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1 Financial Outcomes of Environmental Risk and Opportunity Sustainable Investment Research Platform Lars G. Hassel www.sirp.se Paris Europlace Financial Forum, March 29, 2007
2 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 CaBaAa CbBbAb CcBcAc Specific risk (firm) a to c General risk (Industry) A to C A firm’s EV risk rating 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
3 Olsson 2007: Environmental Risk Ratings of U.S. Firms and Performance of Self-Composed Equity Portfolios EVrisk Required Rate of Return Portfolio return Volatility
5 r m =market return, r f =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.
6 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.
7 Hassel (2007) Environmental Risk and Opportunity and the Economic Value of Companies EVrisk Return on Assets Market Value
8 ROA = α i + β i1 Evrisk + β i2 BVassets + β i3 Debt/Assets + ư it R 2 = 10.17 + 0.40 - 8.28 - 0.11 0.10 (31.73) (5.50) (- 6.23) (-11.80) Tob Q = α i + β i1 Evrisk + β i2 growth + β i3 age + β i3 size + β i4-7 + ưit R 2 = 7.35 - 0.06 + 0.002 - 0.03 -0.83 0.52 (21.84) (-5.23) (7.00) (-1.14) (-18.23)
9 ROA (MEAN)Q (Mean) 8.21 1.61 7.14 2.08 LoRisk industryHiRisk industry Statistically different means (t-test)
10 Does good environmental management pay off in high EVRisk industries ? Environmental Preparedness and Performance (lower specific Environmental Risk) Return on Assets Cost of Capital Market Value
11 Hi vs Lo EVRisk Industries >Operating performance (ROA) higher in HiRisk Industries ! >but ROA decreases with good environmental management >consequently lower cost of capital! >Market value (Q) lower in HiRisk Industries >Environmental risk discount >but market value improves with good environmental management! >Environmental opportunity premium
12 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
13 Appendix 1: American Companies in High Environmental Risk (‘bad’) Industries FrequencyPercent Aerospace & Defense 87.4 Auto Components 1.9 Automobiles 32.8 Building Products 21.9 Chemicals 98.3 Construction & Engineering 1.9 Construction Materials 1.9 Containers & Packaging 21.9 Electric Utilities 1816.7 Electrical Equipment 32.8 Energy Equipment & Services 65.6 FrequencyPercent Gas Utilities 54.6 Industrial Conglomerates 32.8 Machinery 98.3 Metals & Mining 87.4 Multi-Utilities & Unregulated Power 32.8 Oil & Gas 2119.4 Paper & Forest Products 32.8 Real Estate 1.9 Tobacco 1.9 Total 109100.0
14 Appendix 2: American Companies in Low Environmental Risk (‘good’) Industries FrequencyPercent Banks 2311.7 Commercial Services & Supplies 115.6 Distributors 1.5 Diversified Financials 3115.7 Food & Drug Retailing 94.6 Health Care Providers & Services 199.6 Hotels, Restaurants & Leisure 105.1 Insurance 2211.2 Internet & Catalog Retail 21.0 Internet Software & Services 31.5 FrequencyPercent IT Consulting & Services 73.6 Leisure Equipment & Products 21.0 Media 199.6 Multi-line Retail 63.0 Software 115.6 Specialty Retail 157.6 Textiles, Apparel & Luxury Goods 31.5 Trading Companies & Distributors 21.0 Unknown 10.5 Total 197100.0
15 Stockholm, Thursday, March 29, 2007 Paris, Gateway to Euro Capital Markets
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