement of environmental rankings, this paper employs event studies.

  10. RD expense from the year before ranking is used to reflect the lagged effect of RD investment on Tobin’s Q.

  11. Environmental ranking does show a significant and positive relation with Tobin’s Q in firm fixed effect model, however, this relation lost its significance after green and brown dummies are added.

  12. We also compared profit margin and return on equity between decile 1 and 10 and do not find significant differences. Hence, the low market performance for firms in decile 10 is not due to low profitability.

  13. Almost all firms’ rankings change from year to year. The average in the absolute value of changes in rankings from year to year is 67 with a standard deviation of 69.

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Acknowledgements

The author would like to Jane Payne, Ivilina Popova, Subramanian R. Iyer for their insightful comments.

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  1. Department of Finance and Economics, Texas State University, 601 University Dr., TX, 78666, San Marcos, USA

    Yifan Liu & Leyuan You

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  1. Yifan Liu
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  2. Leyuan You
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Correspondence to Leyuan You.

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Appendix

Appendix

Table 9

Table 9 Panel A regress excess returns over one year before ranking on environmental rankings and dummies
Full size table

Table 10

Table 10 MCAR for the environmental neutral firms with rankings of 201 to 300
Full size table

Table 11

Table 11 Tobin’s Q and environmental rankings and dummies
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Liu, Y., You, L. Does the market reward firms for being more green or less brown?. J Econ Finan 47, 564–585 (2023). https://doi.org/10.1007/s12197-023-09633-y

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