Abstract
China Journal of aCC ounting StudieS , 2016 Vol . 4, no . 4, 357–378 http://dx.doi.org/10.1080/21697213.2016.1251768 a b a Yu He , Qingliang Tang and Kaitian Wang School of a ccounting, nanjing university of f inance and economics, Wenyuan road 3, Qixia district, nanjing City, China; School of Business, university of Western Sydney, l ocked Bag 1797, Penrith, nSW 2751, a ustralia ABSTRACT KEYWORDS Carbon reduction Extant literature has failed to document consistent evidence that performance; corporate socially responsible activities are positively related to financial social responsibility; financial performance. Such an inconclusive result raises the question of performance; financial identifying the incentive for firms to voluntarily commit resources obligation; simultaneous for carbon mitigation. Our study attempts to address this issue by equations investigating the relation between carbon performance and financial performance. We employ a sample of US S&P 500 corporations and use emissions reduction to measure carbon performance and Tobin’s Q to measure financial performance. In order to mitigate the concern of endogeneity, we also consider the influence of carbon disclosure on the relation by conducting simultaneous equations analysis. The results show a positive relation between carbon performance and financial performance. In addition, we find firms with better financial performance tend to be more transparent in carbon disclosure. These findings contrast with previous studies that typically report mixed results. A higher degree of correspondence between carbon performance and financial performance indicates managers who have financial and social obligations and who have chosen carbon projects that have not only improved firm green image but have also generated tangible economic benefit. 1. Introduction Growing scientific evidence shows that climate change is a serious challenge and uncon- trolled global warming will cause enormous damage. However, corporate responses are ambiguous and mixed. While more and more companies have developed a proactive strat- egy, others have taken a reactive approach. Our study is important because voluntary initiatives aiming at increased transparency, or at improved emissions management, have recently surfaced at the international or national level (Hahn, Reimsbach, & Schiemann, 2015). These initiatives stem from organi- sations such as the Carbon Disclosure Project (CDP), the Global Reporting Initiative (GRI), the Investor Network on Climate Risk (INCR), and the International Integrated Reporting CONTACT Yu he heyucpa888@163.com, yu.he@njue.edu.cn Paper accepted by t ong Yu. t hat is, these firms tend to take no action until greenhouse gas ( ghg) regulation is announced. © 2017 a ccounting Society of China 358 Y. HE ET AL. Committee (IIRC) (Matsumura, Prakash, & Vera-Muñoz, 2014). Given carbon emissions are still largely unregulated the question is why many companies voluntarily commit resource to cut emissions and disclose carbon information. The literature often uses a win-win sit- uation to justify voluntary corporate social responsibility (CSR) activities, i.e., firms take CSR because that can help achieve financial goals, but empirical research has failed to provide consistent evidence. There is little empirical research regarding the association between carbon emissions, their disclosures, and firm value (Matsumura et al., 2014).This motivates us to examine the association between financial performance and carbon performance. We employ a sample of US S&P 500 corporations that present a carbon report on the website of the Carbon Disclosure Project (CDP) organisation. We use carbon emissions as a proxy for carbon performance, and Tobin’s Q for financial performance. Following previous research (Al-Tuwaijri, Christensen, & Hughes, 2004; Ullmann, 1985), the study also considers the influence of carbon disclosure on the relation by conducting simultaneous equations analysis to mitigate the concern of endogeneity. The results show that carbon performance is significantly and positively associated with financial performance, and firms with higher financial performance tend to disclosure more carbon information. These findings contrast with earlier studies on non-carbon CSR activities that find little support for a positive asso - ciation. On the other hand, our results are consistent with prior literature that CSR activities (other than carbon actions) are largely cosmetic (Clarkson, Li, Richardson, & Vasvari, 2011) and that firms take such activities for legitimation purpose which does not alter their strategy and operational policy. Comparing with early evidence on CSR, our findings suggest a firm’s financial performance is more sensitive to carbon performance than to other general CSR activities. This is probably due to the fact that, while carbon reduction requires considerable investment, cosmetic social activity is often using smaller amounts of funding (Clarkson, Li et al., 2011) and thus investors are unlikely to be impressed. Consequently its n fi ancial impact would be negligible. While carbon legislation is still developing, literature documents that public expectations and corporate responses to climate change have shifted dramatically over the past two decades. By the mid-1990s, some North American firms in energy-intensive sectors perceived the prospect of greenhouse gas (GHG) emission regulations as a substantial threat (Kolk, Levy, & Pinkse, 2008; Levy & Egan, 2003). However, business has recently tended to converge on a more constructive stance that takes climate change as an opportunity rather than a burden and successful treatment of environmental concerns is becoming a significant com - petitive issue (Hansen & Mowen, 2007; Margolick & Russell, 2004). More corporate directors realise meeting business and environmental objectives are not mutually exclusive (Clarkson, Li et al., 2011). Financial markets have started to reward companies that are moving ahead on climate change, while those lagging behind are assigned more risk (Cogan, 2006). Responding to the concern from financial markets, the SEC issued an explicit guidance on disclosures of risks and opportunities related to climate change in January 2010, which requires climate-change-related disclosures in SEC regulatory filings. The International Auditing and Assurance Standards Board (IAASB) approved ISAE 3410 in March 2012, which provides guidance for independent assurance on GHG statement issued by US and interna- tional firms (Matsumura et al., 2014). Prominent environmental non-governmental CHINA JOURNAL OF ACCOUNTING STUDIES 359 organisations (such as CDP ) are pushing companies to disclose GHG that is crucial for more accurate valuation of assets (O’Dwyer, 2005). In contrast to general CSR activity that is usually inexpensive, managers must mobilise more resource to cut carbon emissions. The resources that would be committed include re-designing of product and manufacturing process, establishment of carbon accounting and management system, and less use of fossil fuels and non-biodegradable material. From the perspective of shareholder value maximisation, a financial return is expected from the investment. The decision dilemma facing corporate managers is they cannot only focus on value creation ignoring the impact of its operation on the atmosphere. On the other hand, man- agers’ financial obligations restrict them to take projects that can only meet social obligations without reasonable economic outcome. Traditionally, when the social expectation is low, the corporate response appears to take cheap cosmetic actions to show the firm’s commit - ment (Dowell, Hart, & Yeung, 2000), but without actually or significantly altering its business practices. As a result, such actions would have minimum impact on bottom line. But recently the public have increasingly higher expectation, and interest in carbon emission from various stakeholders has grown 18-fold in the past decade (PricewaterhouseCoopers, 2012, p. 6). Some investors are integrating carbon disclosure into their investment decisions (Eccles, Krzus, & Serafeim, 2011). Some observers predict that concern from capital markets about carbon emissions will drive a redistribution of value from firms that do not control carbon emissions successfully to firms that do so (GS Sustain, 2009, p. 1), and firms must deliver tangible emissions reduction, which cannot be achieved by an inexpensive and cosmetic strategy (Clarkson, Li, Richardson, & Vasvari, 2008). Thus, the optimal option in the equilibrium for firm is to take a green project which can simultaneously meet its financial and social obligations (Matsumura et al., 2014). If this is true, we should observe a positive relation between financial performance and carbon performance. Our results are consistent with this expectation. A sizeable number of CSR proponents have suggested that firms can generate significant goodwill and new market opportunities by displaying social and environmental awareness (e.g., Fombrun, Gardberg, & Barnett, 2000). However, these benefits are not derived from social and environmental compliance with regulatory requirements because the mere com- pliance hardly allows a company to distinguish itself from its intra-industry peers that are affected by compliance in a similar way. In other words, only more rigorous (i.e., proactive) forms of performance that require both changes in production and manufacturing processes and a forward-looking management style which cannot be easily mimicked or duplicated by competitors can impact financially (Dowell et al., 2000; Russo & Fouts, 1997). According CdP is an independent and not-for-profit organisation based in the united Kingdom that addresses the climate change concerns of institutional investors (t ran, okafor, & herremans, 2010). CdP represents 534 institutional investors with over uS$64 trillion in assets under management, and can be seen as a secondary stakeholder that has facilitated collaborative engagement to increase corporate accountability in relation to climate change (arenas, l ozano, & albareda, 2009). u sing a standard questionnaire, CdP collects climate change data on ghg emissions, carbon risks and opportunities and the actions companies are taking to reduce emissions. CdP report format and contents are accepted and adopted by more than 4000 globally large participating firms. i n 2010, CdP sent this questionnaire to more than 4,700 of the world’s largest corporations including S&P 500 firms. t he S&P 500 saw an increase in response rates to the highest level ever: up to 70% (350) in 2010 from 66% (332) in 2009, 63% (314) in 2008, and 56% (280) in 2007 (PricewaterhouseCoopers and CdP, 2010). t he literature proposes variety of methodology to assess financial return and non-financial benefits from carbon investment. g enerally speaking, the returns include saving energy costs, more marketable low carbon products, and improved reputation which helps firm expand its business. 360 Y. HE ET AL. to resource-based theory, these changes provide the key sources of a sustainable competitive advantage (Barney & Arikan, 2005). Unique proactive governance can pay off as long as these efforts are in the interest of the company’s primary stakeholders (Hillman & Keim, 2001). Our findings are consistent with this argument. This study contributes in literature in a number of ways. First, we extend traditional research on general CSR to carbon disclosure and performance. Second, the use of carbon emissions to measure carbon performance in our study is innovative comparing with pre- vious studies that typically use waste, toxic chemical emissions etc which is sector and firm specific and cannot be applied to other firms. Third, our data are from CDP reports rather than from annual reports or sustainability reports that often include self-selection informa- tion. Such information in CDP reports is relatively more consistent (Luo, Lan, & Tang, 2012). Fourth, instead of using a self-constructed index (Plumlee, Brown, & Marshall, 2008), we use the carbon disclosure score index from the CDP, which is regarded as one of the most com- prehensive indexes for carbon disclosure (Luo et al., 2012). Finally, we conduct a joint esti- mation using three-stage least squares (3SLS) simultaneous equations models to deal with endogeneity. Our results should be potentially useful for capital market participants and governmental bodies who care about corporate climate change incentives and activities. The remainder of this study proceeds as follows: Section 2 develops our hypotheses; Section 3 describes our sample and methodology; Section 4 presents empirical results; and the final section summarises and concludes. 2. Literature review and hypotheses development 2.1. Literature review 2.1.1. Corporate Social Responsibility Given the fact that the goal of a commercial organisation such as a company is primarily to maximise profit and shareholder value, to what extent we can expect a company to care about the environment and voluntarily take action to mitigate its impact on climate change and disclose the information to stakeholders? Some authors are suspicious about a firm’s CSR intention. For example, Wood (1988) argues that capitalism cannot avoid environmental devastation and is unavoidably hostile to ecological balance. McNicholas and Windsor (2011) apply a critical analysis of commod- itised GHG traded as financial products in the proposed Australian emission trading scheme and argue the scheme will not reverse the extreme climate change associated with an envi- ronmental catastrophe, suggesting the market mechanism will fail to achieve its objective to control climate change. While some people suggest companies can achieve financial success and environmental goals simultaneously, Banerjee (2007) questions the win-win assumptions and identifies the limits of the good that corporations can do, illustrating the ability of firms to enhance social welfare is constrained by their current form and purpose, and that of a shareholder value maximising entity. CdP provides an index for participating firms that covers many aspects of relevant information such as the carbon governance mechanism, carbon risks and opportunities, carbon strategy and targets, carbon actions and processes, accounting system for carbon emission and reporting, ghg assurance, carbon emission trading and offsetting, and carbon communications and engagement. t he index increases in carbon transparency which is based on the company’s answers to the CdP’s questionnaire. CHINA JOURNAL OF ACCOUNTING STUDIES 361 On the other hand, scientific evidence has accumulated that the climate change is a challenge facing humanity as a whole and that unabated climate change risks could raise average temperatures by over 5°C from pre-industrial levels and the damages would be equivalent to at least 5% of GDP up to 20% or more, while the costs of mitigation can be limited to around 1% of global GDP each year (Stern, 2006). In order to combat global warm- ing, the primary focus of the actions recommended is a shift to low-carbon energy systems. Governments around the world have initiated and implemented various policies and regu- lations in order to stabilise climate change. Thus, the fundamental business environment is undergoing structural reform. Therefore, it is no longer appropriate to assume that business can be run as usual. It is very unlikely that firms can make profits and increase firm value without taking into account the impact on climate change. Firms without a clear carbon strategy may not be able to survive, not mention to achieve sustainable economic success. Hence, even from the perspective of capitalist investors or directors of a profit-seeking firm, an optimal business approach should embrace a proactive carbon policy. In other words, even environmental protection is not their primary purpose, and the firm should show at a socially accepted degree. Its concerns about climate change and demonstrate its operation will reduce global warming. This is increasingly becoming a condition for the viability of a business organisation. 2.1.2. Empirical evidence on environmental versus financial performance Empirical evidence over the last two decades or so is consistent with the view that stake- holder expectation is increasing. Early literature finds little evidence that there is a significant relation between social or environmental performance and financial performance. For exam - ple, Rockness, Schlachter, and Rockness (1986) examined hazardous waste disposal in the chemical industry using environmental performance data from a special site survey submit- ted to the US Congress in 1979. Testing the association among two waste disposal variables and 12 financial indicators representing economic performance, they failed to document a statistically significant relation. Freedman and Jaggi (1988) investigate the relation between environmental pollution disclosure and several accounting-based performance indicators but find little evidence to support the conjecture that there is a clear-cut and significant association. In subsequent research, Freedman and Jaggi (1992) examined the relation, using the percentage change in three pollution measures and various accounting ratios and failed to reject the null hypothesis of no significant association. Apart from possible methodology and measurement issues, these results are likely due to the lower expectation of investors for the social or environmental activities of their firms. As the expectation is lower, firms are unlikely to take serious efforts and the financial impact of these CSR activities are not expected to be significant. In contrast, studies in recent twenty years document increasing sensitivity of financial performance to environmental activities. For example, using a sample of 89 multinational S&P 500 firms with production operations in countries with GDP below $8000 per capita, Dowell et al. (2000) find multinational firms with better environmental performance indicator (i.e. adopting more stringent global environmental standard) have a higher Tobin’s Q. King and Lenox (2001) examine a sample of 652 manufacturing companies from 1987 to 1996. however, use of more stringer standards is an indirect measure of environmental performance. 362 Y. HE ET AL. They measure relative environmental performance as the weighted average of toxic release normalised by firm size (number of employees) and find that relatively high emissions are negatively associated with Tobin’s Q. These findings are consistent with that of Konar and Cohen (2001), who report firms that are disposing of smaller amounts of toxic chemicals, and those that are confronted with fewer or no environmental lawsuits, tend to have a higher Tobin’s Q. King and Lenox (2002) further conclude that waste prevention and future financial performance are positively associated, but that pollution reduction efforts by other means, such as ‘end-of-pipe’ pollution treatment, do not affect Tobin’s Q. Other authors using accounting measures (typically return on assets) to proxy financial performance also docu- ment similar results (Clarkson, Li et al., 2011; Hart & Ahuja, 1996; McGuire, Sundgren, & Schneeweis, 1988; Russo and Fouts, 1997; Waddock & Graves, 1997). Our study is an extension and differs from prior research along several important dimen- sions. (1) The nature and scope of carbon action can be very different from those of other CSR activities. (2) The research year is more recent. Most of the above studies were conducted before 2000, and in the last 10 years or so, there has been a significant change in business environment and investors expectations. (3) The research setting is different. Previous studies focus on polluting firms that may not be able to be generalized to non-polluting firms (but emitting carbons). (4) The measure of performance is different. The above studies typically use pollution prevention and treatment, environmental strategies, hazardous waste disposal, toxic chemicals, environmental lawsuits, and environmental standards etc to proxy environ- mental performance. These indicators are only suitable for specific firms or industries, and cannot be used for carbon performance. (5) The methodology is die ff rent. Our study employs simultaneous equations models to tackle with the potential issue of endogeneity and attempt to overcome several methodological limitations that are often encountered in the empirical literature. Thus, our results may contrast significantly with prior research and shed more insights. 2.2. Hypothesis development 2.2.1. Carbon performance versus financial performance The academic literature has attempted to provide a framework that aligns CSR with firm value creation. Theories in the management literature (e.g., Griffin & Mahon, 1997) have questioned the validity of CSR based on two critical points: CSR is far from well defined thus managers are unable to determine what the CSR of their company is, and CSR activity may decrease firm value which makes CSR inconsistent with the principles of shareholder wealth maximisation. In contrast, proponents focus on the economic significance of CSR and con- tend that organisations can improve goodwill and generate new market opportunities by showing social and environmental awareness (e.g., Porter & Claas, 1995). Authors relying on financial theories and asset pricing models, which centre on the risk-return paradigm, have suggested that as a firm makes strategic investments that reduce pollution and hazards, it can mitigate its risk of litigation and potential claimants on its rents through fines, settle - ments, or other compliance costs (King & Shaver, 2001). If the economic benefits are genuine and significant, that should be rewarded by the market in terms of improved risk perception (Mackey, Mackey, & Barney, 2007; Sharfman & Fernando, 2008). Matsumura et al. (2014) posit that carbon emissions levels will have significant finance implications if capital markets believe that carbon emissions are relevant for valuation and are measured reliably (Barth, CHINA JOURNAL OF ACCOUNTING STUDIES 363 Beaver, & Landsman, 2001). On the other hand, natural-resource-based theory argues that a firm’s competitive advantage is affected by its key resources and capabilities (Hart, 1995). Since a firm has to allocating resources to measure, disclose, monitor, and reduce carbon emissions, cost-benefit trade-offs of allocating resources to carbon emissions reduction ini- tiatives will be important for firm valuation (Thaler & Sunstein, 2008). Those firms that do not integrate climate change risk into their business strategy are likely to lower investors’ market-value expectations relative to firms that do so (Epstein, 2008, p. 145; Hart, 1995). In addition, in our context, a reduction in carbon emissions can decrease the consumption of energy and save energy costs and thus further lower operating risk. Hence, leaders with a strong carbon performance record might be regarded as less risky investments compared to laggards. This means investors would demand a lower return by assigning a lower discount rate to expected future cash flows for ecologically responsible companies that in turn have a higher value. Thus, assume capital markets incorporate information related to carbon effi- ciently we arrive at the following hypothesis (stated in the alternate form): H1: Carbon reduction performance relates positively to financial performance, ceteris paribus. 2.2.2. The relation between carbon disclosure and carbon performance While our primary interest is in the relation of carbon and financial performance, we also take into account carbon disclosure for two reasons. First, investor perception is not only affected by performance, but also influenced by how the carbon performance is disclosed. Second, managers might take strategic policy that simultaneously affects the three variables. Why do firms present carbon disclosures since the capital markets penalise firms for their carbon emissions? Matsumura et al. (2014) answers this question through voluntary disclo- sure theory. Extant literature generally argues that disclosure can generate benefits through reduced information asymmetry between the firm and its stakeholders (Healy & Palepu, 2001). Firms can inform theirs stakeholders of future costs and benefits from initiatives of measuring, disclosing, and reducing carbon emissions through making truthful voluntary carbon disclosures. If firms do not present carbon disclosures, then stakeholders will not only impute the firms’ carbon emissions, but also likely treat non-disclosure as an adverse signal and penalise non-disclosers (Milgrom, 1981). The second cost for non-disclosing firms is from the cost of information searches. Stakeholders are likely to undertake costly infor- mation searches regarding the non-disclosers’ emissions, and the cost of information searches ultimately will be imposed upon the non-disclosers (Johnston, 2005). Voluntary disclosures are also used to reduce potential regulatory intervention (Blacconiere & Patten, 1994). Thus, firms are motivated to present carbon disclosure voluntarily, which will be rewarded by the markets. There are two theories analysing the relation between carbon disclosure and carbon performance, and the first one is signal theory (or voluntary disclosure theory) which suggests that companies have incentives to disclose ‘‘good news’’ to differentiate them- selves from companies with ‘‘bad news’’ in order to avoid the adverse selection problem (Bewley & Li, 2000; Clarkson, Li, Richardson, & Vasvari, 2008; Dye, 1985; Li, Richardson, & Thornton, 1997; Verrecchia, 1983). Hence, this theory predicts a positive relation. On the other hand, legitimacy theories argue that companies with threatened legitimacy are likely to make self-serving disclosures referred to as “legitimisation” (Adams, 2004; Gray, Kouhy, 364 Y. HE ET AL. & Lavers, 1995; Hughes, Anderson, & Golden, 2001). Firms with poor environmental per- formance are vulnerable to certain types of criticism and will make voluntary disclosures to deflect or nullify suspicion or doubt with regard to that area of potential criticism (Gray et al., 1995). Therefore, legitimacy theories suggest a negative association. Previous research provides empirical evidence that is largely mixed ( Tang & Luo, 2011). This is likely due to different indices developed by the authors to measure environmental disclosure and performance. Another possibility is these studies did not adequately address the endogeneity issue. Thus, we use the CDP carbon disclosure index and a joint estimation approach to mitigate these concerns. Since these disclosure theories provide opposite predictions, we test the following two competing hypotheses (stated in the alternate form): H2a (b): There is a positive (negative) relation between carbon performance and disclosure which is consistent with signalling (legitimacy) theories. 2.2.3. The relation between carbon disclosure and financial performance Greater financial disclosure increases investors’ awareness of a firm’s existence, enlarges its investor base, narrow information asymmetry among stakeholders or between firms and stakeholders, which improves risk-sharing and reduces the cost of equity capital (Merton, 1987). Higher-quality disclosures affect the firm’s assessed covariance with other firms’ cash flows, which are non-diversifiable (Lambert, Leuz, & Verrecchia, 2007). The direct effect of carbon disclosure on the financial performance can be attributed to a reduction in the esti- mation of carbon information risk. In a traditional capital market setting, Richardson, Welker, and Hutchinson (1999) present a model that explicitly identifies three broad avenues through which CSR disclosure might influence firm value. First, CSR disclosure could affect the mar - ket’s predictions of future cash flows because the CSR projects are positive (or negative) NPV projects (e.g., lower overall costs or expanded by-product sales), reduce future regulatory costs or bring future product market benefits. Second, CSR disclosure could reduce infor - mation asymmetries and improve capital market functioning, reducing transactions costs and the cost of equity capital. Finally, CSR disclosure could result in a lower cost of equity capital if investor preferences are such that investors will accept a lower rate of return on investments in organisations that are perceived to be socially responsible. In addition, carbon disclosures may be seen as a firm’s credible commitment to environmental issues in their long-term strategic and production systems (Plumlee et al., 2008). Finally, higher-quality environmental disclosures, which have been linked to increased environmental activities, may affect regulators’ decisions, thus influencing costs for firms and for their competitors (Decker & Pope, 2005). Several studies suggest an association exists between environmental disclosure and financial performance. Clarkson, Fang, Li, and Richardson ( 2013) investigated the relevance of environmental disclosures and found that voluntary environmental disclo- sures enhanced firm value. However, empirical studies using different methodologies, sam- ples, and research settings do not provide consistent evidence supporting the theoretical f or more information see the following articles. f reedman and Wasley (1990) and Wiseman (1982) reported evidence of no significant relation. l egitimacy theory is supported by Bewley and li (2000); Buhr (1998); Clarkson et al. (2008); Clarkson, o verell, and Chapple (2011); Campbell (2003); d eegan and g ordon (1996); d eegan and r ankin (1996); h ughes et al. (2001); o ’d onovan (2002); Patten (1992). in contrast, al- t uwaijri et al. (2004) shows evidence which is consistent with signalling theory. CHINA JOURNAL OF ACCOUNTING STUDIES 365 Table 1. Sample distribution. Sector 2007 2008 2009 2010 Total Consumer iscretionary 12 16 19 21 68 Consumer Staples 12 18 23 30 83 energy 8 13 17 15 53 f inancials 1 1 0 3 5 health Care 17 14 19 20 70 industrials 10 18 17 25 70 information t echnology 19 22 30 36 107 Materials 12 14 15 16 57 t elecommunications 1 5 4 4 14 utilities 18 22 25 28 93 t otal 110 143 169 198 620 prediction. Thus, we test the following non-directional hypothesis (stated in the alternate form): H3: There is a significant relation between carbon disclosure and financial performance. The descriptive analyses of prior social-responsibility studies from Ullmann (1985) and Malik (2015) present mixed empirical results of pairwise associations among environmental per- formance, economic performance and environmental disclosure. Since these three factors are endogenously determined, then piecemeal Ordinary Least Squares (OLS) estimation of pairwise relations among these three variables will produce biased and inconsistent results (Al-Tuwaijri et al., 2004). Thus, following Al-Tuwaijri et al. (2004), we adopt a holistic approach and use the simultaneous equations models to jointly test the associations among these three variables. 3. Sample and methodology 3.1. Sample description We collect carbon disclosure data from CDP reports on US firms. Our sample firms must meet all the following criteria. That is, the firm: (1) is an S&P 500 firm and in the list of CDP reports; (2) has a carbon disclosure score (see explanation below) and carbon emission data; (3) has complete financial data reported in the COMPUSTAT and CRSP databases. Our final sample comprises 620 firms. Table 1 shows the industry (based on CDP’s industry classifications) and year distribution of the sample firms. 3.2. Empirical models and variable definitions Following Ullmann (1985) and Al-Tuwaijri et al. (2004) the study employs a system of simul- taneous equations defined in the following structural form: FP = CP + CDHIGH + FIN + LEV + SIZE + CAPIN + GRTH + NEW i,t i,t i,t i,t i,t i,t i,t i,t i,t (1) + IND + YEAR + i,t i,t i,t f or more details, see f reedman and Jaggi (1982), Shane and Spicer (1983) and r ichardson and Welker (2001) on environ- mental disclosure and financial performance, and see Botosan (1997) for financial disclosure and performance. 366 Y. HE ET AL. CD = CP + FP + FIN + LEV + EM + SIZE + LITIGATION + INTENSITY i,t i,t i,t i,t i,t i,t i,t i,t i,t (2) + IND + YEAR + i,t i,t i,t CP = FP + CD + FIN + LEV + SIZE + INTENSITY + CAPIN i,t i,t i,t i,t i,t i,t i,t i,t (3) + GRTH + IND + YEAR + i,t i,t i,t i,t Equation (1) examines the effect of carbon performance (CP) on financial performance (FP). FP is measured using industry-adjusted Tobin’s Q (Guenster, Bauer, Derwall, & Koedijk, 2011). CP is an empirical proxy for carbon performance calculated as the inverse of total carbon emission per million dollar net sales turnover (Clarkson et al., 2008). Thus, CP is a measure of carbon efficiency and increases in carbon performance. A positive coefficient on CP is expected, which would support Hypothesis 1. CDHIGH is an indicator variable that equals one if the firm’s score for carbon disclosure (CD) in year t is higher than the sample median and zero otherwise. CDHIGH is used to control the effect of carbon disclosure on the relation between carbon performance and financial performance (Dhaliwal, Li, Tsang, & Yang, 2011). In order to meet the identification condition of simultaneous equations, we use an indicator variable CDHIGH in Equation (1) instead of CD, which are used in the Equations (2) and (3). To control the effect of other factors, our study requires proxies for both a firm’s financial resources and its management capabilities (Clarkson, Li et al., 2011). We capture financial resources using financing activities (FIN), leverage (LEV) and firm size (SIZE). While man- agement capability is not directly observable, Clarkson, Li et al. (2011) argue that an inno- vative management team is more likely to pursue proactive investment strategies. Hence, we use capital intensity (CAPIN) (Clarkson, Li et al., 2011), sales growth (GRTH) (Al-Tuwaijri et al., 2004; Guenster et al., 2011), and age of equipment (NEW ) (Clarkson, Li et al., 2011) to capture management capability. CAPIN is measured as capital expenditures divided by start- of-period total assets, GRTH is measured by change in sales divided by beginning of period sales, and NEW is measured as net property, plant and equipment divided by gross property, plant and equipment. We include industry indicators (IND) and year indicators (YEAR) to control for potential industry and time effects. Equation (2) focuses on the impact of carbon performance on carbon disclosure (CD). CD is measured by a disclosure score index calculated using data from firm’s CDP report on carbon related activities and information, such as carbon governance, carbon risk exposure, carbon emission data and reduction actions, etc. Technically, a firm is assigned a score based on the content of the information provided by the firm in the CDP report. Thus, CD increases with the level of carbon disclosure, i.e. a higher CD for a firm suggests its carbon emission industry-adjusted t obin’s Q is a firm’s Q minus the median Q in the firm’s industry in the observation year, and firm’s t obin’s Q is measured as market value of common equity plus the book value of preferred stock, book value of long-term debt and current liability, scaled by the book value of total assets. u sing both unadjusted t obin’s Q and log of industry-adjusted t obin’s Q as the dependent variable also produces similar results. t obin’s Q increases in financial performance. i n sensitive analyses, we also use stock return and return on assets to proxy for fP. f ollowing Clarkson, li, et al. (2011), we also use the inverse of total carbon emission per million dollar cost of goods sold as the proxy of CP and obtain similar results. fin is measured as the amount of debt or equity capital raised, i.e. the issuance of common stock and preferred shares minus the purchase of common stock and preferred shares plus the long-term debt issuance minus the long-term debt reduction, scaled by total assets at the beginning of the year. le V is the ratio of total debt divided by total assets. SiZe is the natural logarithm of the market value of common equity at the beginning of year t. See CdP website for details of the scoring methodology applied in this study. CHINA JOURNAL OF ACCOUNTING STUDIES 367 and carbon related strategies and actions are more transparent and visible than firms with lower CD. CP and FP are defined as in Equation (1). A negative (positive) coefficient on CP is consistent with legitimacy theory (signal theory). Following prior studies (Aerts, Cormier, & Magnan, 2008; Bewley & Li, 2000; Clarkson et al., 2008; Magness, 2006), we include FP in Equation (2). Other control variables that may relate to disclosure include financing activities (FIN) (Frankel, McNichols, & Wilson, 1995), debt/asset ratio (LEV) (Leftwich, Watts, & Zimmerman, 1981), firm size (SIZE) (Lang & Lundholm, 1993). Francis, Nanda, and Olsson (2008) find that firms with good earnings quality have more expansive voluntary disclosures, thus, we also control the effect of earnings quality (EM), measured as the absolute value of abnormal accruals estimated based on the modified Jones model (Dhaliwal et al., 2011). Skinner (1997) contends that firms facing a higher level of litigation risk (LITIGATION) have incentives to make voluntary disclosure to preempt potential lawsuits. We control for LITIGATION, which is an indicator variable that equals one if the firm operates in a high-liti- gation industry (SIC codes of 2833-2836, 3570-3577, 3600-3674, 5200-5961, and 7370), and zero otherwise (Dhaliwal et al., 2011). Firms that operate in a high carbon-intensive industry may have incentives to disclose to prepare for the possible future legislation and the dead- weight costs of ex-post regulatory compliance (Al-Tuwaijri et al., 2004). Thus, we also include INTENSITY in Equation (2), which equals one if the firm operates in a high carbon-intensive industry and zero otherwise. Equation (3) examines the influence of FP on CP. It can be argued that emission cutting is not a budget neutral program and to achieve reduction target commits resources. So from a resource based perspective, availability of funds could be a constraint for emission miti- gation strategy and actions. Hence, a more profitable firm is more likely to set up an ambitious emission target and achieve better carbon performance. The reason for carbon disclosure (CD) being included in Equation (3) is that a firm’s environmental disclosures may represent a lower bound for environmental performance (Al-Tuwaijri et al., 2004), because investors’ expectations of environmental performance are conditioned on information provided by environmental disclosures. Matsumoto (2002) finds evidence that firms manage earnings upwards or guide analysts’ forecasts downwards to avoid missing expectations at the earn- ings announcement. Similarly, poor carbon performers may disclose carbon information voluntarily to avoid negative carbon performance surprise. All the control variables in Equation (3) are defined as previously. In Table 2 we present the description of the variables used in the system of simultaneous equations. 4. Empirical results 4.1. Descriptive statistics Table 3 provides descriptive statistics, and Table 4 shows the results of t-tests for mean comparison of different groups classified by carbon disclosure and carbon performance. Tables 3 and 4 show that the mean of disclosure score, CD of all sample firms is 59.09 out of 100. The mean of carbon performance, CP of all sample r fi ms is 0.05, which means on average every tonne of CO generates 0.05 million dollars of sales. The mean of CP of the good carbon performers (i.e. the top 50 percent) is 0.09 and higher than that (0.004) of poor performers utilities, energy and Materials are classified into intensive sectors ( t ang & l uo, 2011). 368 Y. HE ET AL. Table 2. Variable definitions. Variable Definition Cd a measure of the firm’s voluntary carbon disclosure in year t presented by CdP, which is an international collaboration of institutional investors concerned about the business implications of climate change CP t he firm’s carbon performance, measured as the inverse of total carbon emission per thousand dollar sales turnover (net), which also is used in Clarkson et al. (2008) fP Measured using industry-adjusted t obin’s Q (guenster, Bauer, d erwall and Koedijk, 2011) fin amount of debt or equity capital raised by the firm scaled by total assets le V l everage ratio, which is defined as the ratio of total debt divided by total assets eM Measured as the absolute value of abnormal accruals estimated based on the modified Jones model (dhaliwal et al., 2011) SiZe natural logarithm of the market value of equity CaPin Measured as capital expenditures divided by start-of-period total assets grth Measured by change in sales divided by beginning of period sales ne W Measured as net property, plant and equipment divided by gross property, plant and equipment Cdhigh indicator variable that equals 1 if the firm’s Cd is higher than the sample median and 0 otherwise litigation indicator variable that equals 1 if the firm operates in a high-litigation industry (SiC codes of 2833-2836, 3570-3577, 3600-3674, 5200-5961, and 7370), and 0 otherwise intenSit Y indicator variable that equals 1 if the firm operates in a high carbon-intensive industry, and 0 otherwise, which is also used in Matsumura et al. (2014) Table 3. d escriptive statistics. Variable Mean Std. Dev. 25th percentile Median 75th percentile Cd 59.09 18.05 46.00 60.00 73.00 CP 0.05 0.12 0.00 0.01 0.04 fP 1.61 0.80 0.99 1.38 2.01 fin –0.01 0.06 −0.05 −0.01 0.02 le V 0.25 0.14 0.15 0.24 0.34 eM −0.01 0.14 −0.06 −0.01 0.05 SiZe 9.73 1.03 9.05 9.80 10.44 CaPin 0.05 0.04 0.02 0.04 0.07 grth 0.04 0.17 −0.04 0.05 0.12 ne W 0.51 0.14 0.41 0.49 0.62 cdhigh 0.50 0.50 0.00 1.00 1.00 litigation 0.28 0.45 0.00 0.00 1.00 intenSit Y 0.33 0.47 0.00 0.00 1.00 Table 4. Mean comparison (classified by the level of carbon disclosure and carbon performance). CP (top 50% = 1, low 50% = 0) CD (top 50% = 1, low 50% = 0) Full CP = 1 CP = 0 t-value CD = 1 CD = 0 t-value t t t t Sample (n = 310) (n = 310) (difference) (n = 312) (n = 308) (difference) * *** Cd 59.09 57.82 60.37 1.76 73.79 44.20 −35.65 *** CP 0.05 0.09 0.00 −9.59 0.04 0.05 1.12 *** fP 1.61 1.82 1.40 −6.90 1.59 1.63 0.48 *** fin −0.01 −0.02 0.00 4.98 −0.01 −0.01 −1.35 *** * le V 0.25 0.20 0.30 9.74 0.26 0.24 −1.87 eM −0.01 0.00 −0.02 −1.62 −0.01 −0.01 −0.33 *** *** SiZe 9.73 9.59 9.87 3.46 9.88 9.59 −3.53 *** ** CaPin 0.05 0.04 0.07 12.14 0.05 0.06 2.30 ** grth 0.04 0.06 0.03 −2.30 0.03 0.05 1.23 *** ne W 0.51 0.47 0.56 8.84 0.52 0.51 −0.76 Cdhigh 0.50 0.48 0.53 1.28 – – – *** litigation 0.28 0.45 0.10 −10.73 0.29 0.26 −0.80 *** intenSit Y 0.33 0.04 0.62 19.40 0.30 0.35 1.40 notes: *, **, *** i ndicate that the estimated coefficient is statistically significant at the 10, 5 and 1% levels, respectively. all continuous variables are winsorized at the 1st and 99th percentiles. CHINA JOURNAL OF ACCOUNTING STUDIES 369 Table 5. Correlation coefficients (Pearson coefficients in lower left and spearman coefficients in upper right). CD CP FP FIN LEV EM SIZE ** *** Cd 1.00 −0.06 −0.04 0.04 0.09 0.01 0.18 *** *** *** *** *** *** CP −0.12 1.00 0.42 −0.29 −0.46 0.15 −0.18 *** *** *** *** fP −0.05 0.12 1.00 −0.26 −0.30 0.03 −0.27 *** *** *** *** ** fin 0.02 −0.12 −0.24 1.00 0.18 0.13 0.09 * *** *** *** ** le V 0.08 −0.24 −0.29 0.15 1.00 −0.09 0.05 ** *** *** eM −0.02 0.08 0.02 0.20 −0.12 1.00 0.01 *** *** SiZe 0.18 0.02 −0.25 0.05 0.04 0.01 1.00 ** *** *** *** ** *** CaPin −0.09 −0.22 −0.10 0.16 0.10 −0.05 0.14 * * *** *** grth −0.07 0.07 0.21 0.00 −0.13 0.01 −0.04 * *** *** *** *** *** ne W 0.07 −0.12 −0.23 0.18 0.20 0.01 0.29 *** * *** Cdhigh 0.82 −0.05 −0.02 0.05 0.08 0.01 0.14 *** *** *** *** ** litigation 0.04 0.11 0.28 −0.11 −0.28 −0.02 −0.09 *** *** *** *** *** intenSit Y −0.03 −0.21 −0.34 0.22 0.20 −0.03 0.20 CAPIN GRTH NEW CDHIGH LITIGATION INTENSITY * ** * *** Cd −0.07 −0.09 0.07 0.87 0.05 −0.04 *** ** *** *** *** CP −0.59 0.10 −0.43 −0.03 0.40 −0.73 *** *** *** *** *** fP −0.12 0.23 −0.29 −0.02 0.30 −0.41 *** ** *** *** *** fin 0.17 −0.10 0.20 0.06 −0.13 0.27 *** *** *** *** *** le V 0.18 −0.17 0.26 0.08 −0.30 0.25 *** ** eM −0.12 −0.03 −0.02 0.04 0.03 −0.09 *** *** *** ** *** SiZe 0.17 0.03 0.30 0.14 −0.08 0.21 ** *** ** *** *** CaPin 1.00 0.09 0.38 −0.07 −0.17 0.53 * * *** grth 0.07 1.00 0.05 −0.07 0.11 −0.03 *** * *** *** ne W 0.43 0.08 1.00 0.03 −0.11 0.40 ** Cdhigh −0.09 −0.05 0.03 1.00 0.03 −0.06 *** *** *** *** litigation −0.17 0.14 −0.11 0.03 1.00 −0.41 *** *** *** intenSit Y 0.51 −0.06 0.41 −0.06 −0.41 1.00 notes: *, **, *** i ndicate that the estimated coefficient is statistically significant at the 10, 5 and 1% levels, respectively. all continuous variables are winsorized at the 1st and 99th percentiles n = 620. t he Spearman (Pearson) correlations are above (below) the diagonal. at the significant level of 1%, which suggests good performers have higher carbon efficiency. The mean of CD of the good carbon performers is 57.82 and significant less than the mean (60.37) of CD of poor carbon performers at the significant level of 10%. This evidence supports legitimacy theory that poor carbon performers disclose more because of the pressure of legitimacy. The mean of financial performance, FP (i.e. Tobin’s Q) of all sample firms is 1.61, and the mean (1.82) of FP of good carbon performers is significant higher than the mean (1.40) of FP of poor carbon performers at the significant level of 1%, which provides prelim- inary evidence for the positive relation between carbon performance and financial perfor - mance. Good and poor carbon performers also differ in proxies for financial resources (FIN, LEV, SIZE) and for management capabilities (CAPIN, GRTH, NEW ), but no significant difference was found in earnings quality measure (EM). On the other hand, the significant differences between good and poor carbon disclosure firms are found only in terms of leverage (LEV ), size (SIZE) and capital investment (CAPIN). Table 5 depicts both the parametric and non-parametric correlation coefficients for the variables used in the study. Again, the significant correlation coefficient between CP and FP fails to reject the null hypothesis of no association and the direction is consistent with the prediction in H1. CD and CP are negatively correlated consistent with legitimacy theory. CD and FP are insignificantly correlated, suggesting no direct effect of financial performance on carbon disclosure. CD and LEV are significantly positively correlated, which shows the 370 Y. HE ET AL. monitor effect of debtors on carbon disclosure. CD and SIZE are also significantly positively correlated, suggesting larger firms disclose more. CP and LEV or FIN are significantly nega- tively correlated suggesting financial resource exert an influence on carbon decision. The signs of correlation coefficients among CP and three variables, CAPIN, GRTH, and NEW are mixed and signic fi ant, suggesting management capabilities are associated with carbon per - formance and activities. Other results in Table 5 are generally consistent with prediction or prior studies. For example, CP is significantly inversely related with INTENSITY, which suggests carbon performance of firms in a high carbon-intensive industry on average is relatively lower. 4.2. The endogeneity problem Carbon disclosure, carbon performance and financial performance are simultaneously affected by relevant management decisions. Thus, an OLS regression analysis could be biased and inconsistent because of potential endogeneity among these three constructs (Al-Tuwaijri et al., 2004; Clarkson, Li et al., 2011). Hence, we examine the endogenous relations among the three dependent variables (CD, CP and Tobin’s Q) by employing a Hausman (1978) test. The results reject the null hypothesis of no endogeneity with respect to CP (t = 35.05, p < 0.000) and FP (t = 3.62, p < 0.000) in Equation (2), and with respect to CD (t = −2.72, p < 0.01 and FP (t = −1.81, p < 0.1) in Equation (3). Thus we continue our analysis using three-stage least squares (3SLS) simultaneous equation models to obtain asymptotically unbiased results. Our simultaneous estimation of the parameters incorporates the available information from all the equations. 4.3. Regression analysis (three-stage least squares) Table 6 reports the results that adjusted system-weighted R-square of 3SLS estimates is above 90%, suggesting a high explanatory power. In Equation (1), the coefficient of CP is 4.398 at the significant level of 0.01, which is consistent with hypothesis H1 that predicts carbon performance is positively associated with Tobin’s Q. The results suggest carbon mit- igation can not only disentangle the pressure of social legitimacy, but also may generate tangible benefits for investors. The findings contrast with that of early literature that social or environmental responsibility activities are generally unrelated to economic results (e.g. Freedman & Jaggi, 1988; Rockness et al., 1986). In addition, the significant positive coefficient of CDHIGH also suggests firms with higher carbon disclosure have better financial perfor - mance. Taken together, carbon activities, both in terms of carbon performance and disclosure have positive impact on financial strength. Concerning control variables, CAPIN and NEW, which measures sustaining capital expenditures and age of equipment respectively (Clarkson, Li et al., 2011) both have a direct and positive effect. This is consistent with intuition that new technology should be more energy efficient, so can help achieve financial goals. Equation (2) investigates the effect of carbon performance on carbon disclosure. Voluntary disclosure (signalling) theory argues that not all information is disclosed. Managers are inclined to disclose the favourable information and withhold unfavourable information We also perform two-stage (2SlS) and hausman (1978) specification tests to compare 2 SlS and 3SlS estimates and find there is no significant difference, but 3SlS is more efficient than 2SlS. t hus, we report only 3SlS results. CHINA JOURNAL OF ACCOUNTING STUDIES 371 Table 6. t hree-stage least squares (3SlS) regression results ( ad J-Q/Sale) coefficients (t-statistics). FP (Equation 1) CD (Equation 2) CP (Equation 3) *** ** CP 4.398 −915.840 (6.45) (−2.22) *** Cd −0.002 (−3.80) *** fP −18.044 0.222 (−0.73) (6.93) *** Cdhigh 0.175 (3.21) *** * *** fin −1.598 −210.979 0.333 (−3.57) (−1.73) (2.89) le V −0.132 −137.678 0.026 (−0.51) (−1.76) (0.47) ** eM 110.883 (1.99) *** *** SiZe −0.143 8.354 0.035 (−4.82) (1.64) (4.74) *** *** CaPin 4.753 −1.054 (4.91) (−4.59) *** *** grth 0.744 −0.178 (4.10) (−4.05) ** ** ne W 0.526 −0.097 (2.11) (−2.03) litigation −18.095 (−1.17) intenSit Y −33.915 0.084 (−0.85) (1.76) ** _cons 0.000 0.000 −0.235 industry indicators Yes Yes Yes Year indicators Yes Yes Yes a djusted system R 0.957 notes: *, **, *** i ndicate that the estimated coefficient is statistically significant at the 10, 5 and 1% levels, respectively n = 620. all continuous variables are winsorized at the 1st and 99th percentiles. despite the fact that stakeholders (e.g., investors) have “rational expectations” about its con- tent: that is, they presume that withheld information is less favourable information (Verrecchia, 2001). On the other hand, legitimacy theory suggests that voluntary disclosures are part of a process of legitimacy and management tend to make social disclosures to reduce the effects upon a corporation of events that are perceived to be unfavourable to its image (Deegan, Rankin, & Voght, 2000). Thus, the two theories make opposite predictions. Table 6 shows that the coefficient of CP is significantly negative (after controlling for other influences), which supports hypothesis H2a based on legitimacy theory. The result shows that the coefficient of EM capturing earnings quality is significant positive. If earnings quality is a measure of earning transparency, the result suggests there is a positive association between carbon transparency and earnings transparency and both financial and carbon disclosure are complementary channels used by management to relieve the pressure of stakeholders on organisational legitimacy. Equation (3) specifies the influence of financial performance (FP) and carbon disclosure (CD) on carbon performance (CP). The direct effect of FP on CP is significant positive (coef- ficient = 0.222, p < 0.001), the indirect effect of FP on CP is 0.036 (= (−0.002)*(−18.044)) though it is insignificant, and total effect of FP on CP is undoubtedly significant positive. This evidence shows that carbon performance increase with financial performance suggesting firms with better financial performance have more resources and thus are more willing to 372 Y. HE ET AL. deploy funds to finance green activities which is a response to stakeholder demand. We showed in the result from Equation (1) that the effect of CP on FP is also positive, thus, we detect a two way influence between carbon performance (CP) and financial performance (FP), which cannot be achieved by adoption of a single OLS regression. In addition, consistent with Equation (2) the relation between carbon performance (CP) and carbon disclosure (CD) is negative (p < 0.001) under Equation (3), suggesting poor carbon performers may present more carbon information in order to avoid negative surprises and market punishment due to withholding information (Matsumoto, 2002). 4.4. Additional analysis 4.4.1. Alternative market-based and accounting-based measures for financial performance In order to examine whether our findings are sensitive to the research design, we conduct various robust tests. Prior environmental studies have used other market-based measures as proxy variables, such as annual stock return and market value of equity (Burnett, Skousen, & Wright, 2011; Sinkin, Wright, & Burnett, 2008). We also use stock return as the proxy of financial performance to test the previous model. Stock return is measured as the change in stock price during the year (adjusted for dividends), scaled by the stock price at the beginning of year. We report the results using stock return in Table 7, which is virtually the Table 7. annual stock return/Sale. FP (Equation 1) CD (Equation 2) CP (Equation 3) *** ** CP 0.989 −822.242 (5.77) (−2.47) Cd −0.001 (−1.20) *** fP −18.048 1.028 (−0.17) (4.53) Cdhigh 0.014 (0.78) fin −0.025 −150.820 0.016 (−0.19) (−1.82) (0.11) ** le V 0.108 −115.768 −0.107 (1.42) (−2.03) (−1.46) eM 70.440 (1.73) ** * SiZe −0.014 9.767 0.016 (−1.57) (2.23) (1.71) CaPin 0.058 0.005 (0.19) (0.02) *** *** grth 0.208 −0.226 (3.68) (−2.96) ne W 0.102 −0.081 (1.30) (−1.04) litigation −27.871 (−1.84) intenSit Y −105.500 −0.090 (−1.88) (−0.94) _cons 0.000 59.797 0.000 industry indicators Yes Yes Yes Year indicators Yes Yes Yes a djusted system R 0.957 notes: *, **, *** i ndicate that the estimated coefficient is statistically significant at the 10, 5 and 1% levels, respectively n = 620. all continuous variables are winsorized at the 1st and 99th percentiles. CHINA JOURNAL OF ACCOUNTING STUDIES 373 Table 8. roa/Sale. FP (Equation 1) CD (Equation 2) CP (Equation 3) *** ** CP 0.695 −711.136 (6.13) (−2.17) *** Cd −0.001 (−5.43) *** fP −68.905 1.343 (−0.46) (7.63) *** Cdhigh 0.024 (3.89) ** * * fin −0.144 −165.558 0.166 (−2.57) (−1.86) (1.93) le V −0.010 −98.860 0.004 (−0.29) (−1.67) (0.08) ** eM 104.305 (2.57) * ** SiZe −0.006 8.277 0.011 (−1.55) (1.92) (2.13) *** *** CaPin 0.464 −0.610 (4.33) (−4.51) *** *** grth 0.144 −0.203 (6.54) (−5.26) ne W −0.018 0.046 (−0.64) (1.62) litigation 6.958 (0.64) *** intenSit Y −56.973 −0.170 (−1.08) (−3.13) _cons 0.000 0.000 0.123 industry indicators Yes Yes Yes Year indicators Yes Yes Yes a djusted system R 0.876 notes: *, **, *** i ndicate that the estimated coefficient is statistically significant at the 10, 5 and 1% levels, respectively n = 620. all continuous variables are winsorized at the 1st and 99th percentiles. same as in Table 6 except that the coefficient of CP in Equation (3 ) is no longer significant. Researchers also adopt accounting-based measures including earnings per share, return on equity (Bragdon & Marlin, 1972); return on assets (ROA) and price-earnings ratio (Spicer, 1978). We repeat the analysis using ROA measured as the ratio of income before extraordinary items over total assets at the end of each year and the results are tabulated in Table 8 that are completely consistent with our main analysis, thus do not alter our main inferences. 4.4.2. Alternative measure for carbon performance We use the inverse of carbon emissions scaled by cost of goods sold (instead of sales in main analysis) and keep other variables unchanged. The untabulated results are virtually the same as those obtained from our reported tests using emissions or sales measures. The only dif- ferences are: in untabulated analysis in using Tobin’s Q as the proxy measure of carbon performance, the coefficient of LEV in Equation (2) is no longer significant; in untabu- lated analysis using stock return as the proxy measure of carbon performance, the signifi- cance of CD in Equation (2) decreases with t-value reducing from −3.799 to −1.631. These are negligible and suggest strong robustness of the research design. 374 Y. HE ET AL. 5. Conclusions, limitations and future research This study documents a significant and positive relation between carbon reduction and financial performance. The results suggest the green projects that are chosen by firms tend to mitigate emission and create observable financial benefit (reflected in an improved Tobin’s Q) simultaneously. To the extent Tobin’s Q captures the value which investors assign to carbon policies, and the expected returns on stocks compensate investors fairly for the associated risk, the market message is that stakeholders care about global warming issue and a proactive climate change strategy is not only a key to survive, but help achieve sustainable economic success. This strategy is important even for firms that do not dispose of toxic waste or hazardous chemicals. A few caveats should be noted. First, our sample drawn from S&P 500 firms might induce a size bias. Whereas our results may be generalised for large firms, inferring that small firms may behave similarly is overreaching. Second, we obtain the data of carbon emissions from each firm’s CDP report which is voluntary in nature, thus we cannot guarantee the reliability of the emission figures. Regarding future study, we offer two opportunities. First, our research setting is in the US that did not sign the Kyoto Protocol. 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Journal
China Journal of Accounting Studies
– Taylor & Francis
Published: Oct 1, 2016
Keywords: Carbon reduction performance; corporate social responsibility; financial performance; financial obligation; simultaneous equations
