Innovest Strategic Value Advisors

Environmental Regulations and Stockholders` Wealth: An Empirical Examination

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Courtesy of Innovest Strategic Value Advisors

HYPOTHESIS: Null hypothesis: The sample average of the market model cumulative prediction error is equal to zero for any given holding period.  Pass-Through Hypothesis: The presence of competing firms unaffected by the announcement event (foreign exporting firms) would inhibit cost-pass through, since consumers simply switch to competitors in response to higher prices, and stockholders would bear the brunt of the cost increase.  Or the costs of pollution control may be born by consumers.

RESULTS: Results of Event Study
There is a definite negative market response to the announcement that a firm has attracted the attention of the EPA. The statistically weak magnitude of the loss reflects the diversity of events and the uncertainty about the future outcomes of the review. These results suggest that the market expects the EPA to succeed on the average in prevailing with targeted firms and that compliance is expected to be costly. The negative effects also suggest that the market does not expect the firm to be able to pass all the compliance costs to their customers. The cumulative abnormal return for the announcement window (-1,0) is significant, and for these two days 71.43% of the cases have negative abnormal returns.  The evidence is strong that losing a contest with the EPA is costly (cumulative abnormal return is -1.04% significant at the 1% level, on t = - 1 and t = 0) to the stockholders of the firms involved. It appear that there may be some benefits from showing a willingness to cooperate with EPA requirements: the loss of cooperating firms is only 59.2% of those not cooperating. There seems to be little support from the market to justify legal challenges of EPA decisions. There is no market reaction to positive EPA announcements.
Results of multiple regression on Pass-Through Hypothesis Regression analysis shows that targeted and loser firms can pass through pass through costs to consumers, though the effect is limited to monopolistic electric utilities and not to firms that compete freely both domestically and against imports.

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