Presentation on a paper titled as "Capital Market Responses to Environmental Performance"

1. Capital Market Response to
Environmental Performance in
Developing Countries
By:
Susmita Dasgupta
Bendoit Laplante
Nlandu Mamingi
28/01/2024 1

2. 1. Background of the Study
 1. Back Ground of the Study
 2. Data
 3. Methodology
 4. Result and Discussion
 5. Conclusion
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3. 1. Background of the Study
 Exercising Environmental regulations for more than
20 years, but still the results are not good.
Lack of appropriate monitoring and enforcement.
Lack of Resource allocation to the regulatory
authorities
Low fines and penalties
Exemption from fines and penalties
 Ground of financial hardship
 Political influence
 Improvements in the enforcement is required.
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4. 1. Background of the Study
 A general Argument
Firms in developing countries do not have
incentives to invest in pollution control efforts
because of weak monitoring and enforcement.
 Assumption Behind the Argument:
Environmental Regulating agencies are the only
agent;
Penalize the firm lacking pollution control
effort
Reward the firm for good environmental
performance or innovation in environmental
technologies.
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5. 1. Background of the Study
 This argument ignores something very special
 Reaction of Capital Market to the Announcements
Capital markets may react negatively to the
announcement of adverse environmental
incidents
Violation of permits
Court actions
Complaints, etc.
Capital market may react positively to the
announcement of greater pollution control efforts
Adaption of cleaner technologies
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6. 1. Background of the Study
 Support to the Argument?
 Announcement of High Pollution intensity
Inefficiency of the firm’s production process
Loss of reputation
So investors may not invest in the firm.
 Announcement of good environmental
performance
Less scrutiny by regulators
Good reputation and high market value
Greater access to international market etc.
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7. 1. Background of the Study
 Conclusion
Traditional channels of fines and penalties may
not be as serious an impediment to pollution
control as is generally argued.
What is the solution ?
 Capital market if properly informed, may provide the
appropriate reputational and financial incentives
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8. 1. Background of the Study
 Hypothesis of the study
Whether or not capital markets in Mexico, Chile,
Argentina and the Philippines react to the
announcement of firm specific environmental
News.
 Importance of the Study
First of this nature performed in developing
countries.
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9. 0
50000
100000
150000
200000
250000
1990 1991 1992 1993 1994
In
Million
of
US
Dollars
Argentina Chile Mexico Philippines
Capitalization of the stock market
Source: International Finance Corporation, Emerging stock markets fact book, 1995.
2. Data
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10.  News Collection Technique
 Selection of newspaper
Large circulation
Interest to the business community
 Collection of Environmental news
For each country over the period 1990-94
inclusively.
 Identification of News
Firms that are traded in local capital markets
2. Data
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11. Total Number of Events: 7354
Sum of All Events = 126
126 ≠ 7354
Why?
2. Data
Argentina Chile Mexico Philippines
Total Events 20 53 35 18
No. of +ve Events 05 20 04 10
No. of -ve Events 15 33 31 08
No. of Firms 11 17 08 05
No. of Sectors 06 10 10 10
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12.  Repetition or follow-up on an initial event
and
 No additional information to what is
already known.
 included in dataset only the announcement
of the initial event
2. Data
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13. 3. Methodology
 Event Study Methodology
To examine the reaction of investors to positive
and negative new
 Assumptions:
Capital market is efficient to evaluate the impact
of new information
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14. 3. Methodology
 Identification of the events of interest and
definition of the event window.
 Selection of the sample set of firms to include in
the analysis
 Prediction of a “normal” return during the event
window in the absence of the event
 Estimation of the abnormal return within the event
window, where the abnormal return is defined as
the difference between the actual and predicted
returns
 Testing whether the abnormal return is statistically
different from zero.`
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15. Methodology
𝑅𝑖𝑡 = 𝑎𝑖 + 𝑏𝑖𝑅𝑚𝑡 + 𝑒𝑖𝑡 ⋯ (1)
Where 𝐸 𝑒𝑖𝑡 = 0 and 𝑉𝑎𝑟(𝑒𝑖𝑡) = 𝜎𝑒𝑡
2
Where t is the time index,
i= 1,2,3…,N stands for security
𝑹𝒊𝒕 is the Returns on security i during period t.
𝑹𝒎𝒕 is the market portfolio of ith security in time t
𝒆𝒊𝒕 is the error term for security i
Estimation Period 120 to 210 days.
Event Window 10 days prior and after the event.
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16. 3. Methodology
 Normal return can be calculated during the days
covered by the event window.
 The difference between actual and predicted
normal return is called Abnormal Return
𝐴𝑅𝑖𝑡 = 𝑅𝑖𝑡 − 𝑎𝑖 + 𝑏𝑖𝑅𝑚𝑡 ~𝑁 0,1 ⋯ (2)
 Why 𝑨𝑹𝒊𝒕 ~𝑵 𝟎, 𝟏 ?
 𝐴𝑅𝑖𝑡 is actually the error term, which has
white noise properties by assumptions in
eq(1).
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17. 3. Methodology
𝜎2
(𝐴𝑅𝑖𝑡) = 𝜎𝑒𝑡
2
+
1
𝐿
1 +
𝑅𝑚𝑡 − 𝑅𝑚
2
𝜎𝑚
2 ⋯ (𝟑)
Where L is the estimation period Length and
𝑹𝒎 is the mean of the market portfolio.
With L large then 𝜎2
(𝐴𝑅𝑖𝑡) → 𝜎𝑒𝑡
2
 Good for individual event analysis.
 Estimate the abnormal return and
 use the relevant test at each instant in time
within the event window.
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18. 3. Methodology
For more than one event jointly;
𝐴𝐴𝑅𝑡 =
1
𝑁
𝑖=1
𝑁
𝐴𝑅𝑖𝑡 ⋯ (4)
For large L the variance is;
𝑉𝑎𝑟(𝐴𝐴𝑅𝑡) =
1
𝑁2
𝑖=1
𝑁
𝜎𝑒𝑡
2
⋯ (𝟓)
Z or t test can be derived.
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19. 3. Methodology
In order to test for the presence of the impact of the
event during a period 𝑇1, 𝑇2 , the abnormal return can
be added to obtain the Cumulated Abnormal Returns
for security i over the period 𝑇1, 𝑇2 ;
𝐶𝐴𝑅𝑖(𝑇1, 𝑇2) =
1
𝑁2
𝑡=𝑇1
𝑇2
𝐴𝑅𝑖𝑡 ⋯ (𝟔)
And the variance is;
𝜎𝑖
2
𝑇1, 𝑇2 = (𝑇2 − 𝑇1 + 1)𝜎𝑒𝑡
2
⋯ (7)
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20. 3. Methodology
To test the null hypothesis of zero cumulative
abnormal return,
𝑍 =
𝐶𝐴𝑅
𝜎𝑖
2
𝑇1, 𝑇2
1
2
~𝑁 0,1 ⋯ (𝟖)
An aggregation of interest can also be performed
across both time and events. So the Average
Cumulative Abnormal Return is defined as;
𝐶𝐴𝐴𝑅(𝑇1, 𝑇2) =
1
𝑵
𝑖=1
𝑁
𝐶𝐴𝑅𝑖(𝑇1, 𝑇2) ⋯ (𝟗)
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21. 3. Methodology
The Variance of CAAR is;
𝑉𝑎𝑟(𝐶𝐴𝐴𝑅 𝑇1, 𝑇2 ) =
1
𝑁2
𝑖=1
𝑁
𝜎𝑖
2
(𝑇1, 𝑇2) ⋯ (10)
Under the null hypothesis that abnormal returns
are zero, Z-test is given as;
𝑍 =
𝐶𝐴𝐴𝑅(𝑇1,𝑇2)
𝑉𝑎𝑟(𝐶𝐴𝐴𝑅 𝑇1,𝑇2 )
1
2
~𝑁(0,1) ⋯ (11)
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22. 4. Empirical Result
 13 +ve events, statistically significant
increase in market values,
 8 out of 13 involve the report of an agreement with
the regulator or the explicit recognition by the
regulator of a superior environmental performance.
 Firm reporting have no impact on capital markets.
But the recognition.
 Market values increase by more than 20% over the
entire event window.
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23. 4. Empirical Result
 22 –ve events, statistically significant
decreases in market values
especially reported by government’s or
citizens’ complaints
Court actions or fines have less or no impact
Reductions in market values range on
average from 4% to 15%.
These losses are much greater in
magnitude than any losses observed in
previous studies.
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24. 5. Conclusion
Capital market reacts to the announcement
of environmental events involving publicly
traded companies.
Both Penalty and Reward
These results indicate that at the margin,
environmental regulators should devote less
resources to the enforcement of regulations,
and more to the collection, analysis, and
dissemination of appropriate, reliable, and
timely information
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