Being Green: A Capital Idea

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Let’s trot out ol’ Kermit once again: It ain’t easy being green. That’s the usual (but certainly not universal) knock for companies that say they want to be good environmental stewards but at the same time have to answer to investors whose idea of green stewardship pertains pretty exclusively to dead presidents.

So a new study in the latest issue of Strategic Management Journal offers some incentive to be good — green companies can get their capital a little cheaper. Business professors Mark P. Sharfman and Chitru S. Fernando, both of the University of Oklahoma, open their paper by noting that some evidence already exists that being green makes good business sense. But they note that the rationales have been chalked up to some form of greater efficiency, whether of resources or personnel.

Their study of 267 U.S. companies comes up with a new kind of efficiency — of risk. As they posit at the beginning of the paper:

Improved environmental risk management signals the financial markets that the firm represents a less risky investment that deserves less expensive debt and lower equity risk premiums. Such lowered costs of capital should, in turn, increase the firm’s overall economic performance and thereby help to explain the observed positive relationship between economic and environmental performance.

Guess what? They appear to be right.

“Our results suggest that in addition to the improved resource utilization that comes with improved environmental risk management, such actions are legitimated (rewarded) by the equity markets and, in some ways, by the debt markets as well,” the pair conclude. Green firms see benefits in equity capital through broader ownership of their shares and in reduced volatility of their share price, and in debt capital through cheaper borrowing. And capital, after all, is the lifeblood of a company.

But why? After all, cleaner usually means investing in new and expensive equipment or practices, often in the face of competitors who make more mercenary decisions. Well, in addition to those efficiencies of resources and organization, “It also has a payoff in terms of the market’s perception of the risk profile of the firm and helps explain why better environmental performers are also better financial performers.”

Not dealing with lawsuits, fighting regulators or cleaning up after catastrophes saves money, after all, and firms that have decided to spend their money preventing big problems are telegraphing the markets that they won’t be writing blank checks for cleanup later.

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