Financial Outcomes of Environmental Risk and Opportunity Sustainable Investment Research Platform Lars G. Hassel www. sirp. se Paris Europlace Financial Forum, March 29, 2007 1
GES-Investment Services Risk Rating® > > > For firms in MSCI World Index Environmental and Human Rights (Social) Risk and Opportunity ratings 200312 -200606 – updated two times a year, 6 sets of ratings No. of firm ratings: 2006: 1800, 2005: 1100, 2004: 1000, 2003: 900 Sample: 440 U. S. firms in MSCI World Index A-C (capital) indicate the general industry risk. a-c (lower case) indicate company specific EV risk. Specific EV risk can be managed through preparedness and performance • Specific risk: a, b or c • General risk: A, B or C • Aa low risk • Cc high risk Total EV risk contains both industry and company specific EV risks Specific risk (firm) a to c A firm’s EV risk rating Ac Bc Cc Ab Bb Cb Aa Ba Ca General risk (Industry) A to C 2
Olsson 2007: Environmental Risk Ratings of U. S. Firms and Performance of Self-Composed Equity Portfolios Portfolio return Required Rate of Return Volatility EVrisk 3
. 4
rm=market return, rf=riskfree rate, smb=small cap minus big cap, hml=high b/m (value) minus low b/m (growth), mom=return diff between portfolios of prior period’s winners and losers. 5
Summary of findings § Hi EVRisk portfolios higher average return (raw) but also higher standard deviation (risk) than Lo. § Hi and Lo EVRisk portfolios have no risk-adjusted returns different from zero. 6
Return on Assets EVrisk Market Value Hassel (2007) Environmental Risk and Opportunity and the Economic Value of Companies 7
ROA = αi + βi 1 Evrisk + βi 2 BVassets + βi 3 Debt/Assets + ưit R 2 = 10. 17 + 0. 40 - 8. 28 - 0. 11 0. 10 (31. 73) (5. 50) (- 6. 23) (-11. 80) Tob Q = αi + βi 1 Evrisk + βi 2 growth + βi 3 age + βi 3 size + βi 4 -7 + ưit = 7. 35 (21. 84) - 0. 06 (-5. 23) + 0. 002 (7. 00) - 0. 03 (-1. 14) -0. 83 (-18. 23) R 2 0. 52 8
ROA (MEAN) (Mean) Q Statistically different means (t-test) 8. 21 2. 08 7. 14 1. 61 Hi. Risk industry Lo. Risk industry 9
Does good environmental management pay off in high EVRisk industries ? Cost of Capital Market Value (lower specific Environmental Risk) Return on Assets Environmental Preparedness and Performance 10
Hi vs Lo EVRisk Industries > Operating performance (ROA) higher in Hi. Risk Industries ! > but ROA decreases with good environmental management > consequently lower cost of capital! > Market value (Q) lower in Hi. Risk Industries > Environmental risk discount > but market value improves with good environmental management! > Environmental opportunity premium 11
Conclusion > Good companies are rewarded for their ’goodness’ in bad industries!!! > Lower cost of capital (lower ROA) > Higher market values > Environmental risk and opportunity are likely to have longer term implications for firm value 12
Appendix 1: American Companies in High Environmental Risk (‘bad’) Industries Frequency Percent Aerospace & Defense 8 7. 4 Auto Components 1 . 9 Automobiles 3 2. 8 Building Products 2 1. 9 Chemicals 9 8. 3 1 . 9 Construction Materials 1 . 9 Containers & Packaging 2 1. 9 18 16. 7 3 2. 8 6 5. 6 Construction & Engineering Electric Utilities Electrical Equipment Energy Equipment & Services Frequency Percent Gas Utilities 5 4. 6 Industrial Conglomerates 3 2. 8 Machinery 9 8. 3 Metals & Mining 8 7. 4 Multi-Utilities & Unregulated Power 3 2. 8 21 19. 4 Paper & Forest Products 3 2. 8 Real Estate 1 . 9 Tobacco 1 . 9 100. 0 Oil & Gas Total 13
Appendix 2: American Companies in Low Environmental Risk (‘good’) Industries Frequency Banks Commercial Services & Supplies Distributors Diversified Financials Food & Drug Retailing Health Care Providers & Services Hotels, Restaurants & Leisure Insurance Internet & Catalog Retail Internet Software & Services 23 11 1 31 9 19 Percent 11. 7 5. 6. 5 15. 7 4. 6 9. 6 10 5. 1 22 11. 2 IT Consulting & Services Leisure Equipment & Products Media Multi-line Retail Software Specialty Retail Textiles, Apparel & Luxury Goods Trading Companies & Distributors Unknown 2 1. 0 Total 3 1. 5 Percent 7 3. 6 2 1. 0 19 9. 6 6 3. 0 11 5. 6 15 7. 6 3 1. 5 2 1. 0 1 0. 5 197 100. 0 14
15 Stockholm, Thursday, March 29, 2007 Paris, Gateway to Euro Capital Markets
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