Environmental Costs and Firm Value

• DOI: http://doi.org/10.1111/ajfs.12153
• Published date: 01 December 2016
• Author: Hakkon Kim,Kwangwoo Park,Hoje Jo
• Date: 01 December 2016

Environmental Costs and Firm Value*

Hoje Jo

Leavey School of Business, Santa Clara University

Hakkon Kim

**

Department of International Business, College of Business, Chungbuk National University

Kwangwoo Park

College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Received 18 May 2016; Accepted 15 September 2016

Abstract

Using a unique worldwide dataset, this paper examines how environmental costs affect firm

value. We maintain that firms gain reputation and enhance firm value by decreasing their

environmental costs. This argument is labeled as the stakeholder value maximization-based

reputation building hypothesis. Our results, however, show that there are regional variations

in the relation between firm value and environmental costs. We further find that an increased

firm value resulting from lower environmental costs is pronounced among firms during the

Kyoto Protocol commitment period, especially in environmentally conscious countries. This

evidence is consistent with the view of the differential recognition hypothesis.

Keywords Corporate environmental responsibility; Environmental costs; Firm value; Reputa-

tion building hypothesis; Differential recognition hypothesis; Kyoto Protocol

JEL Classification: G30, G32, Q51

*Hoje Jo acknowledges support from a sustainability research initiative grant at Santa Clara

University. The authors are grateful for valuable comments by Rick Vanden Bergh, Kevin

Chiang, Steve Dempsey, Rocki DeWitt, David Jones, Jung Bien Moon, Tom Noordewier, and

seminar participants at KAIST, Nanyang Technology University, National University of

Singapore, Singapore Management University, and the University of Vermont. This research

has benefited from the green finance MBA program sponsored by the Financial Service

Commission of Korea. This research also has been supported by the Korean Ministry of

Science, ICT, and Future Planning through the Graduate School of Green Growth at KAIST

College of Business in 2014.

**Corresponding author: Hakkon Kim, Department of International Business, College of

Business, Chungbuk National University, Chungdae-ro 1, Seowon-Gu, Cheongju, Chungbuk

28644, Korea. Tel: +82-43-261-2344; Fax: +82-43-273-1451; email: kimhk0283@chungbuk.ac.

kr.

Asia-Pacific Journal of Financial Studies (2016) 45, 813–838 doi:10.1111/ajfs.12153

©2016 Korean Securities Association 813

1. Introduction

In corporate finance practices, corporate environmental responsibility (CER) has

gained increasing attention because the issue of climate change and the environment

has emerged as one of the important factors for managerial decision making in recent

years.

1

However, there has been considerable debate over whether CER activities can

be beneficial for shareholder value. There are two competing explanations: agency the-

ory and stakeholder value maximization theory. Traditional views assume that a cor-

poration’s goal should be to generate profits, and environmentally friendly programs

are thought to disadvantage shareholders, with negative long-term effects on share

value. Jensen and Meckling’s (1976) principal–agent theory, in particular, argues that

managers have an interest in over-investing in the environment if doing so provides

model managers with the private benefits of reputation building, however, this may

come at a cost to shareholders. In contrast, proponents of stakeholder value maxi-

mization theory (e.g. Bae et al., 2011; Deng et al., 2013) believe that corporations with

stakeholder-friendly programs improve their reputations, which then positively affects

future financial performance and leads to an increase in shareholder wealth.

Although these studies have enhanced our understanding of the interactions

between firms’ stakeholder relationships and corporate decisions, they only do so

from the stakeholder-friendly initiatives-financial performance perspective, with

almost no attention to the influence of environmental costs (ECs) on firm value.

This lack of evidence is surprising, given that firms’ ECs are increasingly being

viewed as one of the most important factors in competitive success.

2

In this study, we explore the empirical association between ECs and firm value

(FV), based on the underlying assumption that a key driver of CER engagement is

the potential for EC savings associated with measures such as energy, materials, and

waste reduction in manufacturing companies (King and Lenox, 2002). The EC–FV

association, however, has been largely overlooked in the literature, with little evi-

dence on the significance or economic magnitude of the relation between ECs and

1

Until recently, a typical firm’s CER activities have been considered elements of its corporate

social responsibility (CSR) activities.

2

Although it is difficult to put an accurate figure on exactly how detrimental large corpora-

tions are to the environment, Green (2010), in his UN report, suggests that the world’s top

3000 companies created $2.2 trillion in environmental damage costs in 2008 alone. Green

(2010) further suggests that if these firms were held financially responsible for the costs asso-

ciated with pollution, it would “wipe out more than one-third of their profits.” All 500 com-

panies on the Standard & Poor index were included in the report (http://dirt.asla.org/2010/

02/24/new-u-n-report-worlds-top-3000-companies-created-2-2-trillion-in-environmental-

damage/). Undoubtedly, the potential for EC savings, especially for manufacturing compa-

nies, could mean sizeable savings in companies’ production costs. According to Vogel (2005),

Dupont has saved $2 billion due to energy efficiency practices, BP made $650 million in sav-

ings from its energy reduction strategies between 1998 and 2002, and IBM saved $792 million

between 1990 and 2002.

H. Jo et al.

814 ©2016 Korean Securities Association