The effect of ISO 14001 certification announcements on stock performance
Antony Paulraj Department of Management Coggin College of Business University of North Florida 1 UNF Drive, Jacksonville, FL 32224
Pieter J. de Jong1 Department of Accounting and Finance Coggin College of Business University of North Florida 1 UNF Drive, Jacksonville, FL 32224
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Corresponding author:
[email protected]
The effect of ISO 14001 certification announcements on stock performance
Abstract Purpose: This study aspires to explore how the United States stock market reacts to ISO 14001 certification announcements. Design/methodology/approach: The manuscript employs an event-study methodology on a sample of 140 announcements and matching control firms to study the impact of ISO 14001 certification announcements. Findings: Our results suggest that ISO 14001 certification announcements have a negative impact on stock performance. More importantly, it shows that the shareholder wealth reduced due to these certifications announcements. Research limitations/implications: This study focuses on short-term stock market reaction. Future studies should consider the entire sample of ISO 14001 certified firms within the US and use certification date to evaluate short-term as well as long-term improvements in shareholder wealth. Practical implications: Our results suggest that firms will need to educate shareholders about their actions towards the betterment of the environment. Such coordinated communication will ensure that the ISO 14001 standard is highly regarded, widely adopted, and even requested by shareholders. Originality/value: Past empirical studies indicate that certified EMSs help organizations to reduce waste and pollution, thereby ultimately resulting in superior environmental and economic performance. At the same time, given its focus on the process rather than performance outcomes, opponents criticize ISO 14001 suggesting that it is just a label for image-building. Due to this dilemma, it is pertinent to evaluate how shareholders perceive a firm’s attainment of ISO 14001 certification announcements. Keywords: Environmental management systems; ISO 14001; event study; stock performance. Paper Type: Research Paper
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1. Introduction That deterioration in the natural environment is significantly related to business activities is a recently recognized fact. Accordingly, rather than being considered antithetical to a sound business strategy, environmental responsibility is viewed as a basic requirement for firms within every industry, and, more importantly, manufacturing (Montabon et al., 2000). Understanding that adequate environmental performance is at the very least a competitive parity, firms within diverse industries are incorporating pollution prevention as well as waste reduction initiatives. At the basic level, most firms adopt environmental practices due to the pressure from external stakeholders. Alternatively, progressive firms go beyond these minimal expectations and voluntarily adopt a variety of environmental programs that will help in improving their environmental performance. One such touted initiative is the environmental management system (EMS) that consists of creation, planning, implementation, and review of environmental policies that could help in reducing the environmental impact of a firm’s processes (Coglianese and Nash, 2001; Delmas, 2001). EMSs are also increasingly recognized as comprehensive mechanisms for improving performance along economic as well as environmental dimensions (Darnall and Edwards, 2006). Once implemented, the organization could consider the option to certify their EMS using international standards. The ISO 14001 and the European Eco-Management and Audit Scheme (EMAS) are the two most widely adopted standards. Of these two, the ISO 14001 is the most widespread “global” standard due to its intention to motivate any organization, regardless of its size or type or geographical location, to be environmentally clean (e.g., Darnall, 2006; Epstein and Roy, 1998; Morrow and Rondinelli, 2002; Russo, 2009). In fact, by the end of 2007, nearly
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154,572 organizations in 148 countries had formally certified their EMS under the ISO 14001 standard (ISO, 2007), corroborating its widespread adoption around the world. In light of its world-wide recognition, numerous operations management scholars have addressed research questions revolving around the ISO 14001 standard. One stream of research focuses on finding the reasons why firms adopt this standard. A majority of researchers evaluate external forces (stakeholder pressure and legitimacy) and internal capabilities as key reasons for a firm’s interest in achieving certification (e.g., Bansal and Hunter, 2003; Darnall, 2006; Darnall and Edwards, 2006; Delmas, 2002; King and Lenox, 2001; Russo and Fouts, 1997). Alternatively, another important stream of research studies the effect of ISO 14001 certification on the environmental and financial performance of firms (e.g., Delmas, 2001; Montabon et al., 2000; Melnyk et al., 2003; Russo, 2009; Sroufe, 2003). Given the mostly positive relationship between ISO 14001 and firm performance (environmental as well as financial), it is logical to expect an increase in the shareholder wealth (based on stock performance) following these certifications. But, there is a scarcity of research addressing this key research question. To the best of our knowledge, Arts and Vos (2001) is the only study that has evaluated the impact of ISO 14001 certification announcements of New Zealand firms on their stock performance. Therefore, it is important to see how these certifications impact stock performance within the United States (US). Accordingly, we adopt the event study methodology to test how the stock market reacts to the ISO 14001 certification announcements of US firms. The empirical evaluation of this research question is pertinent and compelling due to various reasons. First, the relationship between ISO 14001 certified EMS systems and environmental performance has been slightly mixed. While most studies have found positive impact, a few articles have found weak or negative impact on environmental performance (e.g.,
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King et al., 2005; Russo and Harrison, 2005). Second, critics note that the ISO 14001 is often used as a label for image-building and does not necessarily result in superior environmental performance (Bansal and Hunter, 2003; Krut and Gleckman, 1998). Third, the costs associated with EMS implementation and the subsequent ISO 14001 certification are not trivial2. Fourth, the adoption of ISO 14001 within the US is the lowest when compared to other developed nations. Therefore, even though past research suggests that adoption of EMSs will (1) result in superior long-term environmental and economic performance; and, (2) signal progressive thinking by a firm, investors might not perceive it accordingly. Therefore, by empirically studying the reaction of shareholders to the attainment of ISO 14001 certifications, we believe that our study attempts to address whether the ISO 14001 certification is worth given the significant resource investment required.
Additionally, by studying the link between
certification announcements and stock market performance, we believe that our study will make a significant contribution to current literature on EMSs. In summary, this paper aspires to study the effect of ISO 14001 certification announcements on short-term stock market performance. We use the abnormal returns around the date of certification announcement to estimate this relationship. We also examine how other factors such as size and timing of certifications affect the magnitude of certification announcement impacts on the stock market. The following section reviews previous research focusing on ISO 14001 certifications and its effect on performance. Section 3 explains the research methodology including sample collection, and the method used to test the hypotheses. Section 4 presents the empirical results of this study. Section 5 presents discussion and 2
For example, Darnall (2006) point out that the cost associated with creating and certifying an EMS will approximately range between $268 to $1460 per Employee. Therefore, apart from the organizational commitment, ISO 14001 certification also involves a significant financial commitment by organizations. Interested readers are also recommended to read Darnall and Edwards (2006) to understand how the capabilities existing within a firm could favorably reduce the cost associated with EMS implementation and certification.
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implications of the study findings. Finally, Section 6 highlights some limitations of the study and offers suggestions for future research. 2. Literature Review and Hypotheses 2.1. Environmental Management Systems and the ISO 14001 Certification Environmental management can be defined as a structured approach that organizations adopt to ensure that their processes have a minimal, if not any, negative impact on the natural environment. By systematizing and integrating environmental protection into the overall management practices, an EMS can help organizations to identify as well as manage their environmental obligations and risk, thereby resulting in significant cost-savings and superior business performance (Bansal and Bogner, 2002; Coglianese and Nash, 2001; Epstein and Roy, 1998). Accordingly, researchers argue that an EMS is very essential to environmental management and that firms cannot achieve competitive advantage unless they have a “certified” system in place (Melnyk et al., 2003). Although critics argue that certification of an EMS does not guarantee better environmental performance, a growing number of scholars refute this by rightly pointing out that it does provide a set of guidelines that can facilitate a comprehensive, systematic, and proactive management of the processes that could ultimately lead to sustainable competitive advantage (e.g., Hart, 1995; Porter and van der Linde, 1995; Russo, 2009). The ISO 14001 EMS standard includes seven key requirements: (1) creating an environmental policy; (2) setting objectives and targets that will ensure that the tenets of the policy are met; (3) implementing procedures and practices that will enable meeting the objectives and targets set; (4) monitoring and measuring the procedures and practices for their effectiveness; (5) correcting the problems identified; (6) reviewing the entire system; and, (7) continually improving the system and consequently, the overall environmental performance
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(Tibor and Feldman, 1996; von Zharen, 2001). ISO 14001 can be used by a single plant or an entire organization to model and implement its EMS. The guidelines follow Deming’s (1986) Plan-Do-Check-Act “continuous improvement” cycle. However, ISO 14001 is not a performance-based standard. It does not mandate an optimum environmental performance level for firms. Rather, it focuses on the underlying processes and helps organizations to set and achieve their own environmental objectives (Melnyk et al., 2003). It mandates that firms routinely scrutinize their operations and increase their knowledge about any underlying issues and efficiencies, continually evaluate the interactions between their operations and the environment, train and involve their employees in all environmental initiatives, and routinely monitor as well as improve the mechanisms adopted (Bansal and Bogner, 2002; Darnall and Edwards, 2006). Moreover, it has the potential to cut across the functional silos and integrate environmental practices among the diverse functions within an organization (Delmas, 2001). Due to these unique characteristics, it can help companies reduce their environmental liabilities, increase efficiency through the reduction of waste and pollution, increase awareness of environmental practices and impacts among employees, and ultimately enhance their environmental image and confer on them external legitimacy (Darnall, 2006; Rondinelli and Vastag, 2000). Given its international recognition in managing environmental impacts, numerous multinational corporations have certified their EMSs under the ISO 14001 standard. Consequently, in light of its widespread acceptance, numerous researchers have delved into evaluating the reasons why organizations adopt ISO 14001 certified EMSs and the potential impact such a system will have on improving the environmental, as well as operational, performance. A few of these empirical studies focusing on the latter topic are illustrated to
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showcase the significant impact that ISO 14001 certified EMSs can have on corporate performance. In their study of Alcoa’s Mt. Holly plant, Rondinelli and Vastag (2000) found a significant improvement in (1) employee and managerial awareness; and, (2) operational efficiency and effectiveness after three years of ISO 14001 certification. Based on their survey of 116 US manufacturing firms, Montabon et al. (2000) found that ISO 14001 certified EMSs have a significant positive impact on the efficiency and effectiveness of their firms. Florida and Davidson (2001), in their study of pollution prevention practices in Pennsylvania, found that firms adopting EMSs realized significant in-plant improvements, including increased pollution prevention, worker safety, and waste reduction. Melnyk et al. (2003) conducted an empirical study involving 1222 manufacturing firms and found that certified EMS helps firms to go beyond pollution abatement and achieve positive impact on many dimensions of corporate performance. Sroufe (2003) used a large scale survey research to study the impact of EMS and ISO 14001 on manufacturing firms within the United States. Utilizing the structural equation modeling approach, he found that certified EMSs not only improve environmental performance, but they also improve the environmental design, manufacturing, and waste practices adopted by firms. Using Japanese facility-level data, Arimura et al. (2008) found that ISO 14001 is effective in reducing natural resource use, solid waste generation, as well as waste water effluent. Most recently, by adopting the dynamic capability theoretical perspective, Russo (2009) found that the longer a firm is certified, the better the effect on emissions reduction. Collectively, the above studies prove that ISO 14001 certified EMSs result in superior environmental and operational performance. Hence, it is logical to expect financial markets to react favorably to these certifications and result in an increase in shareholder wealth. Unfortunately, Arts and Vos (2001) is the only study that has evaluated the impact of ISO 14001
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certification announcements of New Zealand firms on stock performance. Though not specifically related to ISO 14001 certifications, Klassen and McLaughlin (1996) adopt an event study approach to study the impact of environmental management awards on firm performance. Using archival data of firm-level financial performance, they find that environmental award announcements were associated with an increase in stock market valuation. Therefore, there is a scarcity of research addressing this pertinent research question. Accordingly, we believe that it is important to empirically evaluate how ISO 14001 certifications announcements impact stock performance, specifically within the US context. With this belief, we forward a few hypotheses in the following section to study the impact of certification announcements. 2.2. Hypotheses Organizations that adopt a certified EMS can benefit significantly by improving their compliance with regulatory norms, thereby ultimately enhancing their corporate image (Darnall et al., 2008). As illustrated in the previous sections, extant literature also provides sufficient evidence that these systems are associated with superior environmental, as well as financial, performance (e.g., Bansal and Bogner, 2002; Delmas, 2001; Montabon et al., 2000; Melnyk et al., 2003; Porter and van der Linde, 1995; Russo, 2009; Sroufe, 2003). This is in line with the ideology it “pays to be green,” which purports that firms with certified EMSs will receive significantly higher economic and market incentives, as well as risk reduction incentives (Christmann, 2000; Feldman et al., 1996; King and Lenox, 2001; Klassen and McLaughlin, 1996). These incentives are supposedly facilitated by the key requirements of the ISO 14001 certification that enables organizations to specify environmental goals, execute these goals through appropriate actions, monitor these actions, and correct the root causes of deviations, if any, from the set goals (Kitizawa and Sarkis, 2000).
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Alternatively, according to the “costs to be green” perspective, implementation, certification, and continuous maintenance of EMSs can enforce a significant cost burden on firms (King and Lenox, 2002; Klassen and Whybark, 2000; von Zharen, 2001). But, as put forth by the traditional economic theory, firms will not adopt voluntary mechanisms, including environmental ones, unless they expect the benefits accrued through them to outweigh the associated costs (Khanna, 2001; Welch et al., 2002). Accordingly, with the realization that a certified EMS could not only offset the cost burden, but also save companies significantly more money through waste reduction and pollution prevention (Melnyk et al., 2003; Russo, 2009), it is argued that ISO 14001 certification will improve the investor confidence in a firm (Rondinelli and Vastag, 2000). Moreover, firms that implement voluntary systems to address environmental aspects could be favorably perceived in the financial markets as those of elevated environmental commitment and lower levels of risks (Welch et al., 2003). This perception has actually been empirically validated by Arts and Vos (2001) in their study of New Zealand firms. They find a significant positive impact of ISO 14001 certification announcements on stock performance. Therefore, following past research espousing it “pays to be green,” we hypothesize that: H1: The announcement of ISO 14001 certification will have a positive stock market reaction. Implementation of EMSs and their subsequent certification involves a significant amount of time and cost (Darnall, 2006). As larger firms are generally expected to have more resources these firms are better equipped to spread the cost and time over an extensive resource base and output level. In addition, larger firms could also use the experience and knowledge gained through past certifications to certify their other plants at much lower costs (King and Lenox, 2001; King et al., 2005). Therefore, given the positive association between the resource availability and observable success of EMSs, larger firms could be perceived to be at a lower risk 10
of negatively impacting their resource base in implementing a certified EMS (Melnyk et al., 2003). Applying similar thought processes, it could also be argued that this perception could result in a better stock performance of larger firms than that of smaller firms. Additionally, firm size actually reflects the firm’s visibility, suggesting that larger firms attract more attention from media, as well as shareholders, than smaller firms (Rindova et al., 2006). Therefore, there is a greater chance that larger firms can experience a higher positive effect on their stock value when compared to smaller firms (Godfrey et al., 2009). The above discussion leads to the following hypothesis: H2: The stock market reaction to ISO 14001 certification will be positively associated with firm size. ISO 14001 certification signifies a positive environmental proclivity of firms. Therefore, apart from giving first-mover advantages, an early certification can also allude to an environmental leadership strategy (Buysse and Verbeke, 2003). Past studies show that early adopters benefit from better performance outcomes. Russo (2009) finds a significant positive relationship between early certification and environmental performance. Additionally, though not significant, Christmann (2000) does find a positive effect of early timing of environmental strategies on cost advantages. Considering these results together, it could be safely assumed that firms achieving early certification can enjoy a favorable ratio of benefits to costs. In addition to offering performance-oriented superiority, early adoption of ISO 14001 also showcases organizational adaptation, which is considered as an important ability to survive and grow, as well as prosper, in a competitive and an increasingly environmentally-oriented landscape (Zhao, 2006). Therefore, we hypothesize that: H3: The stock market reaction to ISO 14001 certification announcement will be more positive for earlier certifiers.
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3. Methodology 3.1. Data Given that our intention was to study the stock market reaction to ISO 14001 certification announcements, we collected public announcements of ISO 14001 certification by US firms.3 We specifically focused on Business Wire and PR-Wire databases as these are good “first-hand” sources of information for investors. Specifically, we identified a sample of publicly traded firms that received ISO 14001 certifications during the 1996-2008 period by performing a keyword search of the Business Wire and PR-Wire databases. The keywords that we used for our search included combinations of “ISO 14001,” “award” and “certification.” There were 1351 firms’ news events during 1996-2008 that reported the specified combination of keywords. To determine which of these firms were publicly held, we then searched the COMPUSTAT and Center of Securities Prices (CRSP) databases for records (known as PERMNOs) indicating the firm was listed on a major US-based exchange (e.g., NYSE, NASDAQ, and AMEX). We identified 316 publicly held firms, world-wide. In an event study, care must be taken to avoid confounded events problems (McWilliams and Siegel, 1997). Confounding occurs when multiple noteworthy events occur on the same announcement date – it is impossible to determine which announcement is responsible for the returns found that day. We therefore examined all news articles about each firm for 5 days before and after each event to eliminate any confounding effects caused by other potentially newsworthy announcements, such as dividend declarations and earnings announcements, thereby reducing the sample to 231 firms. Also, this 11-day confounding event window would mitigate
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The ISO 14001 certification is typically awarded to a single facility rather than to an entire organization. However, an investor can only evaluate publicly available information. Given that publicly available information are related to the entire organization, we follow past research in perceiving that ISO 14001 certification pertains to the entire organization (e.g., Arts and Vos, 2001; Corbett et al., 2005).
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any post-earnings-announcement drift effects (Bernard and Thomas, 1989). We then used CRSP to gather stock returns for the remaining firms in the sample. Owing to problems such as foreign listings, stocks that were delisted on or before the announcement dates, and insufficient stock returns data, we arrived at a final sample of 140 US firms with viable announcement dates and available CRSP trading data (i.e., NYSE, AMEX, and NASDAQ) as well as accounting variables from COMPUSTAT. To test the robustness of our results, we used the matched-pair design. The firms without ISO 14001 certifications were matched to the 140 sample firms with the certifications, one-toone, based on key characteristics. Following the methods used by Purnanandam and Swaminathan (2004), we selected comparable publicly traded firms in the same industry. The procedure was implemented as follows: 1) We selected firms from COMPUSTAT in the same fiscal year as the calendar year of the event date. From these firms, we eliminated subsidiaries and required firms to be incorporated in the US. The firms are required to have information available on CRSP, and are to be identified as common stock (CRSP share code 10 or 11). 2) We used COMPUSTAT SIC codes to group the remaining firms into 48 industries using the industry classification by Fama and French (1997). 3) The remaining firms in each industry were sorted into three portfolios by sales, and subsequently sorted again by EBITDA profit margin (EBITDA/sales), resulting in 9 (3x3) portfolios of comparable firms in each industry. EBITDA stands for earnings before interest, taxes, depreciation, and amortization. 4) We then obtained sales and the EBITDA margin for our final sample and also classified the firms into the different industries (see Fama and French, 1997). Each sample firm was
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matched with a portfolio of comparable firms based on industry, sales, and EBITDA margin. Within that portfolio, the firm with the closest total sales was selected as the control firm. Table 1 reports the summary statistics for both stock groups as well as the difference-inmeans tests. The descriptive statistics show that our sample covers a wide range of firms and that the accounting variables of both samples are not discernibly different. This indicates that the sample firms and control firms share similar characteristics and that changes in the sample stock price behavior is related to the investors’ reaction to the ISO 14001 certification announcements. [Insert Table 1 about here] 3.2. Event Study Methodology We used the event study methodology to measure the stock price effects of ISO 14001 certification announcements. This methodology provides a thorough approach to estimate investor’s reaction to events, while adjusting for both industry and market-wide influences on stock prices (see Brown and Warner, 1980, 1985; and MacKinlay, 1997, for a review of the methodology). These abnormal (i.e., adjusted) returns are an estimate of the percent change in stock price related to the event. The theory underlying the event study methodology is that in an efficient market, stock prices rapidly incorporate publicly available information (see Fama, 1970). The valuation impact of the event can therefore be obtained by observing stock price behavior over relatively short time periods. We only focused on the short term valuation effects since research showed we have more confidence and put more weight on the results of shorthorizon tests than long-horizon tests. While long-horizon methods have improved, serious limitations of long-horizon methods have been brought to light and still remain. We now know that any inferences from long-horizon tests “require extreme caution” (Kothari and Warner,
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1997), and even when using the best methods “the analysis of long-run abnormal returns is treacherous” (Lyon et al., 1999). We will briefly review the key features of the event study methodology (see Brown and Warner, 1985) and the three models that are used to generate the abnormal returns. This study uses an estimation period of 252 trading days and the estimation period ended two weeks (10 trading days) before the day of announcement. This way the estimates are shielded from the effects of the announcement and non-stationarity in the estimates should not be a problem. The estimated parameters, consequently, are used to compute the abnormal returns of the event window (i.e., three days). Extant research shows that shorter event periods allow for a better and more accurate estimation of the effects of new information on stock prices since it decreases the effects of confounding factors not related to the event (see Brown and Warner, 1980; Dyckman et al., 1984; and Barclay and Litzenberger, 1988). It also increases the statistical power of the hypothesis tests. For this study, the calendar dates are converted into the three day event window: t -1 is the day before the certification announcement, t=0 the day of the announcement and t+1 the day after the announcement. Abnormal returns are computed using the following three models: the market model, the mean adjusted returns model, and the market adjusted returns model. The market model is the best specified model since it controls for systematic risk of the stock. The model is based on the Capital Asset Pricing Model (see Markowitz, 1952; Sharpe, 1964) which hypothesizes a linear relation between stock returns and market returns. , where
is the abnormal return from stock i at day t,
the estimated intercept of the relationship for stock i,
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(1) is the return from stock i at day t,
is
is the estimated slope of the relationship
for stock i with the market return,
. The proxy for the market return is the value-weighted
index of all securities traded on the New York, American, and Nasdaq stock exchanges. Averaging the abnormal returns across the sample firms on any day t, the daily mean abnormal,
, can be expressed as: ∑
,
(2)
where N is the number of sample observations on day t. The mean adjusted returns model and the market adjusted returns model compute the abnormal returns by either subtracting the or subtracting
simple average of stock i’s daily return in the estimation period from
from
. To test the statistical significance of the daily mean abnormal return of equation (2), each abnormal return
is first divided by its estimated standard deviation,
standardized abnormal return
, ,
The test statistic
, to yield a
(3)
for any given day t is given by ∑
√
,
(4)
From the central limit theorem, the sum of N standardized abnormal returns is assumed normal with mean 0 and variance N, since under the null hypothesis abnormal returns are assumed to be independent across firms with mean 0 and variance
.
4. Results 4.1. Abnormal Returns Panels A and B of Table 2 presents the daily abnormal returns based on 140 firms with ISO 14001 certification announcements and 140 control firms. We used parametric t-tests to test
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hypothesis H1. But, given that the parametric test is sensitive to extreme values (McWilliams, 1990), we also performed three different non-parametric tests – Wilcoxon signed test (denoted as Median abnormal return), generalized sign test (denoted as Percent less than zero), and Corrado’s (1989) rank test (Corbett et al., 2005; Cowan, 1992) to test these hypotheses. In comparison to the parametric t-tests, non-parametric tests are also considered to be much more powerful (Barber and Lyon, 1996). Therefore, we believe that these tests, together, will help us to comprehensively test hypothesis H1. Initially, we conducted one-tailed tests because our basic hypothesis was that an ISO certification could only have a positive impact on stock returns. However, since majority of the returns were found to be negative, we decided to rather go with two-tailed tests to specifically check for the significance of these negative returns.4 The results of the analyses testing hypothesis H1 are provided in Table 2. As evident from this table, most of the returns on Day 0 (7 out of 12) and Day +1 (10 out of 12) were found to be significantly negative. Accordingly, the results of the parametric and non-parametric tests collectively show that, on average, ISO 14001 certification announcements are associated with statistically significant stock price decreases. Panel A shows that the negative stock market reaction is stronger on the day after the announcement than on the actual day itself. This result follows the well-established notion that investors are loss-averse and that they act quicker on a gain than they would on a loss, i.e., they sit longer on negative news than on positive news (see Kahneman and Tversky, 1979). The mean abnormal return on day 0 for the Market Model in Panel A is 0.10% (p-value of 0.168) and on day +1 the mean abnormal return is -0.46% (p-value of 0.003).5 4
The results from our one-tailed tests clearly showed that the abnormal returns were not positive. Though we conducted two-tailed tests to check for the significance of the negative effects, they were not required to specifically decide on our hypothesis (H1). In fact, the results from the one-tailed tests were sufficient enough to conclude that hypothesis H1 is not supported (i.e., the returns are not positive). 5 The relatively smaller average abnormal returns are related to the significantly larger proportion of bigger firms in our sample as evidence by the mean market value in table 1 (see Banz, 1981; Fama, 2008 for more research on capital market size anomalies).
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The median abnormal return on day 0 is -0.47% (p-value of 0.064) and on day +1 the median abnormal return is -0.20% (p-value of 0.012). Also, the percentage of firms that have negative returns on day 0 is 59 percent (p-value of 0.083), and on day +1 that percentage is 59 percent (pvalue of 0.118). Though marginal, these results indicate that outliers are not driving the results and the depiction in Figure 1 confirms these outcomes. Figure 1 shows the distribution of the mean abnormal returns over the three-day event window. Sixty percent of the mean abnormal returns in the three-day window (-1, 0, +1) are negative and a significant proportion (43%) of the mean abnormal returns lies between -0.4 and -6%. Panel B shows that the mean and median abnormal returns estimated with the Market Model for the control firms are statistically insignificant. To ensure that the results are not contingent on the choice of estimation model, Table 2 also reports the outcomes of the Market Adjusted and Mean Adjusted returns models. The Mean Adjusted returns model uses the stock’s daily average return over the estimation period as the benchmark, while the Market Adjusted returns model assumes that each firm in the sample shares the same characteristics as the market. The statistics of the full ISO 14001 sample in Panel A of Table 2 estimated with the Market Adjusted model on day 0 show a mean abnormal return of -0.18% (p-value of 0.100), a median abnormal return of -0.55% (p-value of 0.032), and a percentage of firms with negative returns is 61 percent (p-value of 0.016). On day +1, the mean abnormal return is -0.43 (p-value of 0.005), the median abnormal return is -0.28% (p-value of 0.028) and a percentage of firms with negative returns is 57 percent (p-value of 0.162). Additionally, the statistics of the full sample in Panel A of Table 2 estimated with the Mean Adjusted model on day 0 show a mean abnormal return of -0.17% (p-value of 0.245), a median abnormal return of -0.30% (p-value of 0.125), and a percentage of firms with negative returns is
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56 percent (p-value of 0.410). On day +1, the mean abnormal return is -0.49% (p-value of 0.003), the median abnormal return is -0.32% (p-value of 0.037) and a percentage of firms with negative returns is 59 percent (p-value of 0.133). Except for the mean abnormal return of -0.17 (p-value of 0.123) estimated with the Mean Adjusted returns model in Panel A of Table 2, all returns are similar. Also, none of the day -1 results are statistically significant at any reasonable level of significance in all the three estimation models, indicating that there is no leakage of information before the ISO 14001 announcement day. The change in market value due to the announcement of a certification could also be the result of an increase of the market value or a change in the underlying riskiness of the assets of the firm. Panel B of Table 2 reports the equity betas for the pre-announcement and postannouncement periods. Equity betas are market slope estimates obtained using daily returns data and CRSP value-weighted index; and the betas for the pre-announcement (post-announcement) period are estimated using data from days -252 to -11 (+11 to +252). The mean beta of the preannouncement period is 1.143, the median beta of the pre-announcement period is 1.155, the mean beta of the post-announcement period is 1.117, and the median beta of the postannouncement period is 1.140. Even though the betas (mean and median) slightly decreased (0.026 and -0.015, respectively) the change in betas is not statistically significant, indicating that the sensitivity of the stock returns relative to the market did not change after the certification announcement. These results suggest that the event day window is not misstated. In summary, the results do not provide support for hypothesis H1. Rather, the direction of relationship is opposite and significant. [Insert Table 2 and Figure 1 about here]
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We continue our analysis by testing hypothesis H3. The sample was divided into two subgroups; one group with “Early Certifiers” and one group with “Late Certifiers”. The classification “Early certifiers” was intended to group firms that achieved certification soon after the ISO 14001 certification was initiated. Given that we did not have any guidelines (based on past research) regarding the cut-off point, we decided to use 2002 (midpoint) as the cut-off year to split the data collection periods 1996-2008 evenly into early and late certifications. We used parametric as well as multiple non-parametric tests to test hypothesis H3. Similar to hypothesis H1, we also followed up our one-tailed tests with two-tailed tests to specifically check for the significance of the negative returns. Table 3 reports the abnormal returns for the ISO 14001 certification announcements before and after 2002 for the Market, Market Adjusted and Mean Adjusted returns model (two-tailed test results). Before 2002, none of the day -1 and day 0 results are statistically significant and the day +1 mean (-0.96%) and median (-0.64%) abnormal returns (p-values of 0.022 and 0.006, respectively) are negative and statistically significant. The results from the Market Adjusted and Mean Adjusted returns model are similar. After 2002, none of the day -1 returns (see all Models) are significant. At the Market Model the mean abnormal return (-0.61%; p-value of 0.069) and the median abnormal return (-0.77%; p-value of 0.006) are negative and statistically significant. Additionally, the day +1 mean abnormal return (-0.28%; pvalue of 0.040) is negative and statistically significant. Again, these results are confirmed by the results from the Market Adjusted and Mean Adjusted returns model. From the results, an interesting pattern emerges. It appears that the market reaction to ISO 14001 announcements has shifted over the years in a way that might reflect a more efficient market. That reaction could be two-fold: 1) information has become more freely available and investors could make decisions even quicker; and, 2) the quality of the information has increased and the “gut” response has also
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diminished as evidenced by the smaller abnormal returns on day 0 after 2002 relative to the abnormal returns on day +1 before 2002. Additionally, our hypothesis H3 was not supported suggesting that the timing of the certification does not have any significant impact on shareholder wealth. [Insert Table 3 about here] 4.2. Regressions Results In this section, we discuss the outcomes of the regression analysis that tests the hypotheses of the effect of certain firm-specific variables (H2) on the abnormal returns during the event period. The model controls for fundamental financial variables that are known to affect firm stock returns: firm size, book-to-market, equity and financial leverage (see Core et al., 2003; Fama and French, 1997). We use the following regression: / where
(5)
is the event period abnormal return for firm i. Size is the natural logarithm
of market equity measured as the stock price in the most recent fiscal year ending prior to announcement times the number of shares outstanding. The predicted sign of the coefficient is positive. In addition to these hypothesized variables, we also add other variables that measure the firm value as well as industry membership. Though we do not have any formal hypotheses relating these variables to the abnormal returns, we would like to explore the effect these variables might have. /
is the value premium, measured as the ratio of book equity to market
equity. The book equity is the value for equity reported in the most recent fiscal year ending prior to the announcement date.
is the natural logarithm of the total long-
term debt scaled by total assets.
21
Model 1 in Table 4 reports the parameter coefficients for equation (5). Hypothesis H2 was supported. The coefficient on size (0.0118; p-value of 0.014) is positive and highly significant, indicating that the negative market reaction of ISO 14001 announcements is smaller for larger firms. Additionally, the book-to-market ratio coefficient (0.0471; p-value of 0.000) is also positive and significant showing that the negative stock return impact is less for value firms (i.e., firms with less growth potential). The coefficient on book equity (-0.0107; p-value of 0.011) is negative and statistically significant indicating that the negative reactions to the certification are more severe for firms with higher book-equity, while the market reaction is less harsh for firms with more financial leverage (0.0038; p-value of 0.032). Overall the model (model 1) is significant with an F-value of 4.98, R2 of 18.36% and an adjusted R2 of 14.68%, which is high relative to other cross-sectional regression stock return model specifications. The Breusch-Pagan test result of 35.10 (p-value of 0.1096) indicates that heteroskedasticity in model 1 is not an issue and that the statistical significance of the parameter t-tests is not biased assuming a reasonable level of significance. The intercept in Model 1 of Table 4 does not allow for industry membership variables that could affect the abnormal returns. We form a model following the methods by Hendricks and Singhal (2003) that allows for separate intercepts for announcements that fall into four broad industry groups and designate dummies for firms within the specific SIC ranges: Industry 1: SIC code is between 0001 and 2999 or 3000 and 3569 or 3580 and 3659 or 3800 and 3999 (agriculture, natural resources, food, tobacco, textiles, lumber, wood, furniture, paper, chemicals, rubber, leather, stone, metals, machinery, and equipment). Industry 2: SIC code is between 3570 and 3579, 3660 and 3699 or 3760 and 3789 (computers, electronics, communications, and defense). Industry 3: SIC code is between 3700 and 3759, or 3790 and 3799 (automobile, airlines, and transportation). 22
Industry 4: SIC code is between 4000 and 9999 (logistics, supply and others).
Using these industry variables, we estimate the following regression: /
1
2
3
4 (6)
Model 2 in Table 4 reports the parameter coefficients on all variables in model 1 as well as coefficients on the four industry classifications. The coefficient on size (0.0091; p-value of 0.041) is positive and highly significant, indicating that the negative market reaction of ISO 14001 announcements is smaller for larger firms, even after controlling for industry effects. Additionally, the book-to-market ratio coefficient (0.0419; p-value of 0.0000) remains positive and significant showing that the negative stock return impact is less for firms with less growth potential across the industry levels. The coefficient on book equity (-0.0087; p-value of 0.033) is negative and statistically significant indicating that the negative reactions to the certification are more severe for firms with higher book equity value, while the market reaction is less harsh for firms with more financial leverage (0.0036; p-value of 0.043). The signs and statistical significance of the parameters in model 2 are similar to the parameter coefficient statistics in model 1. However, the intercepts on the industry variables are negative and statistically significant, indicating the ISO certification announcements have large and negative stock market reaction across all industries. The model (model 2) has an F-value of 3.41, R2 of 20.80% and an adjusted R2 of 14.71%, indicating that the model does well in explaining the variability of stock returns. The Breusch-Pagan test result of 37.82 (p-value of 0.1499) indicates that heteroskedasticity is also not a problem in model 2. [Insert Table 4 about here]
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5. Discussion and Implications By highlighting the significance of certified EMSs, we put forth three hypotheses to study the effect of ISO 14001 certification announcements on short-term stock performance. The first hypothesis H1 suggests that ISO 14001 certification will lead to increased stock value. This hypothesis was encouraged by the “pays to be green” literature that purports a positive relationship between certified EMSs and corporate performance. But, surprisingly, the results did not provide support for this hypothesis. Rather, the abnormal returns were found to be significantly negative (opposite direction). Hypothesis H2 studied the differences based on the size of the firms. This hypothesis was supported by our analysis. This result justifies our logic in proposing that larger firms will result in better shareholder value. It also suggests that larger firms have increased visibility; and investors follow the actions of these firms more closely and tend to react less critically to their certifications than small firms. Hypothesis H3 suggested that earlier certifications will result in increased shareholder wealth. This hypothesis was not supported. The market reaction is consistently negative. But, the results do suggest an interesting pattern. It appears that the market reaction to ISO 14001 announcements has shifted over the years in a way that is much quicker in the later period. In the rest of this section we present a few implications of our results. First, the outright negative impact of certification announcements on the stock market suggests that the ideology “costs to be green” has an overbearing impact on the market rather than the “pays to be green” philosophy. Implementation of ISO 14001 and its subsequent certification requires a significant outlay of cash. Additionally, many of the benefits of the EMSs cannot be easily converted into equivalent monetary savings (e.g., Halkos and Evangelinos, 2002). Therefore, even though ISO 14001 could result in positive performance outcomes in the long run, investors seem to perceive
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such certifications to go against the underpinning goal of businesses – maximizing shareholder wealth through reduction in cost and increase in “immediate” profits. This reaction from investors implies that both “pays to be green” and “costs to be green” are incomplete perspectives to study ISO 14001 certifications. The extent to which environmental initiatives result in economic success depends on a variety of factors such as consumers’ willingness to pay premium price for green products, the nature of environmental regulations, and stakeholder pressure (Schaltegger and Synnestvedt, 2002). Therefore, future research rather needs to focus on evaluating the perspective “when it pays to be green” (Reinhardt, 1999; Schaltegger and Synnestvedt, 2002). By doing so, we would be better able to explain the complex relationships between certified EMSs and performance implications. Second, ISO 14001 has historically been criticized for its focus on process rather than performance outcomes. Though the standard does require that performance targets are set and evaluated, there is no way the actual performance outcomes could be externally verified (e.g., Rondinelli and Vastag, 2000). More importantly, past research studying this link has not sent a unanimous message in regards to the performance implications of ISO 14001. Therefore, in spite of its ability to improve environmental impacts, the results indicate that the investors might perceive such certifications as merely an image-building tactic rather than a legitimate initiative towards improving environmental performance (Bansal and Bogner, 2002). This implies that the positive benefits of ISO 14001 certified EMSs is not reaching the investor base. To make sure that shareholders are knowledgeable, firms with a proactive stance will also need to provide external stakeholders with systematic communications that showcase the environmental impacts of their initiatives (Halkos and Evangelinos, 2002). If such communication is two way, it will not only provide stakeholders with reliable information about the firm’s conduct, but will also
25
facilitate feedback mechanisms that could help firms incorporate stakeholder expectations and preferences. Such two-way communication, if combined with environmental performance reporting, will further publicize the true intentions of the firms and their achievements, and will ultimately lead to a positive impact on shareholder wealth. Third, the interesting pattern evident while testing the effect of early and late certifications also provides an alternate implication for researchers and managers alike. First, in line with the diffusion of innovations literature (Rogers, 2003), this result suggests that late adopter could rather learn from early adopters’ mistakes and derive better financial returns. Second, this result also suggests that the market reaction to ISO 14001 announcements has shifted over the years in a way that is much quicker in the later period. On the one hand, this could suggest that investors are growing more negative about ISO 14001 certification announcements given the lack of information regarding its superiority. On the other hand, this might also indicate that the investors do understand that better environmental performance not only requires pollution control strategies, but also proactive and high-end pollution prevention practices (Hart, 1995). In this line of thought, an EMS certification could be seen as a reactive strategy and could portray the firm to be at the nascent stages of implementing comprehensive environmental programs. Accordingly, it could be seen just as a source of competitive parity and not competitive advantage. So, assuming that the shareholders are capable of assimilating such information, the market might react negatively as these firms are slow in the adoption process and might have a long way to go before they can have a significant positive impact on the environment. Again, as pointed out earlier, this reaction can be streamlined only through proper communication of actions and performance outcomes of certifying firms.
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Finally, at a humanitarian level, this result is disturbing given the recent realization of environmental degradation evident around us. It clearly signifies that the investment landscape is marred by the traditional philosophy of eco-capitalism, which is dominated by profit making initiatives. Accordingly, investors perceive implementation and subsequent certification of EMSs as an unnecessary cost. But, as an advanced society with a clear interest in social welfare, there should be a positive market reaction to established initiatives that could suggest any reduction in negative environmental impact. The underlying premise should be that such actions will provide the firms with unique capabilities which will result in economic benefits in the long run. Such a reaction, couched in the eco-socialism philosophy, will mandate that management actions not only satisfy the economic needs, but also meet the needs of the society and environment at large (Sarkar, 1999). More stringent regulatory forces, as well as superior environmental practices, are bound to become the norm in the near future. In addition, increased public communication and triple-bottom line accounting standards will bring to bear the importance of these environmental practices. And, shareholder attitude will have to change as the operating conditions within the US shifts and the wasteful and resource-depleting activities are directly equated to high cost alternatives. Therefore, though our results indicate a negative stock market reaction to ISO 14001 certification announcements, we urge that organizations rather take note of the “pays to be green” literature and continue to adopt proactive and voluntary environmental initiatives, such as the ISO 14001, as they could help them to: (1) expand their market prospects; (2) realize savings through waste reduction and pollution prevention; and, ultimately, (3) develop distinct capabilities that can help overcome the detrimental environmental problems resulting from business activity (e.g., Hart, 1995; Montabon et al., 2000; Melnyk et al., 2003; Porter and van der Linde, 1995; Sroufe, 2003).
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6. Conclusion and Directions for Future Research In the last decade, consumers have become increasingly cognizant and concerned about the impact of businesses on the natural environment. This has signaled businesses to ensure that their processes are aligned to reduce, if not eliminate, their impact on the natural environment. One touted initiative that signals the positive environmental proclivity of firms is the adoption of a certified EMS. In fact, past studies have consistently shown that certification of EMSs under the ISO 14001 standard can have a significant effect on firms’ environmental and financial performance. So, it is safe to believe that the market will react favorably to ISO 14001 certification announcements, thereby resulting in greater shareholder wealth. With this belief, we extended three hypotheses studying the impact of ISO 14001 certification announcements on stock performance and used the event study methodology to test them. Interestingly, the results from our study suggest otherwise. It shows that the shareholder wealth reduced due to these certifications. This conflicting result brings about many implications. For practice, it suggests that firms will need to educate shareholders about their actions towards the betterment of the environment. Such coordinated two-way communication will also ensure that the ISO 14001 standard is highly regarded, widely adopted, and even requested by shareholders. From the research point of view, this result suggests that future studies surrounding ISO 14001 certifications should be grounded within the philosophy of “when it pays to be green” so that we clearly understand the various nuances involved in achieving superior financial success. At this juncture, the limitations of our study are provided with the ambition of offering potential opportunities for further research. First, in our study we match site-level ISO 14001 certifications with corporate-level stock performance. As stock performance is measured only at the corporate level, this is not a major problem. Moreover, as indicated by past research, it
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actually makes our tests more conservative (Corbett et al., 2005). Second, we used Business Wire and PR-Wire announcements to select our sample of firms. Though this approach is appropriate given our focus on short-term stock market reaction, we suggest that future studies consider the entire sample of ISO 14001 certified firms within the US and use certification date to evaluate short-term as well as long-term improvements in shareholder wealth. But, we suggest that stringent measures be incorporated to ensure that the long-term shareholder wealth is isolated from the impact of any other compounding events. Third, an event study of stock performance cannot provide an overall picture of the impact of ISO 14001 certification announcements. Therefore, in addition to studying the impact on the stock market, future studies could also include financial performance measures from COMPUSTAT and study the long-term impact of certified EMSs along multiple financial performance measures. Fourth, our study includes a few controls variables: firm size and timing of certification; to study their effect on the relationship between ISO 14001 certification announcements and stock performance. Future studies should try to incorporate other control variables to expand our understanding of ISO 14001. More specifically, we recommend future studies to incorporate the level of exports to European countries as a key control variable. As European environmental requirements have been historically much more stringent, firms with higher exports to European countries might presumably exhibit superior performance in comparison to others. Fifth, by arguing that large firms have more resources in comparison to small firms, we have failed to recognize the fact that smaller firms are indeed nimbler in their ability to change as well as adapt to changing environments. Therefore, we recommend future studies to better operationalize firm size and test whether a firm’s ability to adapt plays a dominant role on the relationship between ISO certifications and performance. Sixth, we specifically study the effect of ISO 14001 among
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US manufacturing firms. Therefore, the findings might not apply to non-US firms. Accordingly, we recommend that future studies compare change in shareholder wealth across multi-country samples. It would be really interesting to see whether the level of environmental requirements within a country would have a bearing on the effect of ISO 14001 announcements on stock performance. Seventh, this study has only included ISO 14001 certifications. So, we suggest future efforts to replicate this study focusing on the EMAS standard and comparing it to ISO 14001. Finally, as indicated in the discussion section, stringent regulatory forces, superior environmental practices, and improved environmental communication could become the norm in the near future and shift the operating conditions within the US. Therefore, we suggest that this study be replicated after a few years to evaluate the change in shareholder sentiments and its subsequent impact on shareholder wealth. In spite of these limitations, we believe that this study makes a significant contribution to literature that focuses on ISO 14001 and its impact on corporate performance. References Arimura, T.H., Hibiki, A. and Katayama, H. (2008), “Is a voluntary approach an effective environmental policy instrument? A case for environmental management systems”, Journal of Environmental Economics and Management, Vol. 55, No. 3, pp. 281-295. Arts, F.M. and Vos, E. (2001), “The impact of ISO registration on New Zealand firms’ performance: A financial perspective”, The TQM Magazine, Vol. 13, No. 3, pp. 180-181. Bansal, P. and Bogner, W.C. (2002), “Deciding on ISO 14001: Economics, institutions, and context”, Long Range Planning, Vol. 35, No. 3, pp. 269-290. Bansal, P. and Hunter, T. (2003), “Strategic explanations for the early adoption of ISO 14001”, Journal of Business Ethics, Vol. 46, No. 3, pp. 289-299. Barber, B.M. and Lyon, J.D. (1996), “Detecting abnormal operating performance: The empirical power and specification of test statistics”, Journal of Financial Economics, Vol. 41, pp. 359399. Barclay, M. and Litzenberger, R. (1988). “Announcement effects of new equity issues and the use of intraday price data”, Journal of Financial Economics, Vol. 21, No. 1, pp. 71-99. 30
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Range of returns (r) in percentages 12
