More Benefits for Green Companies, by Francesca Di Meglio, August 17, 2008

B-school researchers find green companies have lower cost of capital.

New research from the University of Oklahoma's Price College of Business shows that for companies being green might not be easy, but it can pay by lowering their cost of capital.

Mark P. Sharfman, professor of strategic management, and Chitru Fernando, the Michael F. Price Professor of Finance at Price and a visiting professor at Southern Methodist University's Cox School of Business, teamed up to study market reaction to green initiatives at 267 S&P 500 companies. They suggest that investors factor in improved management of environmental risks when evaluating companies, resulting in lower risk premiums on equity and higher levels of leverage for the firms, lowering the companies' overall cost of capital.
Favorable Press Coverage

Often, companies look internally to see the benefits of their efforts to help the environment—such as becoming more efficient users of resources. But the professors found that financial markets, particularly equity markets, also reward green efforts. These green firms tend to have higher costs of debt, but that's partly because they are permitted to carry more debt, which reduces tax burdens, according to the research. "Such increased amounts of debt also should allow firms to 'leverage' up their return on equity," according to a brief the researchers wrote about their work, which appeared in its entirety in the Strategic Management Journal in June.

In addition, when a company improved its environmental performance, it attracted a higher level of ownership among individual investors, which lowered the cost of its equity capital. As a result, stocks of these companies are high performers and investors see them as less risky investments because going green often means reducing government penalties, the number of possible accidents, and therefore the threat of lawsuits. "It's pretty clear to anyone looking at the research that if [firms] lower environmental risks, they'll be able to raise equity capital more cheaply," says Fernando. "Obviously if cost of capital goes down, it's a great benefit."

The researchers also say that there is evidence that companies also benefit from the good press they receive for their green efforts, but they have not yet confirmed this with a study. They are, however, replicating the study they conducted in the U.S. by looking at about 950 companies worldwide to see if green efforts get the same kind of reaction from markets abroad. Also, the duo will look at market reaction to companies that are specifically addressing climate change.

They say their purpose is a practical one. "We've broadened the ability of firms to make an argument for environmental efforts," says Sharfman. (Credit: BusinessWeek)