The financial community suggests it increasingly accounts for the environmental and social performance of the companies it invests in. To investigate this claim, Bert Scholtens (University of Groningen) and Emma Witteveen (Lund University) study how stock market participants and credit rating agencies respond to environmental and health controversies with internationally operating companies.¹
Stock returns and rating changes are the most prominent financial signals regarding the appreciation of news by the financial community. The actions of numerous investors who trade on public information determine firm value. Credit rating agencies produce ratings based on private information, in part to support these evaluations. Ratings focus directly on a firm’s default and business risk which itself is increasingly associated with global environmental and health controversies.
Studying a sample of about one hundred events, it appears that financial investors show a timely and significant response to measures of such controversies. However, their response is highly generic and is small from an economic point of view. Furthermore, the credit ratings do not immediately respond in any significant way. Thus, markets and raters respond in a different way to the controversies. The researchers conclude that the response of the financial community to global environmental and health controversies is limited. Therefore, the financial community seems unable to discipline the economic agents behind the controversies.
This has important policy implications as especially financial regulators expect such a disciplining role from the financial community in their policies that aim at greening the economy and combatting the climate crisis. In particular, rating agencies are assumed to play a decisive role in assessing corporate performance in this regard. And investors are assumed to be able to gauge environmental performance of the firms they invest in. Scholtens and Witteveen suggest that these financial agents are not sufficiently capable of doing so. “Addressing market externalities should not be left to the market alone”, says Scholtens.
“The information provided by companies is insufficient to arrive at a thoughtful assessment of their risk”, according to Scholtens. “The information that companies provide is insufficient to make a well-considered assessment of the risks. An example is the mining company Vale. It received rave reviews from the financial community and was praised for its policies following previous scandals. However, insufficient precautions appeared to have been taken against the dam breach in Brumadinho (Brazil, January 2019), which left 250 people dead and caused massive pollution.”
¹Open Access publication Bert Scholtens, Emma Witteveen. 2021. Shocks, Stocks and Ratings: The Financial Community Response to Global Environmental and Health Controversies Global Environmental Change 68, 102245.
For more information, please contact Bert Scholtens l.j.r.scholtens rug.nl.
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