PARTICIPATION OF FIRMS IN VOLUNTARY ENVIRONMENTAL PROTECTION PROGRAMS: AN ANALYSIS OF CORPORATE SOCIAL RESPONSIBILITY AND CAPITAL MARKET PERFORMANCE

I. INTRODUCTION AND LITERATURE REVIEW The role and overall responsibility of the business community in the United States with regard to environmental protection reflects the evolving policy and regulatory framework set by the federal and state governments. Economic theory suggests that policy makers endeavor to set policy and regulatory instruments consistent with socially optimal levels of environmental protection and that businesses seek to operate within this policy and legislative framework in a least cost manner. This still is the mainstay of the environmental protection regime. Over the past 10 years or more, however, the role of the business community beyond mere compliance has received increasing attention. Although there is no well agreed-upon definition of corporate social responsibility (CSR), examples of firms acting "green" are abundant. Examples include an internal carbon-trading regime introduced by British Petroleum, the Responsible Care Program initiated by the Chemical Industry, and the establishment of Socially Responsible Investment (SRI) funds. There is, in fact, an extensive list of firm or industry environmental initiatives that go well beyond mere compliance with the law. A plethora of questions have arisen surrounding the issue. Do firms have additional moral and social responsibilities prompting them to devote resources to environmental protection above and beyond what is stipulated by the law? What are the motivations for doing so, and what is the frequency of such behavior? (Reinhardt et al. 2008). Partly in response to the CSR movement, and partly to address the inadequacies of conventional means of environmental protection, the Environmental Protection Agency (EPA) has introduced voluntary environmental programs that seek to recognize and reward above-average environmental performance. The Environmental Leadership Program (ELP), StarTrack program, and National Environmental Performance Track (NEPT) program are of this form. These programs are characterized by the concept of tiered regulation, which has been described as the "tailoring of regulatory requirements to fit the particular circumstances surrounding regulated entities." Tailoring may include flexibility in compliance schedules, adjusting the frequency of inspections or monitoring requirements, or differentiating the level and form of sanctions. The effectiveness of voluntary programs as a policy instrument depends pivotally on whether firms can participate on a sustainable basis and whether the benefits (including rewards) are sufficient to justify the extra costs incurred by beyond-compliance activities. In this connection, an extensive literature has developed relating some measure of a firm's economic performance with its performance regarding one or more dimensions of social responsibility. One measure of a firm's economic performance is its stock price. Since the 1990s, there has been a series of econometric analyses that examine the effects of environmental-related news on stock prices using the event studies method. First used in the classic stock split event study by Fama et al. (1969), the event studies method remains "vibrant to this day" (Fama 2010) and is widely used in the financial economics, corporate finance, and law and economics literature. Over time, both the number of published event studies and a parallel literature on the methodology of event studies have increased (Kothari and Warner 2007). Kothari and Warner (2007) maintain that while short-horizon methods are "relatively straightforward and trouble-free," long-horizon tests with event windows of 12 months or more have serious limitations.1 Fama (1991) also suggests that more weight should be put on the results of short-horizon tests than long-horizon tests, as the former presents the "cleanest evidence we have on efficiency." While more reliable than long-horizon tests, short-horizon tests also have several limitations, including confounding effects during the event window (McWilliams and Siegel 1997). …