Capital Market Responses to Environmental Performance in Developing Countries

Abstract

Capital markets do respond to information about a firm's environmental performance and if properly informed, may provide appropriate financial and reputational incentives for pollution control. Perhaps more resources should be used for disseminating firm-specific information about environmental performance to allow all stakeholders to make informed decisions.

Firms in developing countries are often said to have no incentives to invest in pollution control because they typically face weak monitoring and enforcement of environmental regulations. But the inability of formal institutions to control pollution through fines and penalties may not be as serious an impediment to pollution control as is generally argued, contend Dasgupta, Laplante, and Mamingi.

Capital markets may react negatively to news of adverse environmental incidents (such as spills or violations of permits) as well as positively to the announcement that a firm is using cleaner technologies.

The authors assess whether capital markets in Argentina, Chile, Mexico, and the Philippines react to the announcement of firm-specific environmental news. They show that: ° Capital markets react positively (the firms' market value increases) to the announcement of rewards and explicit recognition of superior environmental performance. ° They react negatively (the firms' value decreases) to citizens' complaints. Environmental regulators in developing countries could (1) harness market forces by introducing structured programs to release firm-specific information about environmental performance, and (2) empower communities and stakeholders through environmental education programs.

This paper - a product of the Development Research Group - is part of the group's ongoing work on industrial pollution and also to study whether capital markets in developing countries can provide incentives needed for pollution control. The study was funded by the Bank's Research Support Budget under the research project Incentives for Pollution Control: The Role of Capital Markets (RPO 680-76).