When are Environmental Certifications Bad for Business?

Managers and executives from all industries are now considering whether environmental certifications are right for their business given that many companies believe customers will pay more for certified products and services because of the positive signal these certifications send. But how does the financial market react to it? New research suggests the adoption of industry-led certifications present no financial incentive in the short term and can actually harm financial performance in the long run.

Certifications generally have two key components: a set of rules, principles or standards and a monitoring or verification mechanism. They are often used by firms to signal that their products or services abide by a set of regulations set forth by a third party. Popular examples of certifications include the FSC for forestry, LEED for building design and ISO14001 for general environmental management.

Should firms undertake certification? If so, which certification? The decision is complex because: 1. A firm can implement any number of standards for different aspects of their business (e.g. FSC paper products, LEED offices, ISO14001 factories); 2. The impact a designation carries depends in large part on the granting agency a. While industry-led certifications was observed to be linked with negative financial performance in the long run, b. NGO-led certifications don’t affect financial performance in the short term

Why don’t certifications pay off? This may occur because customers aren’t willing to pay more for certified products or services, or because certifications can be onerous to administer. Moreover, when used as a tool to rebuild legitimacy, industry-led certifications may not be powerful enough to overcome a tarnished reputation.

Taking an example from the forestry industry, research has shown firms that have adopted an industry-led environmental certification have experienced a return of -11.02 percent and -16.14 percent, respectively, 24 months and 36 months after certification.

Evidently, the decision is not easy. When faced with the question of whether or not to adopt a certification, managers and executives should employ a cost-benefit analysis to carefully answer two questions: 1. Should we invest in a certification at all? 2. If so, which certification should we invest in? The anticipated costs may initially outweigh the benefits, but the long-term impact needs to be considered. Will demand for certified products/services increase over time? Will more distributors and companies request certified products from their suppliers? Conversely, some firms adopt certifications purely for ethical reasons or to respond to their stakeholders’ expectations. Future research in this area may want to consider whether environmental certifications impact environmental performance and whether certifications are priced by other forces.

Summarized by

Elisa Alt (University of Seville) and the NBS team

Antia, Murad, Christos Pantzalis and Jung Chul Park. (2010).CEO decision horizon and firm performance: An empirical investigation. Journal of Corporate Finance, 16: 288–301.