An Empirical Study on Stock Price Responses to the Release of the Environmental Management Ranking in Japan. Abstract

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1 An Emprcal Study on Stock Prce esponses to the elease of the Envronmental Management ankng n Japan Fumko Takeda Unversy of Tokyo Takanor Tomozawa Unversy of Tokyo Abstract Ths paper nvestgates how stock prces respond to the release of the envronmental management rankng by usng a standard event study methodology. Examnng top 30 manufacturng companes n the envronmental management rankng publshed by Nhon Keza Shmbun (Nkke newspaper) from 998 to 005, we fnd that stock prces on the whole dd not respond sgnfcantly to the release of the rankng whn a three-day event wndow. Moreover, stock prces of companes that experenced a downgrade ncreased sgnfcantly, whle those that experenced an upgrade decreased sgnfcantly. We would lke to thank an anonymous referee for helpful suggestons. Caton: Takeda, Fumko and Takanor Tomozawa, (006) "An Emprcal Study on Stock Prce esponses to the elease of the Envronmental Management ankng n Japan." Economcs Bulletn, Vol. 3, No. 5 pp. -4 Submted: August 0, 006. Accepted: August 30, 006. UL:

2 . Introducton As envronmental ssues have ganed global attenton, more and more companes have started and/or expanded ther envronmentally frendly actves n the world. Behnd these developments, several economsts clam that frms engage n prof-maxmzng envronmental management, expectng benefs that exceed addonal costs, by generatng nnovaton, rasng ther reputaton, chargng hgher prces for ther products, recrung hghly sklled workers, and so on. Such an dea s a bg change from tradonal vews on envronmental actves that could mpose addonal costs on prvate frms. A number of recent emprcal studes have attempted to show the relatonshp between envronmental and fnancal performance by usng an event study methodology. For example, Yamasha et al. (999) nvestgated the relatonshp between envronmental conscentousness (EC) scores, whch were publshed n Fortune magazne (993) and stock returns n the U.S. They found only a weak ncrease for frms wh hgh EC scores. Gupta and Goldar (005) also provded evdence that the announcements of poor envronmental performance based on the green leaf ratng, the envronmental ratng evaluated by the Center for Scence and Envronment, Inda s envronmental NGO, tended to decrease stock prces of pulp and paper, automoble, and chlor alkal companes. Many prevous studes have reported stock markets react posvely to envronmentally frendly news and negatvely to envronmentally unfrendly news. In ths paper, we nvestgate how stock prces n Japan respond to the release of the envronmental management rankng by usng a standard event study methodology. Examnng top 30 manufacturng companes n the Nkke Envronmental Management ankng from 998 to 005, we fnd that ther stock prces on the whole dd not respond sgnfcantly to the release of the rankng whn a three-day event wndow. Moreover, stock prces of companes that experenced a downgrade ncreased sgnfcantly, whle those that experenced an upgrade decreased sgnfcantly. The rest of ths paper s organzed as follows. Secton explans the data. Secton 3 descrbes the event study methodology. Secton 4 dscusses the results. Concludng remarks are provded n Secton 5.. Data For a detaled survey of the relevant lerature, see, for example, Koehler (003) and Nagayama and Takeda (006).

3 Frst, we provde a bref descrpton of the Nkke Envronmental Management ankng. Ths rankng s conducted and released by Nkke newspaper every year snce 997. In order to evaluate companes based on ther envronmental management, Nkke sends questonnare to companes. The questons were classfed nto the followng seven categores; () management system, () long-term goals, (3) ant-polluton measures, (4) recyclng, (5) envronmentally frendly products, (6) reducton of greenhouse gas emssons, and (7) offces. The companes are ranked based on the total scores. Next, we calculate daly stock returns of lsted manufacturng companes, whch are whn 30 ranks n the Nkke Envronmental Management ankng from 998 to 005 and the ndex TOPIX are computed as follows, usng Toyo Keza s Kabuka CD-OM 006: = P P P, and T T t t mt =, Tt where P s the stock prce of the h frm at tme t, refers to s rate of return, T t presents TOPIX at tme t, and mt s s rate of return. 3. Methodology The evaluaton s based on the standard event study methodology as descrbed by MacKnlay (997). Ths methodology hnges on the assumpton that markets are effcent, n the sense that current stock prces reflect all publcly avalable nformaton. In other words, only unexpected events would move stock prces, by updatng the expected profably of a frm. Here, the event s defned as the date when the Nkke Envronmental Management ankng s released. We frst choose a three-day event wndow, whch s the perod over whch stock prces react to the event. We defne the event day as t 0, the nal date of the event wndow as t =, and the fnal date of the event wndow as t = +. We set the estmaton wndow at 50 transacton days pror to the event wndow. Then we estmate the followng market model for each announcement: = α + βmt + ε, where ε s the zero mean dsturbance term. By usng the estmated parameters αˆ The 997 survey results were not publshed.

4 and βˆ, the abnormal return for the stock of frm n perod t s obtaned by: A = ˆ α + ˆ β ). ( mt The cumulatve abnormal return () s calculated by summng up abnormal returns over the event wndow: t ( t, t) = A. By averagng the and s varance σ ( t, t ) across N frms n the same category, t= t we can obtan the average cumulatve abnormal return ( ) and s varance σ ( t, t ): ( t, t ) = N ( t, t ), N = N σ σ = VA ( t, t ) = ( t, t ) = N ( t, t ). Assumng the null hypothess H 0 that each event does not affect the mean or varance of returns, we can test whether the s normally dstrbuted wh a mean 0 and varance σ ( t, t ) by usng the followng J-statstc: J ( t, t ) =. σ ( t, t ) N(0,) 4. Dscusson Table presents the s and the statstcal sgnfcance for each ndustry. The s of all manufacturng companes are posve, but nsgnfcant. Ths result seems to be consstent wh Nagayama and Takeda (006), whch fnd that envronmentally frendly news n general does not affect stock prces sgnfcantly from 997 to 004. Among ndustres lsted n Table, only electroncs and automobles satsfy the reasonable number of observatons. The s of these two ndustres are also nsgnfcant. Although there are three ndustres, whch generate sgnfcant stock prce reactons to the announcements, cauton wll be needed to make use of these results, consderng ther low number of observatons. Next, Table and Fgure show the s by year. The s are sgnfcantly negatve n 999 and 00, but turn nto posve snce 003. However, the recent 3

5 posve trend does not necessarly reflect the enhancement of envronmental conscousness of market partcpants, consderng the results presented n Table 3. Table 3 provdes evdence that stock prces of companes that experenced a downgrade ncreased sgnfcantly, whle those that experenced an upgrade decreased sgnfcantly. Ths result mples that Japanese stock markets react negatvely to envronmentally frendly news and posvely to envronmentally unfrendly news. As for stock prces of companes whose rankng were not changed, we could not obtan relable results due to the low number of observatons. In sum, Japanese nvestors do not seem to apprecate frms envronmental performance unlke the US and European nvestors that were examned n the prevous lerate. Ths may because Japanese companes fal to ncrease profs from envronmentally frendly actves. In other words, envronmentally frendly actves may mpose addonal costs on Japanese companes that exceed benefs. Further research wll be needed to examne how profable envronmental actves really are by usng fnancal statements of Japanese companes. 5. Concludng remarks Ths paper nvestgates how stock prces respond to the release of the envronmental management rankng by usng a standard event study methodology. Examnng top 30 manufacturng companes n the envronmental management rankng publshed by Nkke newspaper from 998 to 005, we fnd that ther stock prces on the whole dd not respond sgnfcantly to the release of the rankng whn a three-day event wndow. Moreover, stock prces of companes that experenced a downgrade ncreased sgnfcantly, whle those that experenced an upgrade decreased sgnfcantly. 4

6 eferences Gupta, Shreekan, and Bshwanath Goldar, (005) Do stock markets penalze envronment-unfrendly behavor?: Evdence from Inda. Ecologcal Economcs 5, Koehler, Dnah A., (003) "Capal Markets and Corporate Envronmental Performance - esearch n the Uned States", Fall 003. Workng Paper DK, Wharton sk Management and Decson Process Center. MacKnlay, A. C. (997) Event studes n economcs and fnance. Journal of Economc Lerature 35, Nagayama, Shohe and Fumko Takeda, (006) An Emprcal Study on the Impact of Envronmentally Frendly News on Stock Prces n Japan. Mmeo, avalable at Yamasha, Mwaka, Swapan Sen, and Mark C. oberts, (999) The ewards for Envronmental Conscentousness n the U. S. Capal Markets. Journal of Fnancal and Strategc Decsons, Vol., No., Fgure : s by year

7 Table : s by ndustry Industry Number of observatons J-statstc () All Manufacturng Industry Electroncs Automobles Electrcy & Gas () Offce Supplyers & Publshers * Food * Machnery Chemcals Others (3) *** Notes:. *** and * ndcate statstcal sgnfcance at % and 0%, respectvely.. Electrcy & gas are ncluded n the rankng of manufcaturng ndustry from 998 to Others nclude rubbers, pharmaceutcals, pulp, steel, metal, and non-ferrous metal. Table : s by year Year Number of observatons J-statstc ** ** *** Note. *** and ** ndcate statstcal sgnfcance at % and 5%, respectvely. Table 3: s by rank ank Number of observatons J-statstc Upgrade ** Unchanged Downgrade *** Note. *** and ** ndcate statstcal sgnfcance at % and 5%, respectvely. 6

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