The Effect of Environmental Activities on Return on Asset
ISO 14001 effect on manufacturing companies in Sweden
%DFKHORU·V thesis within Economics
Author: Fatema Kapasi 881119-2486 Noopur Parekh 880403-0362 Tutor: Sara Johansson, Peter Warda Jönköping June 2011
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Title: The Effects of Environmental Activities on Return on Asset
ISO 14001effect on manufacturing companies in Sweden
Author: Fatema Kapasi 881119-2486
Noopur Parekh 880403-0362
Tutor: Sara Johansson, Peter Warda
Date: [2011-06-14]
Subject terms: ISO 14001, Environmental and Financial Performance, Product
Differentiation, Return on Asset, Swedish Manufacturing Firms
Abstract
Environmental issues have increasingly started to dominate the political, social and economic agenda. The market demand for firms to take social responsibility is increasing. As a result, several environmental management systems (EMS) have started to emerge. The International Standardization Organization (ISO) -14001 is an internationally accepted EMS and covers over 162 countries. The purpose of this paper is to examine the relationship between environmental and financial performance in Swedish manufacturing companies, using ISO -14001 as an indicator for environmental performance and return on asset (ROA) for financial performance. This thesis presents a cross-sectional analysis on the effects of ISO 14001 on ROA, containing a sample size of 3300 firms from the Swedish manufacturing sector, out of which 18% are certified with ISO 14001.
Studies have been conducted for many years on the effects of social responsibility on firms profitability, however, this is far from an exhausted area of research. Contradictive results have been presented in both qualitative and quantitative studies. Our results shows an insignificant relationship between the ISO variable and profitability. However, the insignificant result does not eliminate a possible relation between financial and environmental performance.
List of Abbreviations
BPG Breusch-Pagan-Godfrey
CLRM Classical Linear Regression Model CSR Corporate Social Responsibility
EMS Environmental Management Systems (EMS) EMAS Eco-Management and Audit Scheme
EU European Union
ISO International Standardization Organization
NACE Classification of Economic Activities in the European Community R & D Research and Development
ROA Return on Asset ROE Return on Equity ROS Return on Sales
SIC Standard Industrial Classification SIS Swedish Institute of Standards VIF Variance-Inflating Factor
Table of Contents
1
Introduction ... 3
1.1 Purpose... 3
1.2 Data and Limitations ... 3
1.3 Previous research... 4
1.4 Disposition ... 5
2
Background ... 6
2.1 Environmental Management Systems and ISO 14001 ... 6
2.2 Different Perspectives on Environmental Management Systems ... 7
3
Theoretical framework ... 9
3.1 The Concept of Product Differentiation ... 9
3.2 Product Differentiation for Whom? ... 10
4
Statistical framework ... 12
5
Results and Analysis ... 15
6
Conclusion ... 18
6.1 Suggestion for Future Studies ... 18
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Introduction
Environmental economics is one of the fastest growing fields of study today. A rising demand for the industrial and business world to act environmentally responsible can be recognized among both consumers and other actors of society. Several optional environmental management systems (EMS) have been formed since the beginning of the ·V as a result of the increasing demand. In Sweden, the customary EMS are ISO (International Standardization Organization) 14001 and EMAS (Eco-Management and Audit Scheme). The growing demand for green companies can be explained by an increasing awareness among people about the negative environmental externalities produced by firms on both the nature and health. It can also be a consequence of the higher income levels and lifestyle change that we can witness over last decades. Historically this green movement started by governments and organizations and has now spread to enterprises and has developed to be a global concern. (UN, 2011;; Rondinelli & Vastag, 1996).
The effect of environmental performance on financial performance has been tested without unanimous results. Due to the high consumer demand for green products, especially in Sweden, it is important to prove a positive effect between the two in order to capitalize on the growing demand. In Sweden, the environmental commitment can be shown by their ninth place on the list of number of ISO- certified companies in the world (ISO, 2009). As a result of the uncertain relationship between financial and environmental performance, firms are, to a large extent, not engaging in green activities. This hesitation from firms can be a consequence of the unpredictable benefits involved in combination with the real costs. The benefits are generally long term and intangible while the costs include increased capital expenses and additional administrative work (Bansal & Bogner, 2002).
1.1
Purpose
In this paper we want to analyze if it is economically profitable for companies to restructure their management system in a more environmentally friendly way. Our research will be based on Swedish manufacturing companies divided into two sub-sections depending on if they have been accredited by ISO 14001, or not.
Our research question is as follows:
´'R Swedish manufacturing companies certified with ISO 14001 generate more profit than companies that are QRW"µ
1.2
Data and Limitations
This paper is based on a cross sectional, quantitative analysis, where return on asset (ROA) is the dependent variable and some control variables are included to test if ISO 14001 has an effect on firm profitability. All variables are estimated for a five-year period between 2005-2009. The data is retrieved from the BuUHDXYDQ'LMN·VGDWDEDse AMADEUS, which contains economic intelligence for over 15 million companies, both private and public, in eastern and western Europe. It includes both companies that are listed on the stock exchange, and also unlisted companies. Not all the certified companies are recorded in Amadeus, which excludes a small amount of certified companies from our sample size. The European management system, EMAS, is not as popular and preferred among Swedish companies as the ISO 14001 standards. Therefore ISO 14001 will be our
benchmark for environmental performance in our quantitative research. The majority of the Swedish companies are accredited by ISO 14001 (4862 companies, 18 April 2011) compared to EMAS, (23 companies, 18 April 2011). Another reason is that most of the companies who have been certified by EMAS also have an ISO 14001 certification. We chose to concentrate on manufacturing industries because in Sweden more than half of the certified companies are within that sector (certifiering.nu, 2011).
To collect a consistent data sample, we chose to limit the list of companies to firms that have been certificated after 2004, however, before 2008. 1 The issuing date for all
companies is not the actual point in time when they first got the ISO 14001 certificate, but when they lastly updated their certificate. As a result of this, some companies that got issued a certificate before 2008, and then renewed it after 2008, have unfortunately been removed from the list. This limitation was made to avoid any misleading information in our data, since firms with a newly received certificate might not have had the time to incorporate the system.
1.3
Previous research
Previous findings on this topic have shown large diversity in results, where some researchers have proven an existing relation, while others the opposite. Recently, however, environmental responsibility has increased in demand and with the ISO standard established, the findings have developed a more coherent character. Many statistical studies have been conducted where Corporate Social Responsibility·V &65 LPSDFW RQ ILQDQFLDO performance has been analyzed (Griffin, 1997). Moreover, some statistical studies measuring environmental performance have also been conducted (Murphy, 2002). For CSR to be successfully implemented within firms and for it to induce sustainable development, three dimensions must be considered: economic advancement, environmental improvement, and social development. These three aspects have been developed by the UN Global Compact with the help of nine principles (UN & Business, 2003). Since environment is one of the three aspects, we have also supported our thesis with CSR studies.
Margolis and Walsh (2002) have recognized in their meta-analysis a collection of previous research on the correlation between financial performance and CSR, that the first article was published by Narver (1971). Since then 122 articles (until 2001) within this field have been published with different results (Tsoutsoura, 2004). Those who believe that the relation is negative argue that the firms who engage in CSR risk a profit reduction, since it is believed that the costs of being socially responsible exceeds the profits it generate. Economists who believe that the relationship is neutral argue that there is no reason for any relation since there are too many variables that may affect the relationship between social and financial performance. The third perspective, which recognizes a positive relationship, verbalizes that firms that act socially irresponsible will experience a competitive disadvantage. Strategic management that creates ethical standards is also implemented in this perspective. If the moral and core values are emphasized within a firm,
1 In 2004 there were adjustments made to the standards established in 1996 and ISO
14001:2004 was introduced. This is why we decided to only include firms that have been certified after 2004.
employees, stockholders and the community will pay attention to that firm, leading to a positive relationship between CSR and financial performance (Waddock & Graves, 1997). Murphy (2002) has summarized the twenty leading quantitative studies made to determine the correlation between environment and financial performance. Different methodologies and indication factors are illustrated in the meta-analysis. The existing studies are dominated by American companies (S&P 500), using a range of different explanatory variables. A commonly used research method has been to conduct case studies based on few firms. Another meta-analysis conducted by Capon, Farley and Hoenig covers 320 empirical studies published between 1921 and 1987. The studies are separated by industry, firm and business, and the results are separated by the different variables affecting the dependent variable, financial performance (Capon et al, 1990).
Today, the field is lacking a more general overview of a larger sample size. Many of the existing studies have been based on case studies or some sort of interview collection. Furthermore, the majority of the studies has been based on American companies. The number of industry specific studies are approximately as many as the general studies. In this paper, we seek to analyze Swedish companies and in our sample size include all certified companies in the Swedish manufacturing industry. In this way, our thesis will have an industry focus, but the sample size will be significantly larger than previous studies and the focus will be on Swedish companies. Furthermore, since most previous studies have analyzed CSR or more general environmental activities, we hope that by using the ISO 14001 as our benchmark to be able to present a more focused study.
1.4
Disposition
The structure of this thesis is as follows: section two provides a general background on ISO 14001. It discusses the development of the certificate, its global coverage, and also the gains a firm can expect placed against the potential risks involved. Section three provides the reader with the theoretical part, which presents a framework for product differentiation, and specifically environmental product differentiation. Section four shifts focus to the statistical part where our model and variables are presented. Section five presents our results and provides an analysis of our statistical findings put in relation to our theoretical base. This section will thus answer our research question. Finally, section six, concludes our findings and gives suggestions for future studies.
2
Background
This section will start with a general introduction to the various EMS·V that exist and also in depth explain ISO 14001. Different aspects of an EMS implementation will be brought to light in an effort to give a well-rounded picture of the situation for firms today. Throughout this section there will be an underlying focus on Sweden and Swedish manufacturing firms.
2.1
Environmental Management Systems and ISO 14001
The varieties of EMSs used today are numerous, all with their own distinguished features. Among others, there is the European Standard Eco-Management and Audit Scheme, EMAS, the British Standard, BS7750, and many more industry specific systems. However, the nongovernmental organization ISO is the most commonly used international standard and it has the widest geographical and industrial coverage. The large application can be explained by its flexibility as the standard can be adapted by small, as well as large firms in different sectors within any political framework. (Bansal & Bogner, 2002)
The original initiative for an international standardized EMS was taken by the global industrial and business community. At the UN Earth Summit 1992 in Rio de Janeiro, the process of establishing such a standard had its official start. The key initiative takers were the International Chamber of Commerce and also single states such as Great Britain. However, the idea did already exist as many companies had already implemented management systems similar to ISO 14001. After 1992 the International Organization for Standardization instituted a committee, 7& ´(QYLURQPHQWDO 0DQDJHPHQWµ, working with related issues and presented, the first 14000 ² series, in 1996 (Miljöledningssystem, 2006). Only after recognizing an evident market demand for such standards in the business world, did ISO develop this benchmark. In November 2009, more than 18· organizations across the world, covering 162 countries, were certified by ISO 14001 (ISO, 2009). Since 2005, there has been a steady increase in the number of certified companies and more countries have started to adapt to this standard (Appendix 1)(ISO, 2009). In Sweden the amount was around 4000 companies in the first quarter of 2011 and as graph 1 shows, there has been an accumulated growth even in Sweden (certifiering.nu, 2011).
Figure 1 0 500 1000 1500 2000 2500 3000 3500 4000 4500 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
ISO 14001 in Sweden
ISO 14001 aims to advance the agenda of sustainable development in organizations, governments, businesses, and society so that different dimensions of the economy, the environment, and the society can be properly addressed. It helps companies to take responsibility for their impact on the environment and intends to simultaneously help companies to grow economically. The long term perspective is to make the entire process of being environmentally friendly more efficient and beneficial (Bansal & Bogner, 2002). ISO has instituted more than 17 000 standards (ISO, 2008), of which about 600 concerns the environment. The ISO 14000 series contains about 25 standards for management systems, environmental accounting and labeling (Brorson & Almgren, 2007). The ISO family comprises of only one standard that acts as a requirement for firms to fulfill (14001), while the others are guidelines. ISO 14001 is not a legal obligation, nor is it compulsory for any firm. The idea behind the management system is continuous improvements so companies can easily adapt to changes in regulations instead of having to make radical adjustment if there is an alteration (Bansal & Bogner, 2002). To obtain an ISO 14001 certificate, a firm has several options to consider: a firm can self-declare its adherence to the standard, or choose to apply through an independent accreditation agent (ISO, 2008). If a firm chooses to certify via a third party the firm will not be controlled for its actual environmental attributes of a certain good or the recycling habits at the work site. Instead, WKHDFFUHGLWHGILUPZLOOYHULI\WKHFRPSDQ\·VRYHUDOOenvironmental policies and make sure they cover the entire operation (Rondinelli & Vastag, 1996).
In Sweden there are 10 firms that are accredited and they work solely with certifying companies. They obtain their accreditation from Swedac, which is a sub-section to the Swedish Institute of Standards (SIS), who works with environmental issues in particular. SIS is a national authority that is a member of the international organization for standardization and works to implement various types of standards in Sweden. (swedac.se, 2011). Also, the Swedish government is taking political and legal actions in order to reduce the negative externalities caused by firms towards the environment. The Ministry of Environment has implemented objectives in accordance with the Swedish environment and continued work needed. Regulations and noncompulsory initiatives are together creating an atmosphere in Sweden where environmental concerns are highly prioritized and incorporated in the mindset of a larger share of the population (Sustainable Development, 2007).
In 2004 there were alterations made to the established standards of 1996.The changes can be considered to be minor and are intended to be supplementary to the work already established. The main aims of the adjustments were to clarify the purpose of the criterion of the EMS and also to more closely integrate the environmental standards with the standards for quality, ISO 9000 (Appendix 2 for more details). (Harral & Munro, 2006)
2.2
Different Perspectives on Environmental Management Systems
The change in attitude within the business world that has taken place over the last couple of decades can be attributed to various factors. The process of dealing with environmental issues has been more characterized by adjustments, adaptation, and innovation and most importantly it has become more integrated with the entire firm instead of acting like a sub-activity that the firm deals with. This transformation can be explained by active stakeholders, competitive pressures and firms that exceed the required governmental regulations, among others (Dechant et al, 1994). A very fast growing trend today is the pressure from consumers inquiring about the sellers and if they have or are planning to acquire some sort of certification (Walley & Whitehead, 1994). As mentioned, the demandalso comes from the stakeholders who are putting pressure on firms to act socially responsible. Stakeholders today are socially concerned in comparison to the neo-classical stockholders who were only interested in financial benefits (Ruf et al, 1990). In the short run the costs can exceed the benefits, but the long run gains of more stakeholders, consumers and investors can be economically beneficial (Lee & Douglas, 1997). Another incentive to certify a company with ISO 14001 could be the future expectations from consumers and governments abroad. For example, if a company is based in Brazil, but planning to expand towards Europe, then it might obtain the certificate as a measure to avoid legal issues and also broaden their customer group (Bansal & Bogner, 2002).
Generally, the last decades have been dominated by an optimistic attitude towards the relationship between environmental performance and financial performance. However, Noah Walley and Bradley Whitehead are among those who argues the opposite. They discuss that A win-win situation (refereeing to both financial and environmental prosperity) is rarely reached and even when obtained, it is overshadowed by the overall costs of a FRPSDQ\·V entire spending on environmental activities. In order to attain a truly sustainable solution the focus must be on finding smarter trade-offs between the two, and recognizing the cost of environmental ideal and act knowingly. Overall, they emphasize that firms should strive to find a ´WUDGH-RII]RQHµ, rather than aiming for a ´ZLQ-ZLQ]RQHµ, which is an uncommonly occurring situation. (Walley & Whitehead, 1994)
The optimistic attitude is also questioned by Bansal and Bogner. They highlight the costs involved in a capital investment like this, which they claim has frequently been disregarded in the literature. They argue that the literature on EMS is biased as it only mentions the low costs, increased market power and the higher profits that firms may expect. They point out that, even though most examples provide sky-high figures, all projects are not necessarily successful just like any other capital investment. To gain a proper appreciation of this, a well performed analysis of the specific firm situation is required. Furthermore, the costs involved in certifying a company are unquestionable real, while the benefits are generally intangible and long term. This consequently results in a hesitated response from firms since the balance between expenses and gains are not equally visible. (Bansal & Bogner, 2002) The ongoing debate over the consequences and benefits involved in implementing EMS is highly unlikely to be settled any time soon, as both sides concerns are equally recognized. A generally recurring argument from the environmentalists, is that the market demand of green products in combination with the increased production efficiency will yield opportunities for firms. Although economists usually point to the potential threats involved in higher costs and lower competitiveness.The generality of ISO 14001 can cause difficulties for a successful implementation. Since the external and internal circumstances for each individual firm will look differently, managers will adapt to different sets of goals and policies when certifying their company (Rondinelli & Vastag, 1996). Many companies also choose to certify themselves with more industry specific certificates, as these are generally stricter and in turn more convincing for stockholders (Bansal, 2002). However, this debate has also been argued to be entirely misleading since the market is not static. With constantly changing regulations, technology and market demand we have moved from a stagnated world to a place where innovation in the production process and production attributes is more in focus. Thus by adapting to a well designed EMS, firms can offset the costs of their new attribute, and by being innovative and creative, generate more growth. This requires a more realistic and constantly changing view on green activities and recognition of the opportunities. (Porter & van der Linde, 1995).
3
Theoretical framework
This section will provide an understanding of a theoretical framework which can explain why firms may engage in environmental activities to distinguish themselves on the market. No single study has been adopted as the basis of our research, instead the most common and generally accepted theories are presented. The first part discusses the theory of product differentiation and environmental differentiation in particular. The second part will continue on environmental differentiation and in depth explain for whom the differentiation is made.
3.1
The Concept of Product Differentiation
The New Palgrave Dictionary of Economics defines product differentiation as when ´FRQVXPHU JRRGV DUH DYDLODEOH LQ D YDULHW\ RI VW\OHV DQG EUDQGV 3URGXFW GLIIHUHQWLDWLRQ UHIHUV WR VXFK variation within a product class that (some) consumers view as imperfect VXEVWLWXWHVµ(Anderson, 2008). Two major theories concerning product differentiation have been developed since the ·V ERWK HTXDOO\ DFFHSWHG ZKLFK KDYH VHW WKH JURXQG IRU IXUWKHU UHVHDUFK (GZDUG &KDPEHUOLQ·V WKHRU\ LV FKDUDFWHUL]HG E\ LPSHUIHFW FRPSHWLWLRQ DQG YLHZV FRQVXPHUV DV homogenous, while Harold Hotelling introduces a spatial competition model (Kuenne, 2008). Further, Kelvin Lancaster explores the relation between consumers and producers. Building on his earlier work, Lancaster assumes that utility is derived from a set of characteristics in a good. Hence, the utility that is obtained by the consumers is not contained in the good itself, but by the features it possess. Environmental activities can be characteristics that are combined in a product and has an impact on the utility, and increases consumer welfare (Lancaster, 1975).
LancasteU·VLQWHUSUHWDWLRQLVVKDUHGE\0LFKDHO6SHQFH He remarks on the limitations of the pricing V\VWHPVLQFHFRQVXPHUV·ZLOOLQJQHVVWRSD\YDULHV(DFKLQGLYLGXDOZLOOYDOXHD good differently and to recognize all social gains is only possible with perfect price discrimination. Accordingly, all net surplus that a product provides to its consumers is not represented in the profit of the firm (Spence, 1976). The benefits from an environmentally differentiated product might not be visible in the firm profits but in a larger welfare picture (Lee & Douglas, 1997).
The concept of product differentiation exists because the market recognizes a value in variation. If there is no value in variation, then firms would benefit from producing one single variety as they could take advantage of scale economies. Environmental product differentiation will only take place if there is a market demand for it and if the market values such attributes in goods (Lancaster 1975). The market structure will also effect the variation level. If there is competitiveness on the market, variation will be larger since different firms will compete and scale economies will not be maximized. If there is a monopoly then the single firm will take advantage of the scale economies and produce lower variety (Lancaster, 1990).
By recognizing product differentiation within a market system, the firms attain price setting and market power, and thus marginal cost pricing will not be the only sustainable equilibrium. This way, products are not perceived as perfect substitutes, since they have different characteristics, and firms will not face an absolutely elastic response from their consumers (Anderson, 2008). Product differentiation can be applied to more than just physical attributes in a good. Nonmaterial attributes, such as social responsibility, product labeling and production processes, are all forms of differentiation. Since the market demand is assumed to be increasing for environmental products, those companies that
differentiate themselves environmentally, will eventually gain more market power. This motivation from firms, to certify with ISO 14001, is a response to the increased demand and to remain competitive in the market.
To succeed in a product differentiation within the framework of the environment or any other differentiation, a firm must among others, establish a willingness among consumers to pay extra for their variation (or compromise in other areas). They also have to provide reliable information about the different attributes of its product (Reinhardt, 1998). The cost of an improved attribute must be in line with maximizing profit, ensuring that the firm is lucrative. Assuming no market failures, and consequently no entry barriers, if a specific product is improved one level, the competing firms will upgrade their products so they do not fall behind (Aiginger, 2000).
Environmental product differentiation is a highly straightforward subject, referring to;; (i) companies producing goods with more environmental gains, (ii) companies producing goods with less negative environmental impact or (iii) the production process being less burdensome on the environment. These changes usually increase the costs of the firm and in turn implies either higher price or a larger market share. So, the optimal outcome for a firm would be to meet the growing environmental demand with their products while collecting the extra cost involved from its customers or extend their market share (Reinhardt, 1998).
Firms that differentiate their products, environmentally or not, face different obstacles depending on which market they focus on, e.g. consumer or industrial markets. In consumer markets (in comparison to industrial markets) it becomes much harder for firms to communicate their green activities to individual consumers, especially if the products account for a small part of their budget. This requires more effort and innovative approaches from the managers. An ongoing trend has been to acquire eco-labels, individual standards or third-party certifications (ISO 14001 for example). (Reinhardt, 1998)
3.2
Product Differentiation for Whom?
Aiginger (2000) describes the importance of quality competition for several reasons. Being a high wage region, the EU has the possibility to maintain the high costs for social, health and environment systems in order to increase the welfare. Countries with high wages consequently have to compete with countries with low wages due to advantage of price. Therefore, high wage countries continuously need to compete with the quality differentiation in order to remain competitive. A high quality product is defined DV ´DJRRG ZKLFKSRVVHVVHVRQHRUPRUHDGGLWLRQDOFKDUDFWHULVWLFVZKLFKDUHYDOXHGE\EX\HUVµ, such as an environmental feature. A figure (Appendix 3) illustrated in his paper shows the requirements, types and consequences of the competition in quality. He expresses several techniques in order to upgrade the value of a product, including an environmental standard certification as seen in the illustration. (Aiginger, 2000)
Product differentiation can be separated by horizontal and vertical differentiation. In a horizontal differentiation the products are more or less of equal quality, meaning that they have roughly the same attributes, but in different combinations. Consumers might prefer one good over another, but it has more to do with individual preferences than the good itself. In a vertical product differentiation, however, products demonstrate a clear and visible hierarchy. Either, a good is better than others in all aspects, including price, quality and accessibility, or the good is generally considered to be superior over other goods, e.g. designer clothes relative to ordinary clothes. This means that for a vertical differentiation
consumers have the same preferences, but what causes diversity on the market is the different income level (Lancaster, 1990). The market segmentation plays a critical role for environmental product differentiation, since environmental attributes are considered to be of the same characteristics as luxury goods, thus the elasticity is highly dependent on the income level. Hence, an environmental product differentiation is usually a vertical differentiation. A vertical differentiation will only appeal to a certain group of people, as it might change attributes such as lesser accessibility or higher costs, while a horizontal differentiation denotes an appeal to all consumers without any consideration to income level. Managers will have to find a balance between the gains of premium prices of their environmental products against the losses from consumers that are not willing to pay more. (Reinhardt, 1998)
For firms to capture the added value of environmental differentiation their choices must consider the entire enterprise and their business strategies. The circumstances for each firm will look different, depending on how pronounce the market failure is and what form it takes (e.g. incomplete information or environmental externalities). To create value and to capture it from the consumers will rely on the managers and their creativity. Reinhardt concludes by expressing his belief that even though all firms might not benefit from being green, given the various circumstances a firm might face, more companies will find it profitable if addressing the issue in a correct manner. The balance between profit and green activates, the balance between acting in favor of the stockholder and the response to the increasing environmental demands from the consumers is vital. (Reinhardt, 1998)
Concluding, the concept of product differentiation is used to understand why firms may distinguish themselves on the market in order to gain a competitive advantage. Environmental product differentiation are generally product labeling, changes in the production process, or an implementation of an EMS. It is also considered to be a vertical differentiation since it is a luxurious attribute added to the goods. Firms must carefully consider the tradeoffs involved and are required to find a balance between scale economies (lower production cost) and variety (consumer preferences). Also the tradeoff between premium prices and smaller market share since environmental product differentiation is a vertical differentiation.
4
Statistical framework
Previous researches have shown both positive and negative effects that environmental activities have on return on asset (ROA). Theoretically we expect the effect to be positive, since an additional attribute demanded, in this case the ISO 14001 certificate, will be
economically beneficial for the companies. Thereby our hypothesis is formed as follows:
Hypothesis 1 (H1): Firms engaging in environmental activities, through ISO 14001
certification, will experience higher ROA.
Our sample size contains of 3300 manufacturing companies in Sweden. The data is collected from the Amadeus database. Among these, 604 companies are certified with ISO 14001 which is approximately 18%. Manufacturing of fabricated metal products, except machinery and equipment, is the sub-section that is most outstanding in our data, while manufacturing of beverages and wearing apparel are the sub-sections with the lowest amount of ISO certificated companies (see Appendix 4).
Graph 1 plots the total sample size and the proportion of each sub-section that is ISO certified. From this we can conclude that the certified companies are evenly distributed among the sectors. Number 14 (manufacturing of fabricated metal products, except machinery and equipment) is clearly dominating our sample size, however it is also the sub section that has the most ISO certified companies. Therefore, we can observe that there is no sub-sector that is more ISO intensive than another.
Graph 1
The chosen control variables are based on previous statistical research of the same nature and also theoretical models to present results that are trustworthy and as accurate as possible.
Dependent variable
The primary intention of this paper is to analyze the financial performance of firms that are ISO 14001 accredited. Many articles shows that financial performance can be measured by return on asset (Simpson & Kohers, 2002;; Waddock & Graves, 1997;; Lee & Douglas, 1997), return on equity (ROE) and return on sales (ROS) (Waddock & Graves, 1997). Two meta analyses which have summarized empirical studies on financial performance of
0 200 400 600 800 1000 1200 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Tot. Firms ISO Firms
socially responsible firms, clearly demonstrate that ROA is a widely used indicator (Griffin, 1997;; Murphy, 2002). We choose ROA as our profitability measure, since it is a strong and reliable variable to measure financial performance with. The ROA variable is reported as a net financial value, which means that the debt is already accounted for.
Independent variables
Size, risk and industry are factors that affect the financial performance of firms, and have been suggested by many studies (Waddock & Graves, 1997, McWilliams & Siegel, 2000, Tsoutsoura, 2004). To control for size is very important since research shows that smaller enterprises do not engage in environmental friendly behavior. As for the larger enterprises, to be able to meet the demand of, and to attract more external constituents, engaging in environmental friendly ways becomes crucial. The larger firms generally have more miscellaneous resources so they can better tackle the additional cost and paper work (Bansal, 2002). Size can be measured by total sales, total assets and number of employees and has shown to have a positive effect on financial performance (Waddock & Graves, 1997). A proxy to measure the risk of a firm has been the equity ratio (financial leverage) (Scott & Martin, 1975). It is important to control for industries, otherwise the results can be misleading, since industries have different internal and external business structures. In previous studies, 4-digit SIC codes have controlled the different industries, by using dummy variables for different industry sections (Waddock & Graves, 1997). The basic Cobb-Douglas function informs us about the productivity level of a firm, which depends on the relation between labor and capital that a firm utilizes. To include a variable to measure productivity is necessary when analyzing the financial performance of a firm (Berndt & Triplett, 1991).
We used the following proxies as the explanatory variables:
x Size: The number of people employed controls for size. We have excluded relatively small firms to avoid misleading data. Thus, firms with less than 10 employees were omitted from the data set. We expect this variable to have a positive effect on our dependent variable.
x Risk: To control for risk we will use the equity-ratio variable since it is a good indicator of leverage. When a firm increases its equity, it increases its risk, and the firm expects a higher return. Therefore, the effect of this variable on the dependent variable is expected to be positive.
x Capital Productivity: To control for different levels of factor productivity, labor to capital ratio will be used. This variable is necessary since we have a large sample size and the firms in the various sub-sections have very different production functions. If productivity increases, financial profit is assumed to follow the same trend, and therefore capital productivity is expected to have a positive effect on our dependent variable.
x Industry: To prevent for skewed results, we choose to focus on one industry. We found that ISO 14001 certificates have mostly been given to the manufacturing industry. Therefore we decided to compare the manufacturing firms with an ISO 14001 certificate against the manufacturing firms without an certificate. In order to control for sub-sections within manufacturing we will include dummy variables for 20 of the 21 sub-sectors. The division of sub-sectors is based on 2-digit NACE codes (see Appendix 4).
x ISO 14001 certificate: This variable will be controlled for by a dummy variable. The companies that have ISO 14001 certificate are given 1, and the ones without are given 0.
Including the previously discussed variables the regression model takes the following form:
5
Results and Analysis
To understand the relationship between ROA and ISO 14001, we ran a linear regression model and obtained the results seen in the table below.
Table 3.1 Regression results of ROA
Variable Results
Coefficient (T-statistic)
Constant -2.694511
(-2.176498)*
Size (employee average) -3.56E-06
(-0.034889)
Risk (equity ratio) 0.124113
(12.72594)* Capital Productivity (labor to capital ratio) -0.572756
(-3.934215)* ISO 14001 (dummy) -0.513752 (-1.334619) Adjusted R-square 0.058927 R-square 0.065773 F-statistic 9.607234
Note: Number of observations: 3300
Dummy variables for sub-sections (2-digit NACE) in the manufacturing industry was included in the regression. (Appendix 4)
* = p< 0,05
The variable controlling for size is insignificant in this regression analysis. The explanatory variables that measures risk and productivity have significant values. The risk variable has a positive impact on return on asset, as we expected. The productivity coefficient has a negative sign, which is contrary to what was expected. The negative sign of the productivity coefficient indicates that return on capital is higher in capital intensive sectors. I.e. when the intensity of a production factor increases, then the capital return requirements will also increase. In this case, the manufacturing industries are capital intensive, consequently the return on capital requirement increase2. Our results from the regression analysis also
indicate an insignificant value of the ISO variable at 1% and 5% level. Thus we reject our hypothesis, which implies that we have not statistically proven that companies that have the ISO 14001 certificate have greater return on asset. By looking at the histogram (see Appendix 6), we can determine that the residuals follows a normal distribution.
Heteroscedasticity is tested for by using the Breusch-Pagan-Godfrey (BPG) test, which estimates the variance within the residuals in our linear regression model. The null hypothesis for this test is that there exist no heteroscedasticity. By the result obtained we can reject the hypothesis and conclude that heteroscedasticity exist in this model (Appendix 5). 2 p p ¸¸ ¹ · ¨¨ © § n oductivity Capital Labor Pr
Heteroscedasticity causes the standard errors to be biased and the conclusions or inferences we make can be misleading. The presence of heteroscedasticity can be explained by the possible existence of outliers, that the data is misleading or violating the classical linear regression model (CLRM), that the regression model is not correctly specified. Furthermore, the low adjusted R-square value, the misleading signs of our coefficients and the few significant variables in the model can also be explained by an incorrect functional form or omitted variables. The scenario consequently leads to a biased model. However, the significant t-values found in this regression are notably high, thus the problem is considered to be low.
The Variance Inflation Factor is used to detect multicollinearity. As seen in the table 3.2 the VIF value is close to 1, which means that there is no significant collinearity between the variables.
Table 3.2 Variance-Inflating Factor (VIF)
Variables Capital Productivity Size Risk ISO
VIF 1,145 1,019 1,033 1,049
Note: Dependent Variable ROA.
Our result on the ISO- variable indicates that, even though firms are willing to compromise with other attributes in orGHUWRLQFOXGHD´JUHHQµDWWULEXWHZKLFKLQWKLVFDVHLV,62-14001 certificate, they are not experiencing a significant effect on ROA.
Theoretically, the implementation of an ISO 14001 management system should give firms a competitive advantage. The increased market power should in turn yield larger profits. However, our statistical results do not indicate a positive effect on return on asset for the Swedish firms that adapted this management system. Neither can we conclude a negative effect on return on asset since this was not tested. To successfully product differentiate, there must be a market demand for the extra attribute. Our statistical results can be explained by the immature market demand for the environmental attribute that ISO 14001 is, that there is an increasing demand, but the ISO 14001 certificate has not reached to a sufficiently large market yet.
Bansal and Bogner (2002) highlights the importance of appreciating HDFK ILUP·V VSHFLILF situation and business structure. In order to entirely understand the implications of an ISO FHUWLILFDWH RQ D ILUP·V SURILWDELOLW\ each firm has to be analyzed separately. Accordingly, quantitative studies of the character in this thesis might not be the best approach, indicating that case studies and interview-based research will yield more accurate results (Bansal & Bogner, 2002). If their understanding is accurate, then it might help explain the insignificant results of our ISO variable.
The statistically insignificance of the ISO variable can also be due to the limitation of time that was applied in our thesis. Since we only included firms that had been certified up till 2008, the time to recover and recognize profit from the investment might not have been sufficient. The transformation from an ordinary management system to an EMS should be considered as any other capital investment (Bansal & Bogner, 2002). Firms must be given some time to start earning profits from its investment. We were also time restricted due to the data that was available in Amadeus, since the data that existed were lastly updated in year 2009.
The reason that the statistical and the theoretical results are not matching may also be explained by the insufficient statistical result. The case of omitted variables and an incorrect functional form is possible in our regression model, due to the existence of heteroscedasticity. As noted in the theory, firms operating in consumer markets experience a harder time in informing their consumers about their environmental activities (Reinhardt, 1998). The rejection of our hypothesis could be a consequence of not including advertisement as a control variable, and leading to a biased model. Or it could also be that the management system ISO 14001 is not well established on the market with a good reputation. To correct for the possible presence of omitted variables, other functional forms were tested. Different dependent variables and independent variables were tested but chosen to exclude in the final model. Some of the dependent variables that we reflected on were return on equity, enterprise value and operating revenue. These were excluded either due to missing data or insufficient support in the literature. Independent variables that we considered to include in the model were sales, debt to asset ratio, R&D and total asset. However these were excluded in the final model due to problems of multicollinearity or lack of data. Other financial accounts can be used to measure profitability, and other control variables should be tried. Also other indicators for environmental activities must be tested. Perhaps the ISO 14001 certificate is not well differentiated while other measures for the same activities are. To continue research with other variables is crucial when aiming to find the relation between environmental and financial performance.
Even though we reject the hypothesis and conclude that ISO 14001 does not effect return on asset positively, we do not conclude that the effect is a negative (since this is not tested for and therefore not proven). As discussed above, different aspects should be taken into consideration for the results we obtained, e.g. the time frame chosen for this paper, possibility of a biased model and the immature market for specifically the ISO -14001 certificate in Sweden. Although, as discussed in the second section of this paper, the demand is growing and might just be at the starting point. This results do not determine the effect between environmental and financial performance since the ISO 14001 certificate is only one, relatively small, indicator of all the environmental activities occurring in the whole world.
Neither the theoretical, nor the statistical results can be accepted or eliminated in this thesis. However, the theoretical argument that product differentiation only exists if there is a market demand for it, is more convincing in explaining the effects of environmental EHKDYLRU RQ ILUP·V ILQDQFLDO SHUIRUPDQFH 7KHRUHWLFDOO\ ILQGLQJ WKH WUDGHRII ZLOO \LHOG higher profits for firms, as an attribute is only added if there is a demand for it. However, the time it takes for consumers to recognize a preference of an added attribute might be a long process and can thus explain our statistical results.
6
Conclusion
This study aimed to examine the effect that the environmental management system (EMS) ISO 14001 has on financial performance, more specifically firms return on asset. We chose to concentrate on the Swedish manufacturing companies after investigating the ISO certificate and its distribution. This field of study was chosen due to the growing demand for certificates that shows firm responsibility towards the environment. The theoretical approach was based on product differentiation, which suggests a positive effect between the ISO 14001 certificate and ROA. Since, a firm that has obtained the certification has, theoretically, an competitive advantage on the market.
A cross-sectional regression analysis was carried out with a sample size of 3300 enterprises to test for the effect of ISO 14001 on return on asset. The results that we obtained LQGLFDWHGWKDW´Swedish manufacturing companies certified with ISO 14001 do not generate more profit WKDQFRPSDQLHVWKDWDUHQRWµ, thus we rejected our hypothesis.
The insignificant result of the ISO variable in our regression model could be an outcome of various factors. The empirical results of this thesis could be understood by the limitations of the data, since we were restricted to the data that was available in Amadeus, which was lastly updated in 2009. We also considered the theoretical framework and the time constrain for the ISO-14001 to be implemented in the firm and start earning from such a capital investment. The inconsistency of our theoretical and statistical results could be because the market demand for environmental certificate, specifically the ISO-14001, is growing, but has not become sufficiently large, and thus did not show a significant and positive effect on ROA.
Despite the outcome of the variable, we could not eliminate the possibility of a positive relation between firm responsibility towards the environment and their financial prosperity due to several reasons.
We can conclude that this study did not show that ISO 14001 had a significant effect on ROA of manufacturing firms in Sweden. But while drawing upon this conclusion also remembering the circumstances under which these statistical results were found and not excluding a possible positive relation between environmental and financial performance. Since the ISO-14001 certificate only represents a small part of all environmental activities, other measurement for environmental performance should be tested and also other variables.
6.1
Suggestion for Future Studies
Due to the time frame, limited resources and our specification, the following suggestions have been promoted for future research contribution:
- In this paper the results showed negative effect of ISO-14001 on ROA, but, a research with similar nature could be done, if adding other variables in the statistical framework. R&D and advertisement are recommended variables to use. Also, the size could be divided into sub-sections of numbers of employees.
- There is a risk that the studies made today are not considering the time it takes for firms to start earning profit from a capital investment, such as ISO 14001. Most of the studies conducted have shown a short period of companies financial performance. Long term perspective on this topic is necessary to analyze.
- This paper provides a comparison between companies by doing a cross sectional analysis. One suggestion is to conduct a time-series analysis on the effect of environmental behavior on financial performance.
- Most of the quantitative studies made on social responsibility are examining firms in the United State. Therefore, studies of other countries with different kind of features, such as size, government and economical circumstances would be interesting and necessary.
- There is a need of studies that explain the effect of certificates on firms financial performance. The studies that have been conducted have focused on investigating social and environmental responsibility in general. Since there are firms that work in line with the guidance of the certificates, without obtaining it, it could be interesting to study the effects on ROA (or other financial performance) between the different types of firms (as the demand for firms to attain certifications is increasing from consumers and stakeholders).
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Appendix
Appendix 1
Appendix
Appendix 2
Comparison between ISO 14001:1996 and ISO 14001:2004
Element Key Changes
4.1
General Requirements
¾ New requirements to:
x Document, implement and continually improve the EMS.
x Determine how the organization will fulfill the requirements of ISO 14001. x Define and document the scope of the EMS.
4.2
Environmental policy
¾ New requirement to define the Policy within the scope of the EMS.
¾ Limitation of compliance commitment to those legal and other requirements related to the
environmental aspects.
¾ Policy must be communicated to others working in support of the organization, as well as to
employees. Alternate forms of communication, such as guidance on specific sections of the Policy could be used to communicate with contractors and others.
4.3.1
Environmental aspects
¾ The aspects procedure must be implemented.
¾ The requirement to identify aspects is limited to those within the scope of the EMS.
¾ A new requirement to include planned or new developments and activities within the
as-pects process (formerly under 4.3.4).
¾ New requirement for documentation of the information from the aspects identification and
significance determination processes.
¾ Significant aspects are to be considered in establishing, implementing and maintaining the
EMS. 4.3.2
Legal and other requirements
¾ The procedures must be implemented.
¾ New requirement to determine the applicability of legal/other requirements to
environ-mental aspects.
¾ New requirement to consider environmental legal and other requirements in development,
implementation and maintenance of the full EMS 4.3.3
Objectives, targets and pro-gramme(s) (formerly Objectives and targets)
¾ Objectives and targets must be documented and implemented.
¾ Objectives and targets should be measurable
¾ Objectives and targets should be consistent with legal and other requirements.
¾ Objectives and targets should be consistent with the commitment to continual
improve-ment.
¾ Text from 1996 element 4.3.4 Environmental management programme(s) has been moved to this
element. 4.3.4
Environmental management
programme(s)
¾ The requirement to establish programs has been moved to 4.3.3 Objectives, targets and
programme(s)
¾ The final paragraph referencing new developments was moved to 4.3.1 Environmental
as-pects
4.4.1
Resources, roles, responsibility and authority
(Formerly Structure and re-sponsibility)
¾ New requirement that management provide resources for establishing, implementing,
main-taining and improving the EMS.
¾ Expands list of resources to include organizational infrastructure, as well as people,
tech-nology and dollars.
¾ Management representative should include recommendations for improvement when
re-porting to top management on the performance of the EMS.
4.4.2
Competence, training and
awareness
(Formerly Training, awareness and competence)
¾ Requirements apply to persons working in support of the organization, not just to
em-ployees. Contractors, volunteers etc. also must be competent to perform tasks associated with significant environmental impacts.
¾ 5HFRUGVRIWUDLQLQJRURWKHUDFWLRQPXVWEHNHSWWRGHPRQVWUDWHHYHU\RQH·VFRPSHWHQFH
¾ Specific requirement to identify training needs relevant to environmental aspects and the
EMS.
¾ Awareness procedure must be implemented.
4.4.3
Communication
¾ Procedure should be implemented.
¾ New requirement to decide whether or not to communicate externally about significant
as-pects and to implement the external communication, if the answer is yes.
4.4.4
Documentation
(Formerly Environmental man-agement system documenta-tion)
¾ New requirement for documentation to include:
x The environmental policy, objectives and targets, x Description of the scope of the EMS
x Descriptions of elements of the EMS including their interaction and references to re-lated documents,
x Documents, including records, required by the Standard, and
x Documents, including records, needed to manage processes associated with significant aspects
Appendix
Element Key Changes
ly Document control) mits) necessary to the EMS
4.4.6
Operational Control
¾ No significant changes. Addition of the requirement to implement the procedure.
¾ Subtle word change to communicate applicable procedures and requirements.
4.4.7
Emergency preparedness and response
¾ No significant changes. Addition of the requirement to implement the procedure
4.5.1
Monitoring and Measurement
¾ Change from recording information to track performance, which implies records of results
achieved or activities already performed, to documenting information to monitor performance, which has more immediacy
¾ Requirement that calibrated or verified equipment is used rather than that equipment shall be
cali-brated again implies immediacy.
¾ The requirement for periodic evaluation of compliance with environmental legislation and
regulations has been moved to the new element 4.5.2 4.5.2
Evaluation of compliance
(NEW ELEMENT)
¾ Evaluation of compliance now includes both applicable legal requirements and other
re-quirements to which an organization subscribes.
¾ New requirement to keep records of these evaluation(s).
4.5.3
Nonconformity, corrective ac-tion and preventive acac-tion
(Formerly 4.5.2 Nonconfor-mance and corrective and pre-ventive action)
¾ This element clearly states requirements for:
x Implementing the procedure
x Investigation and determination of the causes of nonconformance to avoid
recur-rence.
x Evaluation of the need for actions to prevent occurrence/recurrence
x Records of the results of corrective and/or preventive actions
x Review of the effectiveness of the actions taken
4.5.4
Control of records (formerly 4.5.3 Records)
¾ New requirement for records to demonstrate results achieved, e.g., results of corrective
ac-tion, programs to achieve objectives and targets etc.
¾ No longer specifies training records, audit results and reviews. Explicit requirements for
these records are incorporated into the appropriate element.
¾ Broader interpretation of records required, including records to demonstrate conformity
with the requirements of the EMS. 4.5.5
Internal audit
(Formerly 4.5.4 Environmental management system audit)
¾ New emphasis on planning the schedule, procedures, conduct, reporting and record
keep-ing for internal audits.
¾ New responsibility for retaining records associated with the audit.
¾ New responsibility for selecting auditors and conducting audits that ensure the objectivity
and impartiality of the audit process.
¾ Annex A references ISO 19011 guidance on auditing of EMS.
4.6
Management Review
¾ Specifies inputs to the management review process including:
x Results of internal audits and evaluations of compliance with legal and other
require-ments,
x Communication from external interested parties, including complaints,
x The environmental performance of the organization,
x The extent to which objectives and targets have been met,
x The status of preventive and corrective actions,
x Follow-up actions from previous management reviews,
x Changing circumstances including developments in legal and other requirements, and
x Recommendations for improvement.
¾ Specifies outputs of the management review including decisions and actions regarding
possible changes to: x The environmental policy x Objectives
x Targets
x Other elements of the EMS
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Appendix
Appendix 3
Quality competition: preconditions, types and consequences
