Accounting Forum 28 (2004) 726

An analysis of the stock market impact of environmental performance information

N. H. J. Lorraine, D. J. Collison , D. M. Power
Department of Accountancy and Business Finance, University of Dundee, Dundee DD1 4HN, Scotland, UK

Abstract This paper examines whether publicity (either good or bad) about environmental performance affects companies share prices. To date, a lot of the research in this area has been conducted in a US setting and has arrived at inconclusive results. This investigation examines the topic in a UK context. Specically, it looks at publicity about nes for environmental pollution as well as commendations about good environmental achievements to see whether such information inuences share prices. The results indicate that there is a stock market response to such news especially for details on nestypically up to 1 week after news is published. A cross-sectional analysis indicates that the share price response is mainly a function of the relative ne imposed on the rm; other explanatory variables such as environmental performance news or sector membership were unsuccessful in explaining variations in the market responses. 2004 Elsevier Ltd. All rights reserved.
Keywords: Stock market; Share prices; Environmental Agency

1. Introduction This paper has examined the relationship between environmental performance information and company share prices within a UK context. Incidents of both good and bad news are considered. The paper builds on a mainly US-based literature that has examined the effect of environmental performance information on company share prices. Most previous studies have looked at environmental performance information that has been disclosed by rms in their annual reports. However, this approach does have its limitations. It is very difcult to attribute any share price changes at the time of the information disclosure to the environmental news since other information is also issued to the market. To overcome

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this difculty, the present study focuses on externally produced environmental performance data. Specically, it considers (i) environmental accidents that have been caused by publicly quoted UK rms and that have resulted in a prosecution by the Environment Agency (EA)1 and (ii) commendations for rms which are improving their environmental performances. Once these incidents have been identied, share price data are examined at the time when this externally produced environmental information is disclosed to the public. The current research therefore facilitates a UK comparison with previous US work, avoids difculties associated with examining the stock market reaction to internally-produced environmental news which is published at the same time and extends previous analyses by considering both good and bad environmental performance information. Previous research has tended to focus on negative aspects of a companys interaction with the environment. Awareness of, and sensitivity to, environmental issues arguably varies with changes in societal norms and with regulatory activity. Therefore, in addition to being a basis for comparison, extensions to the existing literature can also be important in their own right as the context of both norms and regulation changes. The paper uses a conventional event study approach to investigate the impact of news on share prices. This is a well-established technique though its applicability to environmental news has been problematic in the substantive literature. In particular, as Section 2 highlights, no clear consensus exists as to the way markets may interpret such news, although a rst order approach in which good newsinterpreted as tending to less pollutionis rewarded while bad news is penalised will be taken in this paper. The remainder of this paper begins with a review of the literature. Section 3 looks at the role of the EA in the UK and describes two of its reports on environmental performance and the effects of pollution incidents; both reports are employed as the main data sources for this study. Section 4 outlines the sample selection criteria employed, describes the research method adopted and states the hypotheses to be tested. It species how returns are calculated and indicates how the event study method is employed. Section 5 analyses the effects on share price of the disclosures about pollution incidents and environmental awards made by the EA. Finally, Section 6 offers some conclusions.

2. Literature review The stock market impact of environmental information has been an area of debate in the substantive literature for several decades. A lot of this debate arises because the research methods employed by academics have varied from study to study; there have been inconsistencies concerning the data sources used, industry types examined, company size studied and measurement approaches adopted for calculating expected share returns. Therefore, attempting to draw general conclusions from the literature is fraught with problems. Nev-

1 The EA covers England, Wales and Northern Ireland, but Scotland is covered by the Scottish Environment Protection Agency (SEPA). In this investigation, no companies that were ned by the SEPA are included in the sample as they did not satisfy the data requirements employed. Therefore, only the EA will be referenced in this paper.

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ertheless, this review highlights common points raised in a number of investigations while taking note of the difculties that may exist. Much of the early literature is US-based and focuses on the work of the Council on Economic Priorities (CEP).2 It has analysed reports that were produced by the CEP in 19701971; these reports examined pollution control records and costs of pollution abatement in order to derive a pollution control index of US companies. Various authors have adopted different approaches in their investigations. For example, Shane and Spicer (1983) focussed on those companies that had been the subject of one of the CEP reports and which had been featured in the New York Times. However, they chose to exclude from their sample companies that announced signicant news 3 or 4 days before the event date. This exclusion policy reduced their sample size from 104 to 72 rms drawn from only four industries. Shane and Spicer found that when they examined the 6-day window (from t 4 to day t + 1) surrounding the event date (day t), rms experienced a relatively large negative abnormal return on days t 1 and t 2. They noted that companies which had a poor pollution control record experienced a more negative return than those with a high ranking (according to the CEP reports). They concluded, therefore, that investors discriminate between rms on the grounds of pollution control expenditure and past pollution control records. In two earlier papers, Spicer (1978a, 1978b) attempted to determine the nancial characteristics of companies with good and bad pollution control records. He examined the possibility of an association between pollution control and protability, asset size, risk and the price/earnings ratio. The investigation carried out by Spicer involved an analysis of the social and nancial performance of 18 US companies in the pulp and paper industry over the two periods in which the CEP reports were produced (19691971 and 19711973).3 Spicer concluded that more protable, larger companies tended to have better pollution control records, were awarded higher price/earnings ratios by the market and were considered less risky by investors. Chen and Metcalf (1980) expressed some concerns about Spicers results arguing that his evidence rested on spurious relationships created through one or more intervening variables (p. 168) and that adjustments should have been made to these relationships. They argued that Spicers statement that companies with better pollution control records tend to have a higher protability, large size, lower total risk, lower systematic risk and higher price/earnings ratios than companies with poorer pollution control records was far from justied. Similarly, Chen and Metcalf found it difcult to comprehend how a rms pollution control record would have positive, signicant effects on the result of operations and size of the rm. Chen and Metcalfs paper led to a robust rejoinder from Spicer (1980). Inter alia he accused them of a fundamental misinterpretation of his work in that they appeared to believe that he was
2 A separate literature has attempted to gauge the market reaction to environmental information produced by the company itself and issued as part of the annual report (e.g. Anderson & Frankle, 1980; Freedman & Jaggi, 1986; Ingram, 1978; Ingram & Frazier, 1980; Wiseman, 1982). Such a strategy is not followed here because of the difculty of determining whether any market reaction is attributable to the environmental news or whether it is due to other information contained in the annual report which is disclosed to investors at the same time. 3 The CEP reports were not only inuential for their consistency and comparability attributes, but were also compiled around the time of the passing of the Clean Air Act (1970) and the Federal Water Pollution Control Act Amendments (1972) which were two signicant pieces of legislation which affected the environmental behaviour and reporting practices of many US rms.

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testing for causal relationships when in fact he was scrupulous in emphasising that he was investigating associations. Despite Chen and Metcalfs criticisms, the conclusions of both Shane and Spicer (1983) and Spicer (1978a) that (i) information about pollution is leaked to the market, (ii) investors discriminate between rms based on the information provided by the CEP reports and (iii) larger companies tend to have better pollution control records and are considered less risky than their smaller counterparts4 have been scrutinised in more recent studies. For example, in a follow up US study, Stevens (1984) investigated the information content of environmental performance data and observed a reaction by investors to this information when formulating their investment decisions. Adopting an ethical investor hypothesis, he suggested that investors are motivated by factors other than risk and return . . . based upon non-nancial criteria embodied in an individuals value system (Stevens, 1984, p. 43). Stevens believed that if such investors were numerous, their behaviour might affect share prices. An alternative line of inquiry has investigated whether share prices are systematically affected by environmental disasters. Blacconiere and Patten (1994) found that, from a sample of 47 rms, companies with extensive environmental disclosure prior to the Bhopal disaster in 1984 experienced a less negative market reaction to the disaster than their counterparts in the chemicals industry who communicated very little about environmental matters.5 One possible reason for this result could be the expected increase in regulatory costs following the disaster causing a negative intra-industry market effect. In earlier papers, Bowen, Castinias, and Daley (1983) and Hill and Schneeweis (1983) carried out similar investigations on the Three Mile Island nuclear accident and found a similar negative intra-industry market reaction. Mahapatra (1984) suggests that such a link should exist; he described expenditure on pollution control and environmental disclosure as a drain on resources, non-income generating and detrimental to the rms cash position. However, Freedman and Stagliano (1991) refute the argument that such investment always yields a negative net present value. Instead, they suggest that positive returns will occur because investment will be in technologically advanced equipment that is more efcient (p. 70), although they acknowledge that there may be an adverse effect on short-term cash ows and current share prices. Other nancial benets may also arise from a greater level of environmental awareness, including: a broadening of the appeal of the rms shares to

4 The exclusion approach adopted by Shane and Spicer (1983) is important for this paper as it recognises that much of the information produced by companies is included in, say, an annual report. This joint disclosure of news makes the isolation of information for study purposes very difcult. However, this present paper focusses on pollution incidents and environmental commendations, which reduces the confounding information issue. Only comparatively recently have a signicant number of companies started to produce stand alone reports and policy statements covering issues such as health, safety and environmental (HSE) issues. 5 A related strand of the literature has considered how disclosure activity, rather than market reaction, has been affected by incidents. Patten (1992) examined the effect of the Exxon Valdez oil spill on environmental disclosures by petroleum rms other than Exxon and found a signicant increase. Deegan and Rankin (1996) found increased disclosures by companies in years in which they were prosecuted by the Australian Environmental Protection Authority. (This was an increase relative to other comparable rms disclosures and to their own disclosures in years when they were not prosecuted.)

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the ethical investment community and those concerned about the environment;6 a potential reduction in future clean-up costs; lower compliance costs with future legislation; a cut in energy wastage and the possibility of increased shareholder value. Freedman and Stagliano (1991) examined shares of companies in the cotton industry following a ruling by the US Supreme Court concerning the reduction of dust emissions. Any market reaction might be a function of how investors perceived the impact of complying with the legislation. The costs of cleaning up manufacturing facilities and regulatory compliance were likely to be substantial as new, cleaner and more efcient technology would need to have been installed. However, there is a counter-argument that suggests that investment will have a positive net present value because of improvements in efciency, despite the fact that these might have a long payback period. Freedman and Stagliano tested 27 rms affected by the ruling using an event study methodology where the standard market model was employed to generate expected returns. Their results indicated that no signicant effects occurred on the event day, t, but on days t + 1 and t + 2 it appears that market participants viewed the news as detrimental and subsequently revalued the respective share prices downward. This nding suggests that investors may be more concerned with the short-term cash ows of the rms rather than the long run social and environmental benets of the change. However, rms that had made prior disclosure about the likely impact of the standard on their operations before its implementation were not as badly affected as those rms that had made no such prior disclosures. This may suggest that the stock market had already impounded the information into the stock valuation (i.e. before the event window examined) for some rms. A more recent investigation of the impact of the Clean Air Act Amendments (1990) on high-polluting electric utilities arrives at stronger conclusions using a different methodology. Hughes (2000) found a negative relationship between the market value of these rms equity values and a non-nancial pollution proxy which captured their exposure to future environmental liabilitiesespecially at the time of the passage of the Act. In particular, he reports that utilities exposure to (unbooked) future environmental liabilities decreased their mean 1990 share price by 16% (p. 209). Other rms in the sector that were not targeted by the 1990 Act had no signicant relation between their pollution indicators and their share prices. Various rationales can be constructed about subsequent market reaction to good (about cleaner practices) or bad (about pollution incidents) news. For positive environmental disclosures, the literature seems to have a bet each way on how investors might react (Chan & Milne, 1999) since expenditure beyond minimum legal responsibilities could be interpreted as an inefcient use of resources, whereas activity and expenditures to control pollution may be interpreted more generally as a sign of good and forward looking management and as a sign of reduced risk of future liabilities. Bad news might intuitively be expected to be penalised by markets though even here a contra rationale can be applied if polluting incidents are accepted as an occupational hazard that may cost less in terms of penalties than the alternative costs of avoidance.

6 Kreander, Gray, Power, and Sinclair (2000) point out that there were 44 ethical funds in the UK with 2.8bn under management in February 2000. Once Church funds, charity investments and ethical unit trusts are added, they suggest that the amount of ethically managed funds exceeded US$ 15bn.

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Chan and Milne (1999) put the matter neatly: actively seeking to invest in a rm that is avoiding its social responsibilities . . . seems to stretch even Friedmans7 argument but, they acknowledge that exceeding allowances and paying the nes for doing so could be construed as operating within the rules of the game. The results of the study carried out by Chan and Milne were reasonably clear in the case of the bad news: in their experimental design in which investors were presented with voluntary disclosures it leads to avoidance behaviour. The good-news disclosures were more ambiguous suggesting that unusually high levels could indeed be counter productive in terms of investor approbation. Acknowledging Bowman and Haire (1975), they found the advice it pays to be good, but not too good particularly appropriate.8 Further insight into these issues, supported by empirical evidence was provided by Hillman and Keim (2001). Drawing on earlier literature they distinguished between two kinds of social performance which, they reasoned, would impact differently on shareholder value and therefore on market reaction. They contrasted stakeholder management with social issue participation and found that while the former activity could, broadly, be expected to lead to increased nancial returns the latter would not. While they did not explicitly consider environmental pollution their rationale suggests that it would fall into the former category as having a reputational impact that is potentially relevant to a number of stakeholders.9 The empirical work carried out by Hillman and Keim (2001) was based on regression analysis due to the multidimensionality of the constructs they were investigating and the lack of discrete events though they noted that, ideally, event study methodology would be desirable for investigating impacts on shareholder wealth caused by actions that might inuence stakeholder perceptions. A limitation of all previous empirical analyses is that they are US based. A recent study (Thomas, 2001) examines UK information. She used survey data covering 131 companies and showed that the adoption of an environmental policy was correlated with superior shareholder returns. She found that, since the UK Environmental Act in 1995, a history of environmentally-related prosecutions reduced corporate excess returns. A limitation discussed by Thomas in her study was the lack of information about dates of policy adoption or prosecution so that her data did not allow event study analysis to be undertaken. To conclude this section, it seems that there is a great deal of interest in the effect of environmental issues on a companys share priceeither (i) because of the cash ow consequences associated with environmental transgressions or (ii) because of the effect of such news on the reputation of the rm. However, the conclusions drawn from previous
7 Friedman is famously associated with the philosophy that a companys only duty should be to maximise prots while operating within the law (e.g. Friedman, 1962). 8 However, and as already acknowledged in the introduction, societal awareness of, and attitudes to, environmental performance and associated risks are likely to vary over time. 9 Of course disclosures may not be motivated by a desire to inuence the capital market in general but rather specic institutional actors. One could surmise however that the reputational management implicit in disclosure strategies may always have a nancial risk component. Deegan and Rankin (1999) considered aspects of the supply and demand for environmental information but without reference to companies nancial performance. They reported a signicant demand for information on the part of nancial users and relatively greater importance being attached to it by them, than by preparers.

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studies are varied depending on the variables employed as proxies for environmental and nancial performance. There is much evidence to suggest that the use of annual reports is fruitless as the information is, in some instances, unregulated and concentrates on public relations news. Also, environmental disclosures may be seen to be in direct conict with actual environmental performance thus making them unreliable for research purposes. In addition, methodological problems associated with the use of market based tests when confounding events are present call this approach into question. A more popular method employed by many US authors involves the use of the environmental reports produced by the CEP, but this does lead to repetitive research and uninspiring conclusions. There should be a greater focus on new research mediums, other than the CEP, to move forward. The study by Thomas makes a valuable contribution in this regard in a UK context by using non-proxy data supplied direct by companies; her method lacked the sharp focus that an event study can provide, however.

3. The Environment Agency The EA was formed in 1996 after the merger of the separate air, water and waste regulators. Its operations are predominantly . . . [working] in partnership with other organisations to deliver improvements to the environment (Environment Agency Half Year Review, 2000). More importantly for this study, the Agencys functions include pollution control, waste regulation, the management of water resources, ood defence, sheries, conservation and navigation (Environment Agency Enforcement and Prosecution Policy, 1998) and prosecutions for infringement of their guidelines.10 The decision on whether or not to prosecute is based on four key elements; proportionality, consistency, transparency, and targeting. Its prosecution policy sets out the conditions under which, given sufcient evidence, it will take individuals or organisations to court without reservation. One of the main points of the policy is that the Agency prefers prevention to prosecution, however, prosecutions are an important way for the Agency to achieve its aim of securing compliance with legal, regulatory requirements. The law has come under erce criticism in the past both from the environment minister, Mr. Michael Meacher, and the EA chief executive, Mr. Ed Gallagher, for the low level of nes imposed for pollution offences and health and safety violations. Mr. Gallagher said the largest pollution ne imposed on a company after a successful agency prosecution in 1996 represented the equivalent of a 15 nd on someone earning 30,000 a year. In 1999, the average ne imposed was 3500 (excluding the 750,000 ne for the Milford Haven Sea Empress Disaster). One response to the criticism was the introduction, in 1998, of a document naming and shaming those companies that had persistently polluted the environment despite previous EA intervention. Although in its infancy, the report was very detailed placing the chemicals company, ICI, at the top of the league followed by Wessex Water in terms of the value of
10 In 1998, the EA issued 312 Enforcement and Prohibition notices and prosecuted 566 individuals or companies where the average ne was 2786. For 1999, the actual number of notices issued was over 500 while the number of prosecutions had risen to 613 where the average ne was 4750.

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nes imposed (382,500 and 36,500, respectively). This Hall of Shame Report described the performance of companies in the industries that the EA regulated in order to encourage them to be more responsible for their environmental performance. It therefore employed public pressure associated with shaming rms to achieve environmental improvements. Although the total number of substantial pollution incidents had seen a decrease in the previous decade, the Agency was still concerned that this progress was being undermined by some businesses that were persistently failing to meet environmental standards. There was also a concern that it might be more costly for a rm to comply with regulations than to receive a ne for a pollution conviction. The chairman of the EA summed up the purpose of the Reports in his foreword as a commitment to making information more easily accessible, so that members of the public can judge business environmental performance for themselves (Environment Agency, 1999). The 1999 report entitled Spotlight on Business Environmental Performance was the follow-up to the 1998 Hall of Shame report, but unlike the rst report, it also detailed good environmental performers; those rms that had signicantly improved their environmental performance since 1998. The Agency regulates six main industrieswaste, water, chemicals, fuel and power, minerals and metal production and processing. Three industrial sectors account for 52% of the total waste produced in 1998 and the Agency generated league tables of companies that operate in these sectors. The Agency measures poor performance by ranking companies according to the number of times that they have been prosecuted for environmental offences and according to the size of the nes issued for these offences during a particular year. Ranking companies according to the size of ne imposed reects societys current judgement of the seriousness of the pollution incident. However, it is not a measure of the impact of the incident on the environment and the Agency believes that the level of nes should be substantially increased to reect this. Ranking companies according to the number of prosecuted offences has been incorporated because a company may be prosecuted for a number of offences but only go to court once. The Milford Haven Port Authority topped the nes league in 1999 with an unprecedented penalty of 750,000, whereas Thames Water Utilities topped the prosecution table with eight prosecutions generating nes totalling 79,000. The Agency will be developing a broader range of environmental performance indicators over the forthcoming years including measures about how companies manage their environmental risks, as well as details about rms impact on the environment incorporating a pollution inventory listing the most damaging pollutants for individual industries.

4. Data selection, research method and statement of hypotheses Finding companies for this study was a relatively straightforward exercise; it would seem that the media are constantly poised to expose any environmental accidents, especially those involving pollution and large companies. The companies involved in this study were selected from articles in the Financial Times, The Times and press releases from the EA between April 1995 and August 2000, with Internet search engines providing most of the necessary leads. In addition to press releases, the EA published a pollution offenders Hall Of Shame in

N.H.J. Lorraine et al. / Accounting Forum 28 (2004) 726 Table 1 Sample companies selected for investigation Source Number of companies Good news Environment Agency Financial Times/The Times Environment business Less Un-quoted companies Insufcient price data Announcements for further analysis 20 2 0 22 13 0 9

15

Bad news 130 4 13 147 120 4 23

Note: There is some overlap and companies appeared in more than one source. For example, the Financial Times often reported nes issued by the Environment Agency and the same events are reported in more than one Environment Agency publication.

1998 which highlighted additional events to include in the sample. Furthermore, following comments on a BBC On-line interview with the Chairman of the EA, John Harman, a 1999 publication entitled Spotlight On Business Environmental Performance was scrutinised which contained league tables of both good and bad company environmental performance. Initially, the study was intended to examine only those companies that had committed a pollution offence and received a ne. However, several companies ranked highly in performance league tables or received environmental awards, and it was decided to include these rms in the sample and set up appropriate tests to examine the capital market response to good news as well as to details of poor environmental performance. Many of the companies investigated by the Agency were small, unquoted, private rms. Because of the need to examine share prices, these unquoted companies were excluded from the sample and this exclusion reduced the number of events being considered dramatically (see Table 1). Also, share price histories for some companies were unavailable as the rms in question had only recently been oated on the market. Some 32 nal events were included in the analysis of which 23 related to bad-news incidents while 9 referred to good-news performances. The majority of good events were taken from the Spotlight On Environmental Performance report (see Appendix A for details of the companies investigated). To examine the effect on share prices, daily data was obtained from DATASTREAM for each of the 32 events from 31st December 1993 to 31st August 2000.11 From the raw daily data, share returns were calculated according to the formula: Rit = ln Pit Pit1 (1)

11 There is a well known set of limitations associated with this event study approach which have been documented in the literature (Hines, 1984; Kothari, 2001; Lev & Ohlson, 1982): for example, the frequency of the share return data used, the knowledge of the actual event date, and the model of expected returns employed. These difculties are addressed in this paper by the usage of daily return data, the cross checking of the date of the announcement, and the employment of two expected return models which yield similar results.

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where Rit is the share return for rm 1 on day t and Pit is the share price for day t. Unexpected returns were then calculated for the 21-day period from day t 10 to day t + 10, centred on the announcement date, i.e. the day the story appeared (day t), according to the formula: ARit = Rit E(Rit ) (2)

where ARit is the unexpected share return for day t and E(Rit ) is the expected share return for day t. The expected returns were obtained from the market model: E(Rit ) = i + i (Rmt ) + it (3)

where i and i were estimated from day t 310 to day t 11 and Rmt is the market return for day t. The resulting unexpected returns were labelled abnormal returns. The unexpected returns were averaged (i) across the whole sample and (ii) for good and bad-news events separately:
n

ARp =
i=1

1 ARit n

(4)

where ARp is the average unexpected return for the whole sample (p = s) as well as for the portfolio of good (p = g) or bad (p = b) rms and n is the number of rms in each group. This average unexpected return was then tested to determine whether it was signicantly different from zero. Specically, t-tests were performed on the means and Wilcoxon tests on the medians. Finally, a General Linear Model was tted to explain the unexpected returns on the announcement day. Specically, the following equation was determined: ARi = + (NEWS)i + k (SECTOR)k + j (FINSALE)j (5)

In this equation, is the constant term, NEWS is a dummy variable where 1 represents bad-news rms and +1 represents good-news rms, and SECTOR12 is a factor which has six levels representing the different industry groups. FINSALE is a factor with three levels, depending on whether the ratio of the ne on the company relative to its size (the turnover gure in the nancial statements before the news was published) is small (01%), medium (110%), or large (over 10%).13 This nal model therefore attempted to explain any share price reaction over the event period in terms of the nature of the news being disclosed, the size of the ne, if any, and the sector to which the rm belongs.14 We might anticipate that companies in environmentally sensitive industries which incur proportionately larger
12 The following six sector categories were employed: Building (7), Chemicals (4), Drinks (2), Engineering & Industrials (4), Oil & Gas (4), Utilities (11). Each of these sectors was numbered one to six for the SECTOR variable that was constructed. Other ner groupings were considered but had to be abandoned as some industries did not have enough rms in them to enable the statistical calculations to be performed. 13 Thus, a FINSALE factor was constructed where the value 1 represented small ratios, 2 represented median ratios and 3 represented large ratios. Other cut-off points were tested but did not yield any different results. The factor approach based on three levels was adopted because this facilitated the usage of the Analysis of Variance statistical technique. 14 This model was checked for multicollinearity by calculating the Variance Ination Factors for each variable. The values obtained were all less than 5 which is the critical number suggested by Montgomery and Peck (1982).

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nes for environmental pollution might experience a higher and more adverse stock market response relative to their counterparts in other sectors which only attract small nes. The following hypotheses15 were tested (stated here in their alternative form): H1 . There is a relationship between environmental news relating to a company and that companys share price. H2 . Good environmental news is associated with an increase in the companys share price. H3 . Bad environmental news is associated with a reduction in the companys share price. H4 . The cross-sectional variation in unexpected returns is related to the environmental news, the size of the ne to sales ratio for the rm or the sector to which the rm belongs. Our testing of the hypotheses H2 and H3 is based on our a priori reasoning, informed by our review of the literature, that good news will, ceteris paribus, lead to a positive share price reaction and vice versa. While we recognise that a rationale can be put forward for a precisely opposite effect we do not nd that rationale persuasive. The ndings of Thomas (2001) in particular, being both recent and of UK origin, support our maintained hypotheses. In addition, our reasoning is consistent with the arguments and the ndings of Hillman and Keim (2001) given that the good-news and bad-news incidents that we investigate can be construed as falling within their category of stakeholder management rather than that of social participation. H4 builds on H2 and H3 by examining whether the market responds to environmental news on its own or whether other factors inuence any relationship detected. Specically, we study whether the market response may vary according to the relative size of the ne imposed on the company and the sector to which it belongs. News of relatively large nes for environmental pollution may be especially damaging for rms operating in environmentally sensitive industries since it may attract future regulation and exclude such companies from the investment universe of ethical funds. The results of the tests of the hypotheses are shown in Section 5. Our reasoning is also consistent with the reasoning and ndings of Chan and Milne (1999) though the potential for ambiguity in good news (if there is too much) is noted.

5. Descriptive statistics and results The descriptive statistics for the sample rms share returns over the period 1st January 1994 to 31st August 2000 are shown in Table 2. In particular, the abbreviation of each rm is shown together with the mean share return, the standard deviation of share returns, the minimum and maximum share return and skewness and kurtosis statistics.
15 For the purposes of the formulation of the hypotheses in this paper bad news refers to a report of a pollution offence which resulted in a ne; good news refers to a report of an environmental award or to any announcement which reects well on the environmental responsibility of a company, and environmental news refers to a report of either kind.

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Table 2 Descriptive statistics for the sample returns Company ASW PWG NPW BCI SKS HNS RMC SHEL ICI PILK ETQ SVT TW VHE SPW WTB AW CRDA SGC RLRC BG BP WBRY Average FTALLSH Mean 0.0014 0.0000 0.0000 0.0001 0.0005 0.0001 0.0002 0.0005 0.0003 0.0004 0.0019 0.0001 0.0002 0.0010 0.0001 0.0001 0.0000 0.0002 0.0005 0.0001 0.0003 0.0007 0.0001 0.0001 0.0004 S.D. 0.0289 0.0173 0.0196 0.0208 0.0153 0.0189 0.0192 0.0162 0.0196 0.0221 0.0362 0.0167 0.0156 0.0235 0.0171 0.0157 0.0166 0.0160 0.0250 0.0211 0.0194 0.0159 0.0112 0.0189 0.0083 MIN 0.2144 0.1558 0.3168 0.2205 0.1438 0.0851 0.1335 0.0718 0.1552 0.1220 0.6241 0.1034 0.1198 0.5991 0.1029 0.0690 0.1439 0.1823 0.5479 0.2539 0.1260 0.0614 0.0975 0.1783 0.0327 MAX 0.2651 0.0909 0.1380 0.1867 0.1439 0.1604 0.1924 0.0912 0.1011 0.1098 0.2432 0.0736 0.0884 0.2131 0.1126 0.0815 0.0915 0.1163 0.1183 0.1448 0.0990 0.0944 0.0774 0.1227 0.0376 SKEW 0.3026 2.2258 0.4589 1.3550 0.4712 0.4012 0.3679 0.0965 0.0658 3.0484 0.0473 0.2587 9.6124 0.0458 0.0482 0.1276 0.1931 6.3231 0.7654 0.0514 0.3770 0.9449 0.5362 0.2358 1.1664 KURT 21.7856 7.0351 41.8123 15.8143 15.7897 5.3138 11.6041 3.1498 5.5714 2.7965 64.0466 2.8212 5.9084 258.2348 3.6032 2.7972 6.8005 16.6570 136.4596 14.4597 3.2389 2.7652 13.9384 22.1703 1.7873

Note: Descriptive statistics for 1739 daily share returns of 23 companies (32 events) and FT All Share index are supplied. This table shows the average daily return for each company over an 80-month period (Mean), the standard deviation (S.D.), minimum (MIN) and maximum (MAX) returns. A measure of skewness (SKEW) and kurtosis (KURT) is provided in the nal columns. An asterisk in the table indicates signicance at the 5% level.

Five main points emerge from an analysis of this table. First, the companies in the sample performed poorly, on average, over the 80 months covered by the study. Some 13 of the 32 companies had negative mean returns over the period studied and the average return for all the rms was 0.0001. Second, this average measure masks a variety of performances. BP had the best mean return of 0.0007 while ETQ performed poorly earning shareholders a negative average return of 0.0019. Third, the FT All Share index achieved good returns relative to the sample rms over the period. Its mean value of 0.0004 was only bettered by four rms (SKS, SHEL, SGC and BP) and even here the difference was not large. Fourth, this relatively high return for the index was achieved with relatively low risk; the standard deviation of returns for the index at 0.0083 was nearly 50% lower than that for the least risky rm (SKS). This picture of higher volatility in the sample rm returns is conrmed by an analysis of the MIN and MAX statistics. The gap between these two measures is large for some rms (SGC, VHE and ETQ) suggesting that share prices have dropped suddenly and risen sharply in different months, possibly in response to the pollution news being scrutinised in this investigation.

N.H.J. Lorraine et al. / Accounting Forum 28 (2004) 726 Table 3 An analysis of abnormal returns for the sample T 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 Mean 0.0014 0.0104 0.0007 0.0058 0.0028 0.0025 0.0027 0.0065 0.0007 0.0032 0.0007 0.0013 0.0031 0.0035 0.0009 0.0009 0.0017 0.0059 0.0030 0.0023 0.0035 S.D. 0.0201 0.0480 0.0151 0.0160 0.0178 0.0200 0.0161 0.0187 0.0260 0.0231 0.0144 0.0144 0.0207 0.0194 0.0224 0.0197 0.0242 0.0161 0.0138 0.0159 0.0174 t-value 0.39 1.23 0.25 2.04 0.89 0.70 0.96 1.96 0.14 0.79 0.26 0.53 0.86 1.01 0.22 0.25 0.39 2.08 1.24 0.80 1.15 P-value 0.70 0.23 0.80 0.05 0.38 0.49 0.34 0.06 0.89 0.43 0.79 0.60 0.40 0.32 0.83 0.80 0.70 0.05 0.22 0.43 0.26 Median 0.0002 0.0019 0.0006 0.0055 0.0006 0.0010 0.0004 0.0020 0.0001 0.0011 0.0018 0.0011 0.0002 0.0026 0.0006 0.0024 0.0003 0.0028 0.0014 0.0005 0.0000

19

P-value 0.76 0.35 0.84 0.02 0.49 0.38 0.67 0.14 0.77 0.48 0.57 0.93 0.67 0.07 0.98 0.53 0.73 0.10 0.10 0.36 0.58

Note: This table shows the mean and median abnormal returns over a 21-day period for the 32 events where t0 is the event date. The abnormal returns are calculated using the market model. An asterisk in the table indicates signicance at the 5% level.

Finally, an investigation of the SKEW and KURT statistics reveals that for a sizeable number of the sample companies, monthly returns may not be normal. Some 21 of the skewness statistics are signicant at the 5% level; 9 are positively skewed while 12 have a higher than expected tail of negative returns. Also, all of the kurtosis measures are statistically signicant indicating that the sample rms have a relatively high proportion of extreme return values. Overall, these two nal statistics indicate that the monthly returns for the sample rms may not be normally distributed. Therefore, non-parametric as well as parametric statistics were calculated in this study to overcome the problem that the distribution of share returns may not be normal. Table 3 reports the results where expected returns are estimated according to Eq. (4); it documents ndings for hypothesis H1 which examines whether the market responds to the environmental news published about the sample rms. The mean and standard deviation are given as well as the t-statistic which tests whether this abnormal return is signicantly different from zero at the 5% level. The P-value associated with this test is also supplied.16 In the nal two columns, the median and the P-value for a Wilcoxon test on whether this median is equal to zero is shown.

16 This P-value displays the level of condence in the hypothesis that the mean abnormal return is not equal to zero; a P-value of less than 0.05 corresponds to the 5% level of signicance which is conventionally employed in market-based studies of this type.

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All of this information is supplied for 21 daysfrom 10 days before the publication of the news to 10 days after the release of the informationto determine whether there is any leakage of the news in the run-up to the disclosure of the environmental details or, on the other hand, to gauge whether investors take time to respond to the news after it becomes public. Similar pre- and post-event periods have been employed in related US studies (Belkaoui, 1976; Shane & Spicer, 1983) and the choice of the event window in this study aimed to offer some comparability of results with previous investigations. The overwhelming impression to emerge from Table 3 is that at the time of the publication of the environmental news (day t0 ) the stock market reaction is small, negative, and not signicantly different from zero; thus, hypothesis H1 is not supported (the null form cannot be rejected). The mean (median) abnormal return of 0.0007 (0.0018) is small and the P-value of 0.79 (0.57) considerably higher than the critical value of 0.05. A similar picture emerges when the abnormal returns from day t 10 to day t 1 are examined. An exception to this generalisation occurs in day t 7 when the mean and median abnormal returns are positive (0.0058 and 0.0055) and the P-values are just less than 0.05. For these rms, the share price is increasing signicantly over a week before the news is announced relative to variations in the index and after accounting for beta risk. A number of possible explanations for this nding exist. For example, the market may have anticipated good environmental news (or a relatively small ne for those transgressing pollution regulations). Alternatively, the market may be responding to something unrelated to environmental information that just happens to effect the shares of the sample rms or there may have been some leakage of the ndings of the pollution investigation. In the post-announcement period, the mean and median abnormal return on day t + 7 (0.0059 and 0.0055) are negative; the P-value is equal to the 0.05 critical value for the mean but greater than the critical value for the median. On this day, there is a sizeable fall in the average share prices for the sample rms relative to the performance of the FT All Share index, however a large value for a small number of rms appears to be driving this result. The main obstacle in interpreting the results in the above table is that the sample contains both good and bad-news events. For a more concise analysis, the sample needs to be divided and hypotheses H2 and H3 tested according to the type of news event. The t-tests (Wilcoxon tests) were used to analyse the mean (median) ARs for the 9 good-news and 23 bad-news events against a 95% condence level. Unlike the previous tests where the mean was assumed to be zero, the good-news events were presumed to have a mean and median of greater than or equal to zero; for the bad-news events, the unexpected return (ARit ) was assumed to be less than or equal to zero. Table 4 shows the results for the test of hypothesis H2 ; the mean abnormal returns for the good-news events, along with the corresponding standard deviations and t-values are reported. The nal two columns highlight the median abnormal return and its P-value. At the 5% level of signicance, none of the mean abnormal returns were signicant. The mean return of 0.0248 on day t 9 is the largest reported for the 21-day window, but with a P-value of 0.21 is far from the critical value of 0.05. On further investigation, one rmEnergy Technique (ETQ)had a large positive return of 24% on day t 9 and this large capital gain may have pushed up the average results for that day; the median abnormal return was much less impressive on this day.

N.H.J. Lorraine et al. / Accounting Forum 28 (2004) 726 Table 4 The average abnormal returns for good-news events T 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 Mean 0.0048 0.0248 0.0013 0.0050 0.0037 0.0082 0.0005 0.0027 0.0026 0.0027 0.0024 0.0004 0.0074 0.0048 0.0044 0.0032 0.0102 0.0009 0.0025 0.0044 0.0052 S.D. 0.0153 0.0860 0.0094 0.0128 0.0190 0.0172 0.0046 0.0084 0.0107 0.0122 0.0073 0.0130 0.0233 0.0207 0.0111 0.0142 0.0277 0.0092 0.0062 0.0103 0.0187 t-value 0.94 0.86 0.42 1.16 0.59 1.43 0.31 0.94 0.72 0.67 0.97 0.08 0.95 0.70 1.18 0.67 1.10 0.28 1.20 1.28 0.84 P-value 0.19 0.21 0.34 0.14 0.29 0.10 0.62 0.19 0.75 0.74 0.18 0.47 0.19 0.75 0.86 0.74 0.85 0.61 0.87 0.88 0.79 Median 0.0007 0.0000 0.0026 0.0025 0.0010 0.0010 0.0008 0.0032 0.0038 0.0003 0.0007 0.0019 0.0005 0.0027 0.0014 0.0009 0.0028 0.0005 0.0003 0.0062 0.0001

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P-value 0.36 0.41 0.20 0.12 0.36 0.20 0.76 0.20 0.68 0.50 0.32 0.32 0.45 0.86 0.86 0.76 0.88 0.06 0.72 0.88 0.72

Note: This table provides an analysis of the mean abnormal returns for the nine good-news events contained within the overall sample of 32 events.

Overall, the analysis of the good-news events yields little evidence in support of hypothesis H2 that abnormal returns are signicantly larger than zero. Over the entire 21-day period centred on the publication of the environmental news, the stock market reaction was small, with P-values ranging from 0.10 to 0.88 for abnormal returns. Hence, these average abnormal returns were not signicantly larger than zero. Despite the lack of signicance there are positive returns on day t0 following two previous days of negative mean returns. A number of possible explanations for this nding exist. For example, the news may not have information content for investors and has therefore not been reected in share returns. Alternatively, the market may have responded to the information, but not to such an extent as to realise a substantial increase in share price. It could also be argued that the market may have anticipated the environmental news, and correctly impounded the information into share prices much earlier than day t0 ; but the study has already considered the period from day t 10. The mean and median abnormal returns which test hypothesis H3 for the 23 bad-news events are provided in Table 5 with the standard deviations, t-values and P-values. A number of ndings emerge from an analysis of this table. First, there was a mean abnormal return of zero on the event day t0 with a minuscule t-value; the abnormal return therefore was not signicant at the 5% level. Second, the 21-day window yielded nine negative mean abnormal returns, including day t + 7 (0.0079) which, with a P-value of 0.02, was signicant at the 5% level. The median analysis corroborates this result with the largest negative abnormal

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Table 5 The average abnormal returns for the bad-news events T 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 10 Mean 0.0000 0.0048 0.0015 0.0061 0.0024 0.0002 0.0036 0.0080 0.0019 0.0034 0.0000 0.0020 0.0015 0.0030 0.0029 0.0000 0.0063 0.0079 0.0033 0.0014 0.0029 S.D. 0.0218 0.0211 0.0169 0.0173 0.0177 0.0209 0.0188 0.0215 0.0301 0.0264 0.0165 0.0151 0.0199 0.0194 0.0254 0.0217 0.0216 0.0179 0.0160 0.0178 0.0172 t-value 0.01 1.10 0.42 1.69 0.66 0.05 0.93 1.79 0.31 0.62 0.00 0.64 0.36 0.73 0.55 0.00 1.40 2.12 0.98 0.38 0.81 P-value 0.50 0.86 0.34 0.95 0.74 0.52 0.18 0.96 0.62 0.27 0.50 0.27 0.64 0.24 0.71 0.50 0.91 0.02 0.17 0.35 0.21 Median 0.0002 0.0043 0.0022 0.0063 0.0002 0.0011 0.0009 0.0009 0.0005 0.0016 0.0035 0.0003 0.0002 0.0025 0.0023 0.0038 0.0021 0.0060 0.0035 0.0001 0.0000 P-value 0.53 0.85 0.26 0.99 0.66 0.68 0.32 0.90 0.53 0.21 0.51 0.35 0.63 0.08 0.72 0.36 0.89 0.02 0.08 0.41 0.45

Note: This table summarises the mean abnormal returns for the 23 bad-news events contained within the overall 32 events. An asterisk in the table indicates signicance at the 5% level.

return of 0.0060 occurring on that day. This nding is consistent with the results in Table 3 and suggests the possibility that the stock market may be taking a week to assess the full impact of the negative environmental information disclosure. Table 6 shows the results for testing hypothesis H4 when Eq. (5) is estimated. A number of ndings emerge from an analysis of this table. First, the results are mixed; only one significant variable emerged but the variation in unexpected returns explained is relatively high. Second, the size of ne measure (FINSALE) does appear to have signicant explanatory

Table 6 A cross-sectional analysis of the cumulative unexpected returns Source Intercept NEWS SECTOR FINSALE Error Total Sum of squares 0.00004 0.00001 0.00100 0.00149 0.00373 0.00643 d.f. 1 1 5 2 22 31 Mean square 0.000042 0.000009 0.000201 0.000743 0.000169 F-value 0.261 0.053 1.239 4.587 P-value 0.614 0.820 0.323 0.021

Note: The adjusted R squared is 0.219.

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power in the regression equation as the P-value of 0.021 is less than 0.050.17 Third, both the news variable and the sector measure are insignicant in explaining the abnormal share price behaviour of the sample rms over the announcement-day period. The F-statistics are 0.053 and 1.129, respectively, while the P-values of 0.820 and 0.323 are much higher than the critical value of 0.050. Of course, the number of companies in one of the sectors was relatively small which may explain this nding. Also, the fact that only a subset of all sectors are covered by the sample may explain why this variable is not a useful measure in differentiating among the share price responses observed for the different rms. Finally, the adjusted R2 for the equation is an impressive 21.9%. Thus, nearly one fth of the variation in the unexpected share returns at the time of the environmental news can be explained by a general lineal model based on a relatively small number of variables.

6. Conclusion This paper set out to provide descriptive statistics for the share returns of rms whose environmental performance has been highlighted (either in a positive or in a negative fashion) over the period from April 1995 to August 2000. Specically, it examined whether the favourable or adverse environmental news inuenced capital market values for the rms in the sample. Company share returns were statistically analysed for the 32 news events over a 21-day period from 10 days before the ofcial announcement date to 10 days after. An initial analysis of the share returns showed that, on average, companies performed poorly with 13 of the 32 companies yielding a negative mean return and only four rms outperforming the FT All Share index. Abnormal returns were examined and tested at the 5% level of signicance. An analysis of the abnormal returns for all 32 events showed that there was no signicant price change on the ofcial announcement date although there may have been some information leakage to the market 1 week before the event date. The parametric tests on abnormal returns showed that there was a signicantly negative return on day t + 7: this lagged reaction is surprising and possibly worthy of further scrutiny with a larger dataset of EA announcements over a longer time span. Discussions with nancial analysts and company personnel might reveal whether the stockmarket takes time to consider the implications of news about a companys environmental performance. Of course the possibility cannot be discounted that the day t + 7 result is a statistical artifact; one might expect one false abnormal return over a 21-day period at the 95% condence level. To assess the individual impact of good- and bad-news events, the sample was divided and t-tests were carried out on the 9 good and 23 bad-news items. An analysis of the good-news events provided little evidence to suggest that the stock market had utilised this information as none of the mean abnormal returns were signicant at the 5% level. The bad-news events analysed were more consistent with the overall ndings from the 32 events with a signicant

17 As expected, the sign on this FINSALE variable (not reported here) was negative suggesting that the higher the relative ne imposed for the bad-news rms, the larger the reduction in abnormal returns.

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negative return on day t + 7. This nding is hardly surprising since the bad-news events were disproportionately represented in the sample. Of course the event study approach works better on larger samples and further work in this area might yield more conclusive results. In addition, this investigation only examines pronouncements by the EA in the early years of its existence; possibly stock market participants need more time to respond quickly to any news contained in announcements about environmental performance. Finally, a lot of the nes imposed by the EA were on unquoted companies and the impact of this news could not be considered with the present event study methodology; share price data were needed for the approach adopted. Nevertheless, this UK evidence complements the US results about the growing importance of negative environmental performance indicators. Also, the cross-sectional ndings appear to lend support to the activities of the EA: the relative size of the nes that are imposed by courts seems to impact adversely on the market values of guilty companies possibly encouraging them not to re-offend in the future. In summary the main contribution of this paper is to provide limited evidence of a lagged market reaction to bad environmental news (nes due to breaches of regulations). It also describes sources of, and the potential importance of, externally-provided environmental informationin particular that provided by the EA within the UK. The papers limitations principally derive from the small scale nature of the sample. Further work in this area could benet from the use of larger data sets, and comparison of regulatory regimes in various jurisdictions. The longitudinal element is also worthy of explicit study as awareness of and attitudes to environmental behaviour develop. In addition qualitative research which investigates companies, investors and regulators perspectives on these issues would be worthwhile.

Acknowledgements The authors would like to thank the Institute of Chartered Accountants of Scotland for their generous funding of this project and Rob Gray for his ideas and suggestions regarding this area of investigation. We would also like to thank Glen Lehman and two anonymous referees for their helpful comments.

Appendix Companies selected for further investigation Company name Good-news events Energy Technique Pilkington Powergen National Power Abbreviation No. of events 1 1 1 1 Sector Pre-tax prot 1999 (m) 3.39 2469.00 762.00 452.00

ETQ PILK PWG NPR

Industrials Building Power & Water Power & Water

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Appendix (Continued ) Company name ASW RMC Blue Circle Shanks Group Hanson Bad-news events Shell Anglian Water BG Group BP Amoco Croda Resins ICI RMC Rolls Royce Scottish Power Severn Trent Stagecoach Thames Water VHE Construction Westbury Construction Whitbread Abbreviation ASW RMC BCI SKS HNS SHEL AW BG BPA CRDA ICI RMC RLRC SPW SVT SGC TW VHE WBRY WTB No. of events 1 1 1 1 1 2 2 1 1 1 3 1 1 1 3 1 2 1 1 2 Sector Industrials Building Building Industrials Building Oil & Gas Power & Water Oil & Gas Oil & Gas Chemicals Chemicals Building Engineering Power & Water Power & Water Transport Power & Water Building Building Brewing Pre-tax prot 1999 (m) 0.03 277.00 195.00 0.04 316.00 3592.00 227.00 1195.00 4343.00 24.80 503.00 277.00 360.00 644.00 1364.00 210.00 419.00 0.14 53.56 256.00

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