Guenster, Nadja, Jeroen Derwall, Rob Bauer, and Kees Koedijk. "The Economic Value of Corporate Eco-Efficiency." Working Paper, Erasmus University, July 25, 2005.

This strong paper (full text is here, author's presentation is here) finds that environmental information, as contained in the Innovest environmental rating system, was related to firm financial performance and mattered for firm valuation during the 1996-2002 time period.

The sample consists of companies covered by Innovest: 154 names at the end of December 1996, rising to 409 in September 2002. The authors create a numerical version of the Innovest rating system, and then match the Innovest ratings to the CRSP stock price and Compustat financial databases. Importantly, this helps control for survivor bias. The resulting database includes "not only firms that were covered by Innovest recently, but also those which disappeared over time, for instance, due to merger or bankruptcy."

The Innovest ratings are related to two dependent variables:

1) Valuation (measured using Tobin's Q). The formal hypothesis tested is: "Eco-efficiency is positively associated with firm value. Companies with a high eco-efficiency rating have a higher value than do companies with a lower rating." The hypothesis is confirmed, as Innovest ratings were a consistently significant positive factor in Tobin's Q, even after adjusting for Sales Growth, R&D intensity, Size (book value of assets), Age, and membership on Nasdaq.

2) Operating performance (measured using Return on Assets). The formal hypothesis tested is: "Eco-Efficiency is positively associated with return on assets. Companies with a high eco-efficiency rating have a higher ROA compared to companies with a lower rating." Again, the Innovest ratings were a statistically significant factor after adjusting for total assets, total sales, and financial risk (debt/assets ratio).
The authors check both findings for robustness using a variety of models and independent variables, finding in each case that the environmental information in the Innovest ratings is related to both valuation and operating performance.

The study also includes a highly informative subgroup analysis, in which it is shown that the observed effects appear to be asymmetrical:

Poor eco-efficiency is shown to be statistically significantly related to poor operating performance and lower valuation. Superior, eco-efficiency, is not similarly related to higher valuations or superior operating performance to a statistically significant degree.

The authors conclude that "the results suggest that managers do not face a tradeoff between eco-efficiency and financial performance, and that investors can use environmental information for investment decisions."

This study is carefully done, highly detailed, and important. It is closely related to Derwall et al (2005), suggesting that the outperformance observed in that study may have been due primarily to valuation effects.

This study won the 2005 Moskowitz Prize competition for the best quantitative study of socially responsible investing.