Effects of harmful environmental events on reputations of firms

Abstract

Many previous event studies have found unexpectedly large losses to firms involved in negative incidents. Many of these studies' authors explain such losses as “goodwill losses” or “reputation effects.” To test this hypothesis, we search for residual losses (in excess of direct costs) to firms involved in events that produce ill will, but do not affect the quality of the firms' final products nor break implicit labor or supply contracts. Our sample of events is 73 negative environmental events reported in the Wall Street Journal between 1970 and 1992 in which electric power companies or oil firms with listed stocks were involved. We find an overall insignificant capital market response. We interpret this as showing that firms are punished only for actions that actually harm customers or suppliers. Although others have found similar outcomes, our results enhance previous research by extending the findings to a broader range of environmental incidents over a longer time period. Further, our findings suggest that the large residual losses in other event studies may be due to reputation mechanisms (and not measurement errors or event study idiosyncrasies), when defined traditionally — only those who are (potentially) harmed incur the costs of punishment.

Citation

Jones, K. and Rubin, P.H. (2001), "Effects of harmful environmental events on reputations of firms", Advances in Financial Economics (Advances in Financial Economics, Vol. 6), Emerald Group Publishing Limited, Leeds, pp. 161-182. https://doi.org/10.1016/S1569-3732(01)06007-8