Pollution and Capital Markets in Developing Countries

Abstract:     
It is said that firms in developing countries do not have incentives to invest in pollution control because of the weak monitoring and enforcement of the environmental regulations. This argument assumes that the regulator is the only agent that can create incentives for pollution control, and ignores that capital markets, if properly informed, may provide the appropriate financial and reputational incentives. We show that capital markets in Argentina, Chile, Mexico, and the Phillipines react positively (increase in firms' market value) to the announcement of rewards and explicit recognition of superior environmental performance, and negatively (decrease in firms' value) to citizens' complaints. An immediate policy implication from the current analysis is that environmental regulators in developing countries may explicitly harness those market forces by introducing structured programs of information release on firms' environmental performance. At the margin, less resources should be devoted to the enforcement of regulations and more to the dissemination of information which allows all stakeholders to make informed decisions.

JEL Classifications: Q28, Q38

Working Paper Series