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Firms’ Environmental Ratings Reduce Analyst Coverage, UC Davis Study Finds

By Julia Ann Easley on October 29, 2018 in Science & Technology

As investors and creditors demand to know about the environmental performance of firms, the cost of processing that information is leading analysts to cover fewer firms and affecting their earnings revisions.

That’s among the major findings of new study from the University of California, Davis.

Paul Griffin, lead author and a professor at the university’s Graduate School of Management, said the higher the costs, the less information and less timely information analysts provide. And that means it takes longer for capital markets to reflect earnings announcements and discover the right price of stocks.

“These results have implications for firm managers considering voluntary environmental disclosures and for investors deciding on what stocks to include in socially responsible portfolios,” Griffin said.

The higher costs come mainly from the time analysts spend trying to understand the environmental performance of each firm in their portfolio through environmental ratings or indicators such as the use of renewable energy and the liability for hazardous waste.

Effects on portfolios and revisions

Griffin, an international authority in accounting, financial information and disclosures, conducted the study with Thaddeus Neururer of the University of Akron and Estelle Yuan Sun of Boston University.

They found that as the number of environmental performance ratings for firms in their portfolio increases, analysts cover fewer firms and provide fewer and less timely revisions for earnings-per-share forecasts. 

The average number of firms in their portfolios dropped 14.2 percent or 1.1 firms. Revisions to earnings-per-share forecasts decreased 3.2 percent, and those issued within two days of quarterly earnings reports were down 1.4 percent.

The effects are greater for negative environmental concerns than for environmental strengths, Griffin said.

Standardization could help

Among the factors contributing to higher costs, Griffin said, is the lack of a common reporting framework as well as little consistency in the definitions and principles used for the environmental performance information that analysts go through.

Standardization could bring costs down. Griffin said he would then expect analysts to evaluate more firms, and market prices would be more efficient because the firms would be covered more often. 

Interestingly, the research found that the management fees that investors pay for green mutual funds were 34 basis points higher than those for otherwise identical nongreen funds.

The study, which covered the period from 1996 to 2014, found higher costs since 2005.

The researchers used up to 28 environmental strength and concern ratings from KLD Research and Analytics, which are used in developing environmental mutual funds.

Environmental performance and analyst information processing costs” appears in the Journal of Corporate Finance.

Within the last year, Griffin has also published research articles on the disclosure of climate risk by fossil fuel firms, how credit rating agencies respond to risk from research and development investment, and the relationship between voluntary corporate social responsibility disclosure and religion.

Media contact(s)

Paul Griffin, Graduate School of Management, cell 530-219-1176, pagriffin@ucdavis.edu

Julia Ann Easley, News and Media Relations, 530-752-8248, cell 530-219-4545, jaeasley@ucdavis.edu

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