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December 27, 2000
Environmental Performance Linked to Shareholder Returns

Conclusions in a new report support the growing body of evidence that a positive relationship exists between corporate environmental practices and financial returns.


Research in a new study indicates that companies with superior environmental performance generally have greater shareholder returns. The success and growing number of mutual funds and investment advisors that incorporate environmental performance in their equity choices bolsters this assertion.

The study, entitled "The Emerging Relationship Between Environmental Performance and Shareholder Wealth," was written by Ralph Earle III of The Assabet Group. Based in Concord, Massachusetts, The Assabet Group assists companies in integrating environmental considerations into their business practices.

"Our own evidence in most sectors supports this theory," commented Hewson Baltzell, Chief Operating Officer at Innovest Group. Innovest is a New York-based firm that has built a business around investment research products and services that center on corporate environmental performance. "We completely believe in the relationship between environmental practices and financial performance," Baltzell added.

The Assabet report weighs the two main theoretical arguments for explaining the relationship between environmental performance and shareholder value. "The Cost Center" argument basically states that environmental regulations impose a burden on companies, pulling capital away from other activities that result in economic benefits. The "Value Creation" argument, on the other hand, is a relatively newer theory which proposes that environmental management potentially can create shareholder value.

The report cited six studies that focused solely on the links between environmental performance and financial returns. According to the author's analysis, the studies "present a consistent picture that is generally supportive of the Value Creation view."

The author writes that no evidence was found to back up the claim that exceptional environmental practices erode shareholder value. While there were more general studies that documented how regulatory systems were costly or ineffective, the author was unable to locate studies that specifically back up The Cost Center view.

It was acknowledged that each of the six studies mentioned had one or more flaws. Most of the studies were conducted over too short a time for the results to be conclusive. Other problems included the use of backward-looking metrics and financial measures that cannot accurately forecast future shareholder wealth.

The author also looked to the market for indicators of the relationship between environmental performance and financial returns. Nine mutual funds that use environmental performance as a major factor in choosing companies for investment were examined.

Results again supported the Value Creation view, but the author noted flaws here as well. With the exception of the Green Century Balanced Fund, the other funds have been in existence for five years or less. This relatively short term makes it difficult to draw conclusions.

The report ended with four noteworthy points. One was that investors who want to align their values with their investments, in terms of environmental performance, can do so with the possibility of reaping higher returns; two, all investors may find new opportunities in integrating environmental analysis into financial analysis; three, use of environmental performance as a tool requires research of considerable depth, such as on how the company incorporates the environment into product planning; and four, work in this field needs to be expanded in order to build more conclusive evidence.

The findings in this report should validate what many social investors already know. Contrary to the old belief that social investing incurs a cost, using environmental performance as a key in selecting companies can potentially lead to higher-than-average returns. Social investors are betting that those companies will be the strong performers over the long term.

 

 
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