Karpoff, Jonathon M., John R. Lott, Jr., and Eric W. Wehrly. "The Reputational Penalties for Environmental Violations: Empirical Evidence." Journal of Law and Economics, October 2005.

This strong event study examines the impact on stock prices from violations of environmental regulations.

The study examines 478 environmental violations by publicly-traded firms over the 1980-2000 time period, drawn from The Wall Street Journal Index, and draws supplemental information from the Factiva database.

Finds an average abnormal stock return of -1.7% (t=-4.8) following initial press announcement of allegations, and a -1.6% abnormal return after formal charges are filed. The authors checked for confounding events and found 55 cases in which they might have been important - re-running the sample without these events only slightly reduced to the negative impact, to -1.15% (t=-5.4).

The authors examine 148 situations in which details of the penalties are known, and finds that the average financial impact of these events (2.3% of share value) was close to the the observed abnormal share price impact.

"Thus, while environmental violators lose market value, the losses reflect these firms' legal penalties. Market-induced reputational penalties, on average, are negligible."

The Exxon Valdex incident was excluded from the database "because it resulted in an extremely large penalty." The authors argue that including it would not have altered their conclusion that reputational effects are not important in this context because "the legal penalties for Exxon far exceed the loss in firm share value at the time of the event."

This paper also includes a brief but outstanding review of the literature of reputational impacts on stock prices.