1. The Economic Value of Corporate Eco-Efficiency Nadja Guenster RSM Erasmus University SRI in the Rockies September 27, 2005

2. CONTRIBUTION We investigate the relationship between eco-efficiency, operating performance (Return-on-Assets) and valuation (Tobin’s q) Eco-efficiency is a closely defined and comprehensive measure Eco-efficiency data are available on a monthly basis from December 1996-2002 Relate eco-efficiency to accounting-based and market-based financial performance criteria Investigate the relation between these criteria and eco- efficiency over time We relate our current results to prior research on SRI

3. FRAMEWORK Eco-Efficiency Risk-adjusted long-run stock returns + Operating Performance: Return-on-Assets (ROA) Valuation: Tobin’s q + + Eco-efficiency is positively related to operating performance (ROA) Eco-efficiency is positively related to firm valuation (Tobin’s q) Portfolios of most eco-efficient companies outperform portfolios of least eco- efficient companies by about 6% annually (Derwall et al., FAJ, 2005) These abnormal long-run stock returns should over time translate into a higher valuation for more eco-efficient companies +

4. DATA Financial data are obtained from the Compustat US Research Database Monthly “Eco-efficiency Ratings” for 154 to 408 US firms (1996-2002) provided by Innovest Innovest defines eco-efficiency along 5 dimensions: Historical liabilities: involves risk resulting from preceding actions Operating risk: risk exposure from recent events Sustainability and eco-efficiency risk: future risks initiated by the weakening of the company’s material sources of long-term profitability and competitiveness Managerial risk efficiency: the ability to handle environmental risk successfully Environmentally-related strategic profit opportunities: business opportunities, such as a competitive advantage

5. METHODOLOGY: FAMA-MACBETH (1973, JPE) We estimate 24 quarterly regressions from 1997-2002: Performance measure i1 =  1 +  1 Eco-efficiency i1 +  1 X i1 +  i1. Performance measure i24 =  24 +  24 Eco-efficiency i24 +  24 X i24 +  i24 Time-series statistics This approach allows us to investigate the time-variation of the effects of eco-efficiency on firm performance

6. ECO-EFFICIENCY AND ROA Fama-MacBeth regressions of a firm’s ROA on a set of independent variables, using: The firm’s eco-efficiency score Controls: Firm size, Debt/Assets, Total sales Several measures of ROA: regular & industry-neutral Our results indicate that there is a positive and significant association between eco-efficiency and ROA A one-point increase in the eco-efficiency rating corresponds to a 2.1% increase in ROA Asymmetric effect: least-eco-efficient firms display significant operational underperformance relative to the remainder of firms; most eco-efficient firms do not display significant operational outperformance

7. *** significant at 1% level ** significant at 5% level * significant at 10% level (-1.74) (-1.35) -6.36 E -6 * -8.44 E -6 SALES (-5.95)(-6.93)(-5.95)(-6.84) -2.39 *** -4.04 *** -2.33 *** -3.99 *** DEBT / ASSETS (-4.64)(-8.98) -2.62 E -6 *** -4.98 E -6 *** SIZE (0.10)(0.69)(0.19)(0.87) 0.010.060.010.07ECO HIGH (-7.69)(-6.72)(-7.91) (-7.53) -0.38 *** -0.37 *** -0.39 *** ECO LOW (7.30)(24.10)(7.66)(25.03) 0.55 *** 4.71 *** 0.56 *** 4.77 *** Intercept Ind.- adj. ROA ROA Ind.- adj. ROA ROA EXAMPLE OF RESULTS We find a positive and asymmetric relation between eco-efficiency and ROA

8. ECO-EFFICIENCY AND TOBIN’S Q Fama-MacBeth regressions of a firm’s Tobin’s q on a set of independent variables, using: The firm’s eco-efficiency score Controls: Firm size, Age, R&D, Advertising, Nasdaq Dummy Several measures of Q: regular, log, trimmed, industry-neutral Q Results indicate that there is a positive and significant association between eco-efficiency and Tobin’s q A one-point increase in the eco-efficiency rating corresponds to a 3.4% increase in Q Asymmetric effect: especially low-ranked companies have lower Q values; high-ranked firms did not display a significant positive association with Q over the whole period.

9. -3.11E -6 *** -1.25E -6 *** -1.31E -6 *** -3.21E -6 ***Size 11.01*** 3.02*** 4.48*** 11.27***R&D 0.01 0.01***-0.00-0.02AGE 1.39*** 0.36*** 1.26*** 1.49***SG -0.020.02-0.030.02 ECO HIGH -0.32*** -0.10*** -0.32*** -0.31***ECO LOW 1.79*** 0.45***0.12 1.81**Intercept Trimmed QLog(Q)Q Ind. Adj.Q EXAMPLE OF RESULTS We find a positive and asymmetric relation between eco-efficiency and Q *** significant at 1% level ** significant at 5% level * significant at 10% level

10. The Eco-Efficiency Premium Puzzle (FAJ, 2005) Derwall et al. compose two equity portfolios. One consists of the most eco- efficient companies while the other one consists of the least eco-efficient companies. They compare the returns on these portfolios using performance attribution models and find: The most eco-efficient portfolio earns an abnormal return of 6% p.a. compared to the least eco-efficient portfolio The performance differential between the portfolios is due to the outperformance of the most eco-efficient companies. The least eco- efficient companies hardly underperform compared to a benchmark These abnormal returns should over time translate into higher prices for the most eco-efficient firms compared to least eco- efficient firms. ECO-EFFICIENCY AND TOBIN’S Q: A time-varying relation (I)

11. ECO-EFFICIENCY AND TOBIN’S Q: A time-varying relation (II) -3.59E -6 *** -2.87E -6*** Size 8.46** 14.09***R&D -0.03 0.04 * AGE 1.36***1.62***SG ECO HIGH ECO LOW 2.27 *** 1.36 *** Intercept Period 2 Q Period 1 Q -0.42 *** -0.24 *** -0.20 0.21 *** During the first half of our sample period, we find that the least eco-efficient and the most eco-efficient companies trade at a discount. During the second half, the most eco-efficient companies trade at a significant premium.

12. ECO-EFFICIENCY AND TOBIN’S Q: A time-varying relation (III) The valuation differential between the most eco-efficient and the least eco- inefficient companies increases over time Value of most eco-efficient companies versus least eco-efficient companies

13. SUMMARY (I) Eco-efficiency and operating performance (ROA): Significantly positive relation While most eco-efficient firms don’t outperform, least eco-efficient firms perform much worse Eco-efficiency and valuation (Tobin’s q): Significantly positive relation While the most eco-efficient firms don’t have a higher valuation, the least eco-efficient firms trade at a substantial discount During our complete sample period, the benefits of eco-efficiency at least outweigh the costs

14. SUMMARY (II) Eco-efficiency and valuation (Tobin’s q) over time: The most eco-efficient firms traded at a discount at the beginning of our sample period. Over time a premium arises The least eco-efficient firms traded at a discount during the first half of our sample period. During the second half, the discount is not statistically significant This evidence is in line with the abnormal returns on portfolios of eco- efficient companies reported by Derwall et al. While investors used to punish the least eco-efficient and most eco-efficient firms at the beginning of our sample, they reward the most eco-efficient firms towards the end of our sample period The financial market increasingly values the benefits of eco- efficiency during our sample period