environmental engineering and management journal environmental performances – way to boost up...

Environmental Engineering and Management Journal April 2014, Vol.13, No. 4, 1003-1016

http://omicron.ch.tuiasi.ro/EEMJ/

“Gheorghe Asachi” Technical University of Iasi, Romania

ENVIRONMENTAL PERFORMANCES – WAY TO BOOST UP FINANCIAL PERFORMANCES OF COMPANIES

Monica-Violeta Achim1, Sorin Nicolae Borlea2

1Babeş-Bolyai University, Faculty of Economics and Business Administration, Cluj-Napoca, Romania

2West Vasile Goldis University, Faculty of Economics, Arad, Romania

Abstract The aim of this paper is to evaluate the link between environmental and financial performance. In this study, we use a sample of 76 Romanian companies that are listed at Bucharest Stock Exchange, in 2011. The results reflect a negative correlation for the internal performance of the company represented by ROA and a positive correlation for the external performance represented by Tobin's Q. Our study reflects the fact that environmental investments are not immediately reflected in an increase in the companies' internal performance but rather in an increase in investment costs and a decrease in assets’ efficiency. For investors, these investments in environmental activities are appreciated as "good news", as a factor that will ensure long-term sustainability of the company; this aspect being correlated with Tobin's Q rate’s growth, yet not with other market indicators, namely Market capitalization or Price to book ratio. Key words: corporate governance, corporate social responsability (CSR), economic and financial performance, environmental perfomance Received: Aprilie, 2013; Revised final: February, 2014; Accepted: March, 2014

Author to whom all correspondence should be addressed: E-mail: [email protected], [email protected]; Phone: 0741/194473

1. Introduction New economy firms exhibit a company to a

society’s critical eye becoming more and more attentive to ethical values. The complexity of the current business environment has demonstrated over time that financial models which assess the performance of the company are insufficient and do not reflect its overall performance.

Various studies show that, in many cases, there isn’t a correlation between financial performance reflected by the company's financial statements and the real performance of the company on the market. Consequently, in order for a company to maximize performance, it must take into account not only financial growth targets but it also needs to maximize other non-financial performances (such as social, environmental or governance performances)

(Achim and Borlea, 2013: McDaniel et al., 2000; Nikolaou et al., 2013).

In the new context of sustainable development, there are set new social and environmental standards and non-financial issues that come to complete the overall performance of a company. The term ‘responsible capitalism’ has come into question together with the first major crisis of the twentieth century and culminating with the great financial crisis burst in 2007.

One of the consequences of the crisis has opened a public debate about the role of corporations in society and how businesses can restore trust with corporate and civil stakeholders (Accounting for Sustainability and Global Reporting Initiative, 2012). In the actual context of world economy globalization, the performing company is an “enterprise that creates added value for its shareholders, customer’s demand, taking into account the views of employees and

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protects the environment. Consequently, shareholders are satisfied that the company has achieved the desired return and customers have confidence in the future of the company and the quality of its products and services. The company’s employees are proud of where they work and the society benefits from environmental protection” (Jianu, 2006). The concept is based on the stakeholder theory and managers act in order to maximize the company's value and to respect the interests of their social partners. In a sense of harmonizing all these interests, an effective corporate governance system must be ensured (Dumitrascu et al., 2013; Robu et al., 2004).

The extent to which the company is involved in corporate social responsibility (CSR) activities is gaining more importance in evaluating the company's performance issues and further in adopting investor’s decision. Business literature and business practice also highlight a more acute need for investors to access as much information regarding the social and environmental issues in order to adopt as good and as responsible investment decisions. For example, the study conducted over a period of 16 years by Amir (2000) on a sample containing 5,000 U.S. companies reflects a decreasing correlation between reported profits and shareholders’ returns, thereby reducing the impact on the financial results of the investment decision of potential investors on the market. Other authors such as Kaplan and Norton (1996) have concluded in their studies that non-financial indicators, compared to the financial ones, reflect better the company's performance.

According to a 1996 study by Lev, nearly 40% of the company’s market valuation was “missing from its balance sheet”. For high-tech firms, that percentage was over 50% (Ernst and Young, 1997). The same specialists from Ernst & Young Center for Business and Innovation (1997) draw the same conclusions based on the study on the use of non-financial indicators. They highlight factors such as management quality, corporate culture, quality of communication with investors, policy effectiveness and remuneration of executive management as non-financial performance criteria used by investors to assess the listed companies.

As Bouquin (2001) stated that while financial performance is only "race results", the overall performance is the race itself or the future vector to success (Albu, 2005). This idea is emphasized by other authors such as Mironiuc (2009) who highlights that the company's contribution to sustainable development is not a matter of what a responsible business does with 1% of its profit, but rather how they get 99% of the profit. If, for example, the company, with its products and services, provokes adverse health effects and in the same time it allocates 1% of the profits to the persons to whom they have caused such adverse effects, in the extent of social responsibility, its impact is negative. Profit remains a prerequisite for sustainable development and the company opts to transparency in order to obtain it.

Based on a survey which explores how 34 investors and 35 analysts use and are influenced by extra-financial information, a recent research, conducted by the Accounting for Sustainability and the Global Reporting Initiative (2012), found out that over 80% of the respondents believe that extra-financial information is very relevant or relevant to their investment decision-making or analysis. In regard to the structure of non-financial information about the company, the same study highlights that over 70% of the respondents consider information about corporate governance to be very relevant. With a close percentage of relevance (about 65%), natural resources and environmental information are also considered very important for investors and analysts. About 55% of the respondents consider social community capital and human capital very relevant information and less than 40% of the respondents appreciate intellectual capital as very relevant information.

In conclusion, it can be said that for any stakeholder and mainly for any investor interested in responsible investment, the importance of environmental performance is undeniable. The interest is motivated by long-term sustainability, increasing investor’s confidence and thus increasing company’s performances. 2. Literature review

Various studies show that a firm’s concerns

about environmental issues influence its social valuation. From a traditional point of view, the environmental expenses, which include various pollution prevention efforts, are seen as a waste of a company’s resources (Palmer et al., 1995). Nevertheless, even since 1982, Arlow and Gannon have considered environmental management to be an important duty of a company. McGuire et al. (1988) has also found a significant positive correlation between corporate social responsibility and future economic performance.

A large number of studies are concerned with the effects of environmental performance on financial performance and their results show either a positive or a negative connection. Numerous studies attest the positive correlation between social or environmental performance and the company's financial performance (Berman et al., 1999; Hart and Ahuja, 1996; Hillman and Keim, 2001; Margolis and Walsh, 2003; McWilliams and Siegel, 2001; Moneva and Ortas 2009; Nakamura, 2011; Orlitzky et al., 2003; Pérez-Calderón et al., 2011, 2012; Roman et al.,1999; Schaltegger and Synnestvedt, 2002; van Beurden and Gössling, 2008; Wu, 2006).

Among the effects of implementing social and environmental programs, we perceive those of financial nature such as increasing revenues, reducing costs and increasing profits. On a study based on Standard and Poor’s 500 listed companies, Hart and Ahuja (1996) pointed out that financial performance is positively related to environmental

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performance. According to them, by integrating environmental activities into the existing management program, a firm can achieve significant cost saving, higher productivity and also better economic and financial performance within one to two years of initiation.

In 1997, DePaul University from Chicago, found on their study that those companies that made social and environmental investments achieved much better financial results (reflected in percentage of annual sales in total revenues) than those that did not adopt such a responsible approach. A similar study extended over a period of 11 years conducted by Harvard University determined that those companies that acted as social partners on the market had a growth rate of 4 times or 8 times higher than those companies that focused only on their business and profit (KPMG, The Business Case for Sustainability, 2001). Three years later, Austin et al. (1999) demonstrated that good environmental performance, expressed through various measures (e.g. toxic emissions), positively influenced the rates of return on equity. Similarly, Konar and Cohen (2001) found environmental performance to be correlated with the intangible asset value of S&P’s 500 firms and reductions in toxic chemical releases to be associated with greater firm market value. Further going, in accordance with the above-mentioned studies, on their survey, Filbeck and Gorman (2004), showed a positive link between financial and environmental performance by comparing the revenues for a period of three years with the penalties related to the environment.

In the area of corporate social responsibility’s (CSR) investment, most studies show that a firm dealing with social problems can achieve a higher level of financial performance. Based on some USA companies’ surveys, Berman et al. (1999) and Hillman and Keim (2001) highlighted a positive relationship between financial performance and various aspects of social performance, notably employees, clients and civil society. Similar conclusions are drawn by McWilliams and Siegel (2001) who determined that increasing social responsibility of an organization in relation with either its offered products or its manufacturing process, may lead to an increase in the attractiveness of the offered products and, therefore, to an increase in turnover. Thus, organizations that are distinguished with better social performance can be expected on the long term to achieve a better financial performance. Also, the Institute for Business Ethics IBE (2008) has highlighted through calculations of financial and corporate responsibility indicators that 'ethical' companies generate an economic added value and profits about 18% higher than other companies.

Moneva and Ortas (2009) analyzed the environmental and financial performance on a sample of 230 European companies over the period 2004-2007. Under the stakeholder approach, conducted on sample companies, they are trying to

identify a link between the degree of achieving environmental performance and financial performance. The results support the fact that the enterprises which obtained higher rates of environmental performance show better financial performance levels in the future. Remaining in Europe, Pérez-Calderón et al. (2011) used a sample of 122 firms from different sectors which belonged to Dow Jones Responsibility Index Europe for the years 2007- 2009. They found that the best environmental performance during this period is reflected in the largest economic and financial benefits. In Japan, Nakamura (2011) has examined the effects of environmental investment both on the short term and on the long term. Also, by using a survey conducted on 3,237 Japanese firms, he obtained the following results: on short-term, the investment environment does not significantly affect the company's financial performance scales but on the long-term this relation is highlighted on a significant level.

The benefits of adopting corporate social responsibility (CSR) by companies vary from one company to another, depending on the area and global community in which the company operates. In any case, however, the benefits of implementing corporate social responsibility are identified. However, there are also studies that identify either negative or inconsistent correlations between social or environmental performance and the financial performance of a company (Filbeck and Gorman, 2004; Goll and Rasheed, 2013; Porter and Kramer, 2006; Vogel, 2005; Watson, 2004).

Vogel’s study (2005) counters the overall results and proves that socially responsible investments do not lead to better performance than the non-socially ones and many of the responsible companies are not necessarily financially successful. In order to reason these insconsistencies, Porter and Kramer (2006), explains that responsible investments are not always as productive as desired and one of the reasons is that the approaches concerning CSR are taken on a general basis and not adapted to a specific business strategy.

Following this ideea, in a recent study, Calabrese et al. (2013) emphasizes the idea to rethink the strategic management regarding CSR activities and proposes a CSR model based on two dimensions: “CSR development” dimension and “CSR Commitment” dimension. The “CSR development” dimension refers to the fact that in their decisions, managers must take into account the cultural evolution of CSR in the specific environment in which the company activates while the “CSR Commitment” dimension envisages economic, legal, ethical, philanthropic and other aspects. Goll and Rasheed (2013) emphasize that the environmental and financial performance can be connected to each other only in a specific context in which managerial choices matter more in certain types of environments than in others. In their study, they have identified a variety of factors that influence the relation between


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environmental and financial performance reflected by ROA (return on assets) and ROS (Return on sales) and highlight the major role that the munificent environments have on the intensity of this correlation. They found a significant positive correlation between financial performance (measured by ROA and ROS) and CSR in highly munificent and not in low munificent environments.

Returning to the factors that affect the environmental-financial performance correlation, various studies prove that in order to obtain such financial benefits as a result of environmental investments, a distinct process takes place in developed countries compared to the developing ones. Corporate social responsiveness is defined by Frederick (1978) as “the capacity of a corporation to respond to social pressures” (cited by Wood 1991), therefore, various stakeholders put differently pressure on the companies in developed countries compared to the developing ones. Thus, Henriques and Sadorsky (2006) conducted a study concerning manufacturing companies in Hungary in 2003 and found out that unlike in the case of developed countries, in Hungary, the influence of buyers, community, public authorities and investors has little impact on the number of environmental management practices adopted by a facility. In another study conducted by Bluffstone and Sterner (2006) based on a sample of firms from Bulgaria, Hungary, Lithuania, Poland, Romania and the Slovak Republic, they analyzed the relation between some factors as privatization, public pressure, environmental regulation, export orientation and environmental behavior. They reached the conclusion that generally, these factors contribute to the adoption of environmental activities.

Besides these factors specific to the emerging countries, we can mention other factors that influence the performance of those companies with a high environmental impact, such as the liberalization of natural gas market prices. The study of Capece et al. (2013) conducted over the period 2004-2009 based on 111 natural gas companies operating in Italy shows that many of the analyzed companies are affected by the profits’ decrease and present serious financial problems.

Based on investigated the literature presented above, we consider the relation between environmental performance and financial performance to be fundamentally devoted to the different international economic spaces and to action in a specific managerial context and consequently it justifies our research in order to validate this relation for the Romanian economy area.

3. Methodology

3.1. Hypothesis

In this study, we propose to test the following main hypothesis:

H0: The increase of a company's environmental performance contributes to the increase of the company's financial performance

Accepting the above hypothesis means that performing responsibility activities in relation to the environment brings a competitive advantage to the company leading to an increase in its financial performance. At the same time, accepting the hypothesis reflects the validation of the assumption "Win-Win" both for the environment and the company meaning that the companies are not only “green” but also competitive. The acceptance of the hypothesis is included in the debate framework that is Friedman (only the profit counts no matter the means of obtaining it) versus Freeman (both the profit and the means of obtaining it are important).

Hypothesis’ rejection reflects that the concern for responsible activities in relation to the environment does not create a competitive advantage which is reflected in the increase in the company’s performance. 3.2. Measuring financial perfomance and selecting dependent variables

In terms of measuring the financial

performance of the company, according to literature there are two main approaches:

a) accounting performances or accounting-based measures of financial perfomances reflects an organization's internal efficiency manifested through various indiators of profitability, efficiency, liquidity, growth, such as: Return on sales, Return on assets, Return on equity, Assets turnover, Leverage ratio, Equity to fixed assets ratio, Working capital, Flexibility ratio, Growth ratio, Cash flow return on Assets (Achim, 2008; Achim and Borlea, 2012; Brealey, 2005; Damodaran, 2006; Mironiuc, 2009).

b) market performance or market-based measures of financial perfomances reflected by: Market capitalization, Price to book ratio, Earning per share, Price to sale ratio, Dividend yield, Total shareholders' return, Tobin's Q (Achim, 2008; Achim and Borlea 2012; Barnett and Salomon, 2006; Bhattacharya, 2006; Brigham et al., 1999; Damodaran, 2006; Davidson and Worrell,1990; Dowell et al., 2000; Helfert, 2006; Kumar et al., 2002; Luo and Schnietz and Epstein, 2005; Moneva et al., 2010; van Beurden and Gössling, 2008; Wolfe, 2003). Such a category of performances reflects the company’ s perfomances on the market.

When evaluating a company’s performance by refering to either one or the other performance category, it leads to different results (Trunk and Stubelj, 2013). In literature there are various concerns when it comes to determining the best categories of indicators, both accounting and market in order to obtain the best assessment of a company (Damodaran, 2006; Glen, 2005; Huang et al., 2012; Odar et al., 2012; Ong and Chen, 2013).


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Regarding the preference for one of these financial performance categories, in testing the correlation between environmental and financial performance, in literature, the opinions are divided as follows: a) Both are relevant

A first category of authors includes those authors who believe that both accounting and market performance are relevant for a company’s financial performance because of the advantages that each category has. One of the limitations in using one or another category would be that they would focus on only one aspect from the overall performances that concerns a company (Al-Tuwaijri, 2004) and thus the results would be inconsistent or incomplete. Consequently, the study conducted by Wu (2006) attests the fact that studies using market measurements report a more limited relation between social and financial performance than studies using other measurements, such as profitability measurements, asset utilization, and growth.

Therefore, because of the many advantages that each category has, many authors choose to utilize both types of financial performance measurement (both accounting and market) as follows: Watson (2004) used Return on assets and Profit margin as ratios which characterize the company's profitability and on the other hand, he used Price to earnings ratio and Market to book ratio as representative indicators for company's market performance; Al-Tuwaijri (2004) used ROA as accounting-based measure and the annual industry adjusted stock return as market-based measure; van Beurden and Gőssling (2008) no exemplified specific indicators for each category but they are the adepts at using both categories when a company's financial performance is measured in environmental performance versus financial performance framework; Perez-Calderon (2012) used, on the one hand, Return on assets, Return on investments and on the other hand, Market to book ratio.

Some authors such as Elsayed and Paton (2005), Rassier and Earnhart (2010) and Perez-Calderon (2012) reached a consensus on the determination of the most used financial indicators in studying the relation between environmental and financial performance. These indicators would be: Tobin's Q, price-to-book ratio-PBR, Return on capital employed- ROCE, Return on own-funds - ROE and ROI.

b) Accounting- based measures prevails

A second category of authors includes those authors who express their preference for accounting performances such as the accounting-based measures type when they want to measure the influence of environmental performances on financial performances.

The preference for choosing accounting performance is based on the fact that it reflects the organization’s internal efficiency and therefore, such

a choice meets the informational needs of managers. They want to know how important is the impact of their ecological investment decisions on the company’s performances and consequently, they want to measure this impact as it is reflected on the organization’s internal efficiency.

Among the authors who prefer this type of performances when they want to measure the influence of environmental performance on the financial one, we mention: Hart and Ahuja (1996) used Return on assets, Return on sales, Return on equity; Carter et al. (2000) used Net income, Revenues, Leverage; McDaniel et al. talked about The Environmental EVA; Ruf et al. (2001) used Return on equity, Return on sales, Growth in sales; Goll and Rasheed (2004 ) used Return on Assets, Return on sales; Gunzi et al. (2004 ) used Return on assets and Return on equity; Eanhard and Lizal (2007) used absolute values of indicators Revenue, Cost and Profit; He et al. (2007) used Growth rate of sales, Growth rates of profit and Growth rate of market share; Moneva and Ortas (2009) used Return on assets, Net profit margin, Cash flow, Operating profit; Nakamura (2011) used Return on assets. c) Market- based measures prevails

A third category of authors expresses their preference for market performances to the detriment of accounting performances when analyzing the influence of environmental performance on financial performance. A company’s market measures mainly satisfy the informational needs of investors and also those of shareholders, who prefer this type of performance’s measurement. The reason for this choice lying in the fact that the market value of the company better reflects shareholders' wealth than the accounting value (Davidson and Worrell, 1990).

Among the authors who prefer market performance instead of accounting performance in the correlative analyzes environmental and financial performances, we include: Filbeck and Gorman (2003) who used Market value equity; Klassen et al. (1996) who used Stock equity return; Schnietz and Epstein (2005); Luo and Bhattacharya (2006), Barnett and Salomon (2006) who used Stock performance, Market return, Share price appreciation and others; Brian et al. (2010) who used Market value. Based on each advantage, in our study we proceed to use both performance categories, respectively accounting and market performances, as follows:

a) In the category of accounting performance we use the following categories of financial performance indicators: Return on assets (Net Profit /Total assets)-ROA, Return on equity (Net profit / Shareholder equity) – ROE; Leverage ratio (Debts/Shareholder equity)–LEV;Equity-to-fixed-assets ratio (Shareholder equity /Fixed assets) - EFA; Flexibility ratio (Net working capital /Total Assets) - FLEX; Growth ratio (Turnover deviation / Basis Turnover) – GROW; Cash flow return on assets (Cash flow / total assets) - CW.


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b) In the category of market performance we use the following market indicators: Market capitalization (market value company) - MK; Price to book ratio (Market value of share / Book value of share) – PBR; Tobin's Q ((market capitalization + book value of debt) / book value of assets) - TQ.

In conclusion the previously defined general working hypothesis,

H0: The increase of a company’s environmental performance contributes to the increase of the company’s financial performance.

It can be divided into two other secondary hypotheses:

H00: The increase of a company’s environmental performance contributes to the increase of the company’s financial performance represented by accounting-based measures.

H01: The increase of a company’s environmental performance contributes to the increase of the company’s financial performance represented by market-based measures.

In our analysis model, we consider as dependent variables, first the financial performance of the company represented by accounting-based measures and then, that represented by the market-based measures.

3.3. Measuring environmental perfomance and selecting independent variables

According to the view of numerous authors,

the indicators selected to measure environmental performance were used for different areas of manifestation of the environmental performance, as follows:

Environment input zone- including indicators such as: environmental site planning (Jasch, 2000; Kuhre, 1998); energy consumption (Apajalahti, 2008; Clayton Group Services, 2001; International Organization for Standardization, 2006; Jasch, 2000; Kuhre, 1998; Meyer, 2001; Müller and Sturm, 2001; Tibor, 1996); used materials (Morioka et al., (2005), Hoffrén and Apajalaht (2009), Hoffrén (2010); water consume (Müller and Sturm, 2001; Sturm et al., 2004).

Environment output zone, reflected by: climate change, oxygen deficiency in water systems (Pihlatie, 2006); water waste (Chappin et al., 2007; the regulatory compliance (Jasch, 2000; Tam et al., 2002; Thoresen, 1999; Vasanthakumar, 1999; White and Zinkl, 1999); environment report (Al-Tuwaijri et al., 2004; Dasgupta et al., 2006; Cormier and Magnan, 2007; Moneva et al., 2007; Moneva and Ortas, 2008); environmental auditing activities (Jasch, 2000; Moneva and Ortas, 2009).

Input and output zone involves combining certain input and output indicators when assessing environmental performance (Adams et al., 2000; Bidwell, 2000; Chappin et al., 2007; Koskela 2012; Helminen, 1998; Hiltunen, 2004; Lupu et al., 2012; Saling, 2005; Tam and Le, 2007; Verfaillie and Sturm et al., 2004, Wall-Markowski, 2004; Wall-

Markowski et al., 2005; Wang et al., 2011; Yang et al., 2012; GRI Guides).

The assessment of the ecological dimension of performance is not an easy task but a complex one that takes vast knowledge. Selecting the most representative indicators for environmental performance is a highly disputed process because they must correspond to some common accessibility, comparison, representation, clarity, cost-benefit report requirements (Achim et al., 2011; Ienciu 2009; Moneva and Ortas, 2009; Orlitzky et al., 2003; Pintea 2011).

In our study we consider as proxy for environmental performance the extent to which the companies are involved in corporate social responsibility (CSR) activities.

This choice is based on various studies establishing the important role of the environmental impact in all CSR activities. In this regard, we mention a main representative study of Kinder, Lyndenberg and Domini (KLD) from 2008 KLD STATS (STATS stands for Statistical Tool for Analyzing Trends in Social and Environmental Performance). The database contains about 80 binary negative and positive indicators (Concerns and Strengths) belonging to seven different issue areas (community, employee relations, environment, product, human rights, diversity and corporate governance). In their study, they have based themselves on a sample of the largest 3,000 publicly traded U.S. firms. They found that the most consistent CSR activities are performed in “environment” areas, reflecting that a greater proportion of goods-producing firms showed strength in the environment areas. “Community” concerns were situated on the second place and on the third place there were “human rights”.

Similar results highlight that the environmental management is an important corporate duty within the corporate social responsibility activities (Arlow and Gannon, 1982; Dabija and Pop, 2013; Klassen and McLaughlin, 1996; McGuire et al., 1988; Siegel and Vitaliano, 2007).

Chen and Delmas (2011) based on a vast analytical and critical literature review found that environmental strengths must be of equal importance with social strengths. Eccles et al. (2011), in a vast study based on statistical data provided by Bloomberg, ascertained a higher interest in environmental data relative to social data which could be explained by the fact that compared to social data, environmental implications are easier to quantify and integrate into valuation models. In Poland, a recent study conducted by Mróz-Gorgoń (2013), invoked ecological innovation as being the tool of corporate social responsibility and presented some innovative solutions in the fight for environmental protection.

In Romania, according to the study of Obrad et al. (2010), Romanian companies developed the main CSR activities in environmental, social and educational areas (in equal percentage), followed by


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art and culture, human rights, employee support, community development and sports. One year later, the same results were achieved by Pintea (2011) in his study on Romanian economy. In conclusion, we consider that the studies described above, highlighting a main part of CSR activities consisting in environmental activities, reflect a solid argument to consider the usage of CSR variable as a good proxy for the best representation of environment activities conducted by a company.

The measurement of the CSR performance is reflected in the 51st question of “Complain or Explain Statement” as “Does the issuer perform activities regarding Social and Environmental Responsibility?” and the answer can be YES or NO. If the answer is NO the company would have to explain this noncompliance to Corporate Governance Code issued by Bucharest Stock Exchange. Consequently, we consider the CSR variable as a DUMMY variable with two states: YES (if the companies conduct CSR activities) and NO (if the companies do not conduct CSR activities), with a role of independent variable in our analysis model.

3.4. Selected control variables

We use as a control variable the corporate

governance (CG) performance. We justify the choice of using such a control variable with a large number of studies that identify a strong correlation between the adoption of good corporate governance practices and companies’ performances. Also, some studies of Yermack (1996), Basu et al. (2007) and Nakamura (2011) argue that board characteristics have an important control variable for the relation between performance and management. Similar conclusions are found in various other studies (Aguilera et al., 2006; Guay et al., 2004; Kimber and Lipton, 2005; Kolk and Pinkse, 2009; McLaren, 2004; Monks et al., 2004; Rossouw, 2005; Ryan, 2005; Sjöström, 2008; Welford, 2007; Wieland, 2005).

A positive relation between good corporate practices and financial performances has been established by numerous expert studies (Achim and Borlea, 2013; Agrawal et al., 2012; Al-Hussain and Johnson, 2009; Arcot and Bruno, 2011; Bauer et al., 2003; Bushman and Smith, 2003; Doidge et al., 2007; Feleagă et al., 2011; Gompers et al., 2003; Hope and Thomas, 2008; Klapper and Love, 2004; Kowalewski, 2012; Kusnecovs, 2011; McKinsey, 2001; Renders et al., 2010;. Standard and Poor's, 2002). In our study we have assessed the quality of corporate governance as a score of corporate governance (CG) determined by using the „Complain or Explain Statement” (Achim and Borlea, 2013). Each of the first 50th questions included in “Complain or Explain Statement" can be answered with YES/NO/If NO then EXPLAIN. For our reason to develop a corporate governance score, we will give 1 point for each correct YES answer and 0 points for NO. The minimum governance score obtained by a company is 0 and the maximum is 50.

3.5. Sample and data In determining the sample analysis, we started

from the large companies publicity traded on Bucharest Stock Exchange (BSE). At the end of 2012, the Bucharest Stock Exchange traded 106 companies. From the total number of companies traded on BSE, we removed the unlisted companies, also the financial institutions (banks) and foreign companies listed on BSE in order to obtain as homogeneous sample of companies as possible. Our final sample consists of 76 large Romanian companies which activate in different economic sectors (mining, manufacturing, electricity, construction, commerce, transport and storage, accommodation). In order to assess the accounting based measure of financial performance, we extracted information from the financial reporting of sample companies, at the end of 2011. These are posted on the websites of the companies and also on the BSE website (www.bvb.ro). The market price of the shares is taken from the Bucharest Stock Exchange, as the average price of the shares calculated for the analysis year, 2011.

In order to determine the degree to which the company adopts the best practices of social corporate responsibility but also the best corporate governance practices, we use public information contained in the “Comply or Explain Statement” for the year 2011. This type of statement contains companies which voluntarily report to the Bucharest Stock Exchange in the first part of the following year (in our study, the first part of 2012). We mention that only since 2008 Bucharest Stock Exchange has adopted a new Corporate Governance Code based on the OECD principles of corporate governance. Because “Comply or Explain Statement” is relatively new in Romania, this can explain the late period of survey, 2011.

The constructed models are cross section data models and were estimated by Ordinary least square (OLS) method. To test coefficients’ significance, the „t” test was used. The null hypothesis is given by the fact that the coefficients are not statistically significant. The „F” test was applied to test the overall significance of the model. The null hypothesis of this test is that the model is not overall significant. R-square was also reported to show to what extent the variation of the dependent variable is explained in relation to the variation of the independent variables.

4. Results and discussion

To ensure that there isn’t multicollinearity,

before building the models, we build the correlation matrix of the independent variables. The matrix is presented in Table 1.

As shown in the matrix, there aren’t very strong correlations (rxy > 0.9) between the independent variables that should give multicollinearity.


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Analyzing the testing of the H00 hypothesis: The increase of a company’s environmental performance contributes to the increase of its financial performance represented by accounting-based measures, we have estimated a series of models in which, alternatively, one of the following variables were considered dependent and the rest were considered independent:

- Return on assets (Net profit/Total assets)-ROA; - Return on equity (Net profit/ Shareholder

equity)- ROE ; - Leverage ratio (Debts/ Shareholder equity)-

LEV; - Equity-to-fixed-assets ratio (Shareholder

equity/fixed assets)- EFA; - Flexibility ratio (Net working capital/Total

assets)- FLEX; - Growth ratio (Turnover deviaton/Basis

Turnover)- GROW ; - Cash flow return on assets (Cash flow/total

assets)- CW. From these models, we present the results of

the model’s estimation with ROA as a dependent variable, since only for this model in particular the CSR variable is statistically significant (The estimation’s results for the other models can be sent on request). The variables CASH and GROW were removed from the model because these variables are not statistically significant (“t” statistics reported for these variables are smaller than “t” from Student’s t distribution with 69 degrees of freedom or the probabilities associated to the t test are greater than 0.1). The estimation’s results are presented in Table 2. As shown in the Table 2 which regards the exogenous variables with positive influence on the sample companies, we remark ROE, LEV, EFA, FLEX and CG. The coefficient for corporate governance (CG) indicates a weak but still positive correlation for Romanian companies. In other words, the companies with good values for return on shareholders equity ratio, debt ratio, financial flexibility ratio, with strong corporate governance are expected to generate an increase in profitability’s companies (expressed by ROA).

In what the relation between CSR and ROA is concerned, our study attests a negative correlation. This means that the adoption of CSR activities is not directly reflected in an increase of the company’s return on assets as ROA, but rather shows a decrease. This decrease appears as an immediate resultant of a decrease in the profits rezulted by adopting high CSR investments. The company’s internal performance, such as ROA, reflects at the same time the managemant’s team performance. Therefore, on the short-term, the managerial performance (rated as ROA) will register a decrease due to increased environmental investments costs and thus a decrease in activity efficiency.

In other words, hypothesis H00, concerning financial performance represented by accounting based measure performance, is rejected. We can affirm this because even if we would have estimated

the models having as dependent variables the other variables that represent financial performance as accounting-based performance (ROE, LEV EFA, FLEX) the CSR coefficient would have not been statistically significant. Our study reveals the fact that environmental performance does not lead to an increase in financial performance for the analyzed period (2011).

In support of some explanations for the obtained results, we will refer to a few studies (Hart and Ahuja, 1996; Judge Jr. and Douglas, 1998; Khanna and Damon, 1999; King and Lenox, 2001; Moneva and Ortas 2009; Nakamura 2011) that attest the existence of a lag (of 1-3 years or longer) between the time of environmental investment and the date when the effects are seen as an increase of a company’s financial-accounting performance. Thus, this correlation’s analysis for the same period leads to a negative correlation and only in the subsequent periods it becomes a positive one, reflecting a growth in the company’s performance due to an increase in environmental investments.

Thus, Hart and Ahuja (1996), in their study based on Standard and Poor's 500 Listed companies, identify a negative relation between Emissions’ reduction and operating performance (ROA) in the base year "t" and only in the following year (t +1), it can be seen a positive impact on operating performance (ROA). As for influences of Emissions’ reduction on ROE, according to the study by Hart and Ahuja (1996), they are seen only after two years.

On the same level is situated the study by Khanna and Damon (1999) which ascertained that the companies in the chemical industry which participated in EPA's 33 out of 50 voluntary program (encourages emissions’ reduction) were on the short term affected by the reduction of return on investment but on the long term, an increase in benefits measured by excess value per unit of sales was confirmed.

In Japan, the study conducted by Nakamura (2011) on a total of 3,237 companies, found the same results both on short-term and on long-term results. Thus, on the short term, the environmental investment does not significantly affect the firm’s performance (represented by ROA) but on the long term it is significantly increased. Returning to Europe, Moneva and Ortas (2009) analyze the environmental and financial performance of a sample of 230 European companies. They found a positive and significant correlation between the two indicators only on the mid / long-term. Thus, firms that included corporate environmental performance issues in their strategic management policies would obtain a competitive advantage in the mid/long-term, significantly increasing their financial performance reflected by ROA, Profit margin, Cash flow, Operating profit. In support of explaining the negative correlation found between environmental performance and the company’s profitability, any invocation of high costs of CSR reporting, in addition to actual costs of investment in CSR, costs that lead


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to a lower operational efficiency of the organization during the investment period, is not negligible. Among those who emphasize environmental reporting issues and the costs of performing them, are: Al-Tuwaijri et al. (2004); Cormier and Magnan (2007); Dasgupta et al. (2006); Frieedman and Pattern (2004); Kim and Lyon (2011); Moneva and Ortas (2009); Murray et al. (2006); van Beurden and Gőssling (2008).

Analyzing the testing of the H01 hypothesis: The increase of a company’s environmental performance contributes to the increase of its financial performance represented by market-based

measures, we have estimated a series of models for which the below variables were considered dependent.

- Market capitalization (market value company) - MK;

- Price to book ratio (Market value of share /Book value of share)- PBR;

- Tobin’s Q ((market capitalization+ book value of debt)/ book value of assets)- TQ.

From running regressions with Market capitalization (MK) and Price to book ratio (PBR) as dependent variables, we can conclude that the resulted models are not statistically valid (Table 3).

Table 1. The correlation matrix

CG ROA LEV ROE EFA FLEX GROW CW CSR

CG 1.0000 ROA 0.2793 1.0000 LEV -0.0641 -0.0024 1.0000 ROE 0.0965 0.0334 -0.9852 1.0000 EFA 0.0896 0.4036 -0.1150 0.0615 1.0000 FLEX 0.1524 0.5064 -0.0744 0.1071 0.6338 1.0000 GROW 0.1524 0.0157 -0.0110 0.0111 -0.0729 -0.1008 1.0000 CW 0.1076 0.1142 -0.0055 -0.0042 0.3835 0.2226 -0.0239 1.0000 CSR 0.7201 0.0686 0.0521 -0.0216 0.0859 0.1277 0.0652 0.1564 1.0000

Table 2. Estimation results of the model with ROA-Return on assets, as dependent variable Independent variables Coefficients

ROE 0.0865537* (1.62) LEV 0.0074193* (1.73) EFA 0.0362232* (1.97) FLEX 0.1325813* (1.85) CG 0 .0032569*** ( 3.02) CSR -0.0905698** * (-2.40) Constant -0.0640496** ( -2.14 )

R-squared = 0.3833 F( 6, 76) = 0.000

Note: (i) t statistics in brackets. (ii) *,**, *** denote significance at the 10%, 5% and 1% levels, respectively. (iii) F test indicates the overall significance of the model. The null hypothesis is that „the model is not significant” and p-value is reported.

Table 3. Estimation results of the model with MK-market capitalization, as dependent variable

Independent variables Coefficients ROA 20400000 (-0.06) ROE 206000000 (1.36) LEV 13700000 (1.12) EFA -38100000 (-0.69) FLEX 49100000 (0.24) GROW 500000000*** (80.48) CASH 428000000 (0.92) CG 6454767**(2.01) CSR -11300000 (-0.10) Constant -173000000 (-2.02)

R-squared = 0.9905 F ( 7, 76) = 0.000

(i) t statistics in brackets. (ii) *,**, *** denote significance at the 10%, 5% and 1% levels, respectively. (iii) F test indicates the overall significance of the model. The null hypothesis is that „the model is not significant” and p-value is reported.

Table 3 reveals that only two variables are statistically significant and those are GROW and CG and the R square’s value is of 99% which means that the model is not correctly specified (they are variables that take each other’s effect). In Table 4 it can be observed that only the LEV variable is

statistically significant (“t” statistic reported for this variable is greater than “t” from Student’s t distribution with 66 degrees of freedom or the probability associated to the t test is smaller than 0.1). Moving on to the model’s analysis having Tobin's Q (TQ) as dependent variable, we ascertain


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that the model is valid and most variables are statistically significant.

The economic growth (GROW) and corporate governance (CG) variables were removed from the model because they were not statistically significant (“t” statistics reported for these variables are smaller than “t” from Student’s “t” distribution with 68 degrees of freedom or the probabilities associated to the “t” test are greater than 0.1). The model’s estimation results are presented in Table 5.

As shown in Table 5, for the sample companies between CSR and Tobin's Q there is a positive correlation showing that the companies which conduct corporate social responsibility activities achieve higher market performance reflected in Tobin's Q ratio. In other words, the study reveals that those companies which engage in corporate social responsibility activities (and achieve high environmental performance) have a competitive advantage among the Romanian companies reflected in the company's market performance’s increase, highlighted by Tobin's Q ratio .

The investors’ preference to invest in companies that act responsibly is reflected in the increase of the shares’ price and finally in the increase of a company’s market rates, such as the Tobin 's Q rate. Our conclusions reflected in the Tobin 's Q indicator are part of the Efficient Market Theory according to which any news, good or bad, is reflected in the stock 's share price. Varous studies (Al-Tuwaijri et al., 2004; Brian et al., 2010; Dasgupta, 1998,2006; Freedman and Patten 2004; Ganzi et al., 2004; Klassen et al., 1996; Konar and Cohen, 2001; King and Lennox, 2002; Lorraine et al., 2004; Perez-Calderon, 2011, 2012) have identified environmental information’s relevance to investors. Thus any positive or negative information regarding environmental performance is immediately reflected in indicators that show the company’s market value. We believe these studies to be extremely close to the results of our study which certifies a positive correlation between environmental and market performance reflected through Tobin's Q rate.

First of all, we want to mention Konar and Cohen's study (2001) conducted for the publicly traded companies included in the S & P 500. Their study’s results attest the significant positive effect of good environmental performance, expressed by the effect of toxic emissions on the value of firms’ intangible assets measured through Tobin' Q rate (approximately 9% of the intangible assets’ value is a result of the relevant environmental information’s influence).

The study conducted by King and Lenox (2002) on a sample of 614 publicly traded companies of the U.S. manufacturing industry also leads to interesting results. They found that waste prevention is consistently profitable (as measured by Tobin’s Q, the firm’s market value per value of assets), in comparison to other means of reducing pollution. Two years later, Freedman and Patten (2004)

concluded that negative information on a company’s environmental performance tends to decrease the shares’ price of that company.

Moreover, the Lorraine et al. (2004) study highlighted the impact that information on environmental pollution fines or the positive aspects that refer to achieving environmental objectives have on the shares’ market value of UK companies. Conducting a study on 198 companies from Standard and Poor’s 500 companies based on a one year analysis, Al-Tuwaijri et al. (2004), ascertained that “good” environmental performance is significantly associated with “good” company performance on the market, as we have ourselves concluded. The study conducted by Brian et al. (2010) on a sample of 340 multinational companies highlights the significant market reaction (measured by market value) to the announcements regarding the companies’ environmental initiatives. Specifically, the announcements of philanthropic gifts awarded for environmental causes are associated with a significant positive market reaction, voluntary emission reductions are associated with significant negative market reaction, and ISO 14001 certifications are also associated with significant positive market reaction.

Our study’s results reflect the fact that the increase of companies’ environmental performance only influences the stock performance represented by Tobin's Q and not the performance represented by Market capitalizations or Price to book ratio. Thus, hypothesis H01 is accepted in the case of financial performance represented by Tobin's Q and rejected in the case of Market capitalizations performance or Price to book ratio.

Moreover, the Tobin's Q rate is evidenced in literature as being superior to Market capitalization or even Price to book ratio indicators because of the complexity of Tobin's Q rate. Unlike MK and PBR, the construction of Tobin’s Q reflects both the companies’ market value and the relation with the companies’ fixed assets (McNicols and Rajan 2014; Roll and Weston, 2008; Ross et al., 2005; Wolfe and Saddle 2003). Tobin's Q is the ratio between the market value of the firm's assets and the replacement value of those assets. On the other hand MK and PBR are indicators that reflect the market with predilection.

Table 4. Estimation results of the model with PBR- Price-to-book ratio as dependent variable Independent variables Coefficients

ROA 0.2422141 (0.31) ROE -0.5608908 (-1.60) LEV 0.0998859*** (3.54) EFA 0.1167253 (0.91) FLEX -0.0489074 (-0.10) GROW 0.020849 (1.45) CASH 0.7988376 (0.74) CG 0 .0062259 (0.84) CSR 0 .0448345 (0.18) Constant -0.0290407 (-0.15)

R-squared = 0.9577 F (7, 76) = 0.000


Table 5. Estimation results of the model with TQ-Tobins’s Q as dependent variable

Independent variables Coefficients ROA -1.526178*** (-3.70) ROE 0.4734461** (2.38) LEV 0.037889**(2.37 EFA -0.2076199*** (-2.87) FLEX 0.4636523* (1.74) CASH 1.239256 ** (2.02) CSR 0.2663077 *** (2.73)

Constant 0.5950894 *** (5.70) R-squared = 0.4853 F (7, 76) = 0.000


Due to its advantages, Tobin’s Q ratio was preferentially used in different studies for a better accuracy of the correlations: Anderson and Gupta (2008); Bauer et al. (2003); Black et al. (2005); Brown and Caylor (2006); Coşkun and Sayilir (2012); Hermes and Katsigianni (2011); Klapper and Love (2004); Kowalewski (2012); Kuznecovs (2011); Monda and Giorgino (2013); Renders et al. (2010); Stiglbauer (2010); Yu (2009). However, we remark the prevention of Tobin's Q’s valences in recent studies such as that of Dybvig and Warachka (2012).

The hypothesis H01’s acceptance in the case of market performance reflected in Tobin 's Q rate and its rejection reflected in MK and PBR could be explained in terms of construction differences between Tobin 's Q rate and the other two analyzed stock rates (MK and PBR).

Unlike Tobin 's Q rate, which is more complex and oriented towards the company’s tangible assets, MK and PBR rates are indicators which are closer to the market given that the Romanian stock market is of poor efficiency and reacts less or late to external information. These conclusions are supported by the studies of Henriques and Sadorsky (2006), Bluffstone and Sterner (2006) and Eanhard and Lizal (2007) who were preoccupied with the correlation between environmental and financial performance in the emerging economies of Hungary, Bulgaria, Lithuania, Poland and Romania and compared to the results obtained in the developed countries, they have found significant differences due to special factors that act in those countries with transitional economies

(privatization, public influence, export orientation and others). Last but not least, among the factors which influence the analyzed correlation, we must invoke the widespread financial crisis in emerging European countries that in 2007 affected the companies’ market performance in relation to the accounting performance. Here we can mention the study conducted by Trunk and Stubelj (2013) for Slovenia reflects the fact that the market value of equity capital in relation to the fundamental value of equity capital of the selected companies was lower in 2011 than in 2006 (before the crisis). 5. Conclusions

This paper aims to investigate a possible link

between a company’s environmental performance and its financial performance, for the Romanian companies. For this purpose we used a sample of 76 Romanian companies that were listed at Bucharest Stock Exchange in 2011.

The study’s originality appears primarily on the background of the small number of works that have tested the relationship between environmental and financial performance for the Romanian companies. This is mainly due to the fact that in Romania, corporate social responsibility is a novelty both in theory but especially in practice in the corporate business, in the context in which Romania belongs among those countries with transitional economy and still has much to learn about best corporate practice.

A second element of originality for our study consists in using a less-known data source of CSR


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activities, namely “Complain or Explain Statement”. Another plus for our study would be taking into consideration for our statistical regression the “corporate governance” variable, expressing the role of corporate governance in leading a business, which is a relatively new concept in Romania. However, the survey’s results reflect that for the Romanian companies there is a weak but positive correlation between corporate governance and a company’s financial-accounting performance.

Moving on to our findings, they reflect a negative correlation for the company’s performance represented by ROA and a positive one for the market performance represented by Tobin's Q ratio. In conclusion, our study illustrates that environmental investments are not immediately reflected in a growth in the companies’ financial-accounting (or domestic) performance but rather in a performance’s decrease based on the increase of environmental investment costs that leads to a decrease of assets’ efficiency for the analyzed period. These investments in environmental activities are appreciated as “good news” for investors as a factor that will ensure long-term sustainability of the company and are therefore reflected in the growth of Tobin's Q rate, yet not in the growth of Market capitalization or Price to book ratio.

A short-term negative correlation between environmental performance and financial-accounting performance represented by ROA is certified by numerous previous studies that identify the existence of a lag (of 1-3 years or longer) between the time of environmental investment and the date on which the effects are seen as increasing company's financial accounting performance. Thus, the correlation’s analysis for the same period leads to a negative correlation and only in the subsequent periods it becomes a positive one, reflecting a growth in the company’s performance due to the growth of environmental investments.

According to the analysis of the link between environmental performance and market performance, we find a positive correlation for the Tobin’s Q rate. The fact that between environmental and market performance there is not a statistically significant connection when the performance is measured by MK and PBR can be explained by the fact that the indicators MK and PBR are more market oriented than the Tobin's Q indicator (which is extensively oriented to tangible assets) and in terms of a reduced efficiency of the emerging stock market (such as the Romanian one), the information is not so rapidly absorbed by the stock price and consequently by MK and PBR. Therefore an increase in environmental performance is not associated with an increase in stock performances manifested by Market capitalization and Price to book ratio.

The results are supported and explained by studies conducted for other emerging economies (Hungary, Bulgaria, Lithuania, Poland, Romania) which show the notable differences between the factors which act in emerging economies compared

to those with act in the developed ones, differences which are inclusively manifested in the relation between the company’s environmental performance and its financial performance. All these conditions specific to emerging countries to which the financial crisis and its impact on the capital markets around the world is added, come to explain the inconsistent results that we have obtained on the influence of environmental performance on Market capitalization or Price to book ratio.

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