Testing the Relationship between Perceived Environmental Risk and Tangible Financial Loss

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A study by Vasi and King (2012) says social activism that increases perceived risk of environmental crisis can translate into real financial loss—to the tune of tens of millions.

Multinational corporate giants are not especially immune to the negative effects of perceived environmental risk. (See Finding the Smart Mobs Before they Find You).

Ion Bogdan Vasi and Brayden King, respectively from ISERP at Columbia University and the Kellogg School of Management, conducted a study linking social activism to perceptions of corporate environmental risk. They tested the delicate relationship between perceived risk and real financial loss, hypothesizing that the two are positively correlated.

It’s All in the Eye of the Beholder - Perceived Environmental Risk

Environmental risk is defined as the belief that a firm’s actions will increase the potential for environmental issue or crisis. Harm caused by poor waste management practices, for example, can be an organization’s environmental risk.

Perceived environmental risk, however, is the mere idea that a firm’s practices are environmentally damaging. If audiences believe the firm’s actions are harmful, this impression could negatively impact their bottom line.

This is especially relevant for the professional community. It is their perception alone that has the greatest impact on shareholder and investor relations, regardless of observable environmental differences. Perceived environmental risk does not measure how green a company is, nor does it measure the impact of a firm’s activities on the environment around them. Rather, it works on the level of public relations – how people think the firm engages with sustainability.

With this in mind, the authors sought to answer two important questions:

  1. To what extent does environmental activism directed towards a company affect its perceived environmental risk?
  2. To what degree does perceived environmental risk in turn affect financial performance?

 

Using a 5-year data set of the top 700 US firms from 2004 to 2008, two dependent variables were measured: a) analysts’ perceptions of a firm’s environmental risk; and b) the firm’s Tobin’s Q. Perceived risk was calculated using a rating system that accounted for firms’ past liabilities, operating risk, sustainability risk indicators and industry specific risk. Tobin’s Q represents the ratio of the company’s book to market values.

Inside Out: Activism from Within

Aside from these units of measurement, the researchers make a distinction between primary and secondary activism:

Primary activism is dissent by primary stakeholders who engage directly with the firm (such as employees, customers, etc.) Secondary activism involves momentum generated by external audiences and community members, usually through means of public objection like street protests and boycotts.

The researchers identify this internal, primary stakeholder activism as having the greatest influence on perceived environmental risk. The negative skewing of public image resulting from secondary activism was about half that of primary activism.

From the Looks to the Books: Impacts of Activism on Financial Performance

While primary activism resulted in greater negative perceptions of environmental risk, contrary to what the researchers hypothesized, there was no significant difference between primary and secondary stakeholder activism on financial loss. Regardless of the type of activism, the greater the perceived environmental risk, the more likely a firm is to suffer financially. The researchers found that, on average, for every standard deviation increase in risk, firms suffer a 2% decrease in financial performance. When we consider that even a 1% drop in market value could mean tens of millions of dollars in losses, the gravity of damage enacted by social activism in all its forms, becomes proof-of-concept.

In other words, the greater the perceived risk, the harder the financial fall.

Listen to Internal Warning Signals

Though primary and secondary activism in the short-term did not produce significantly different financial results, stakeholder pressures that increase perceived risk of environmental issues can send stronger warning signals to investors and shareholders. In the long-term, this may indeed financially hurt a company more than activism coming from outside the firm.

Companies will do well to listen to inner turmoil. Responding to shareholder pressures and controlling issues from within will be essential to staying competitive. Social activism is a strong, present and growing movement. Your firm can steer clear of financial agony by practicing good corporate citizenship, promoting environmental cognizance, and responding vigilantly to consumer, shareholder, and employee concerns.

Source

Vasi, I., and King, B. 2012. "Social Movements, Risk Perceptions, and Economic Outcomes: The Effect of Primary and Secondary Stakeholder Activism on Firms’ Perceived Environmental Risk and Financial Performance." American Sociological Review. 77.4: 573-596.