Effects of harmful environmental events on reputations of firms

Abstract

Many previous event studies have found unexpectedly large losses to firms involved in negative incidents. Many of these studies' authors explain such losses as "goodwill losses" or "reputation effects." To test this hypothesis, we search for residual losses (in excess of direct costs) to firms involved in events which produce ill will, but do not affect the quality of their final products nor break implicit labor or supply contracts. We find an overall insignificant capital market response to a sample of 98 negative environmental events (representing all such incidents reported in the Wall Street Journal between 1970 and 1992 in which electric power companies or oil firms with listed stocks were involved). Although others have found similar outcomes for more limited samples, our results enhance previous research by extending similar findings to a broader range of environmental incidents over a longer time period. Further, our findings suggest that the large residual losses of other studies may be due to reputation (and not measurement errors or event study idiosyncrasies), but only when the notion of "reputation effects" is limited to punishment solely by those who are directly harmed by the firms' conduct.

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