Innovations in environmental performance: the importance of financial performance and management quality

Abstract

Empirical analyses exploring the relationship between environmental and financial performances hypothesise that good corporate environmental performance and the associated re-evaluation of production processes and adoption of innovative solutions increase the resource productivity and/or competitive advantage, thereby creating opportunity for improved financial performance. Although recent studies provide evidence supporting this hypothesis, they do not establish that good environmental performance causes good financial performance, nor do they control for underlying firm characteristics, such as management quality, that may enhance both environmental and financial performances, thus overstating the relationship between the two. The primary objective of this study is to explore the relationship between environmental performance, risk and expected cash flows/earnings, and the resulting impact on stock returns so that managers and investors can make more informed decisions. In addition, this study examines potential factors driving corporate environmental performance. The empirical analysis suggests that to the extent that investors consider environmental performance, they perceive environmental improvements and management as costly, unless made to avoid non-compliance penalties. Furthermore, the empirical analysis indicates that corporate financial performance does not influence environmental performance. Instead, the level of corporate sophistication and trust and transparency are the driving factors behind environmental performance improvements.