Asian Review of Financial Research Vol.23 No.2 pp.121-158
Environmental Management and Firm Value
Key Words : Environmental Management,Firm Value,National Environmental Management Award,Endogeneity,Difference-in-difference Test
The protection of environment in parallel with firms' sustainable growth has never been such an important issue as it has become today when the environmental damages have begun to threaten the global ecosystem and the survival of many plants and animals including human beings. Evidently, increasing consumption and mass production of goods to satisfy incessant consumption needs are the most significant culprit of environmental damages. Therefore, companies must take responsibilities by changing their production processes and establish procedures to control the pollution created by their production processes. But firms would not initiate such environmental management activities unless they are certain of the positive effects of incorporating environmental elements in the company management since the major goal of firms is to maximize the profit. With this issue in mind, we attempt to provide a scientific evidence that is related to the environmental management of companies. Specifically, we investigate the effect of environmental management on firm value based on the sample of firms that received the National Environmental Management Award. This award was initiated by the Korean government in 1999 and is now the most prestigious prize in the environmental management area. It has been given to firms that invest a significant portion of their resources on the environmental activities. In order to win the Grand Prize the firm must have the records of continuous environmental management activities for at least three years. As such, these firms can serve as a good proxy for the better environmental management. The environmental management could have both positive and negative impacts on firm value. Typically, firms must spend a substantial amount of capital to install and implement the pollutant control, and it is definitely a cost factor in the short-run. However, the environmental management enables firms to upgrade their corporate image as a good global citizen, which can contribute to a sales increase. It also makes firms reduce the unnecessary or marginal inputs in the manufacturing process which can lead to a decrease in production costs. Or under the circumstances wherein many countries and regions strengthen the regulation on environmental protection, the environmental management could be especially effective in preventing costly environmental lawsuits that may occur when a company ignores the environmental factors. These long-term effects will have a positive influence on firm value. Therefore, the overall impact of the environmental management must be measured by an empirical investigation. In this regard, our OLS regression results indicate that firms with significant environmental management activities have a higher Tobin's q value. Thus, we conclude that the environmental management activities by firms are not a waste of resources but actually contribute to the improvement of firm value. However, the positive relationship between environmental activities and the firm value could be spurious, since there could exist the endogeneity problem in the underlying process. In other words, it is possible that the firms with a higher value could engage in environmental management since they have resources to invest in such activities, not the other way around. In order to control the confounding effects caused by endogeneity among variables, we employ three different methods when analyzing the impact of environmental management on firm value. First, we control the firm fixed effects in panel data analysis to eliminate the possibility that the unobserved firm characteristics may generate spurious results. Second, we estimate the simultaneous equation model with two dependent variables where one of the endogenous dependent variables is a dummy variable that is also an independent variable employed to explain the other continuous dependent variable. Third, we examine the difference in firm value increase between environmental management firms and control firms by the difference-in-difference test. The difference-in-difference method allows us to observe the increase of firm value caused purely by the environmental management after controlling for the firm value changes over time and the firm value difference without environmental management. Even after controlling the endogeneity problem we obtain the results that environmental management has a strong positive relationship with firm value and the increase in firm value is economically significant. We also examine the characteristics of the firms engaging in environmental management. The results indicate that the environmental management firms are bigger in terms of total assets and sales. Most of them are also members of the 10 biggest chaebol groups and other remaining business groups that are subject to the regulation on shareholdings in other domestic companies. Since the environmental management often requires a huge amount of capital expenditure, these companies can reap the benefit of economies of scale in this regard. Then, it is understandable that bigger firms can more easily employ environmental management while, in fact, most of bigger firms are chaebol firms. Further, they should have an additional incentive to engage in environmental management, which is to countervail the negative publicity of chaebol as a whole. In addition, we find that environmental management firms spend more on advertisement and R&D and have a higher profitability and a larger cash flow from operating activities compared to the firms in control group. We conjecture that profitable firms with high cash flows are better positioned to perform environmental management since they have more resources to allocate on environmental activities. However, environmental management firms in general have shorter business histories and higher fixed debt ratios.