Exploring the Association between Environmental Cost and Corporate Financial Performance: A Study of Selected NIFTY Companies

Abstract

Purpose: The environment is assuming an important socio-economic and political issue all over the world. The world is facing the dilemma of promoting economic development and, at the same time, protecting the environment. At this juncture, proper accounting of the environmental impact on economic development is a pre-requisite to sustainable development. This study mainly endeavours to confirm whether there is any important connection
between environmental cost incurred by the company and its profit earning ability.

Methodology: This research relies on secondary data collected from different web sources and annual reports of companies covering a period of 5 years i.e. from 2010-11 to 2014-15. In order to achieve the objective of the study, to find out the impact of environmental expenditure on the financial performance of the selected companies (NTPC, NHPC, Hindalco, TATA Steel and NMDC), the data has been collected for the dependent variable i.e. environmental cost (EC) and independent variables i.e. EPS, ROCE and P/E ratio (being good indicators of financial performance). Environmental cost has been directly sourced from the annual reports of the respective companies; the data for the independent variables and control variables has been obtained from the companies’ and database websites. The analysis incorporates firm size (in terms of market capitalization) and price-to-book value ratio as the control variables.

Findings and Conclusion: Based upon the sample data and its analysis using regression analysis, it has been found that there is no significant relationship between environmental expenditure of the company and its financial performance. Besides, it has also been found that companies with higher market capitalization are spending more on environmental issues.

Practical implications: It is evident from the findings that environmental expenditure has no significant impact on profit earning ability of companies. Thus, companies are not motivated to incur environmental expenditure. To encourage companies to spend on conservation of the environment, the government may consider providing some tariff concessions or tax benefits to companies which are conscious about the environment.

JEL: Q01, Q51, Q56 & Q58

Introduction

In the era when sustainability is a key issue globally, the performance of a corporate entity cannot be judged only on financial standards; other parameters include social and environmental impact of its operations. ‘Environmental issues have become a significant variable in the models used by the investors and creditors to determine the risk associated with their investment’ (Gupta). (Environmental Accounting Guidelines, 2005) mentions environmental accounting as a procedure that allows a company to identify the cost of environmental conservation during the normal course of business, identify benefits gained from such activities, provide the best possible means of quantitative measurement (in monetary value or physical units) and support the communication of its results. EA is a broad-based term that refers to the incorporation of environmental costs and information
into accounting practices. Naturally environmental accounting system includes both national and business accounting, and deals with both financial and
non-financial information (Schaltegger, 1997).

Accounting for the environment helps in accurate assessment of costs and benefits of environmental preservation measures of companies (Schaltegger,
2000). Environmental Accounting facilitates costs and benefits analysis of a project on environmental issues which guides managers in decision making and striking a balance between ecology and economy (Kumar & Pandey, 2015). It provides a common framework for organizations to identify and account for past, present and future environmental costs to support managerial decision-making, control and public disclosure (KPMG & UNEP, 2006). Ecological cost accounting directly locates a cost on every ecological facet and determines the cost of the associated action. Environmental activities include contamination prevention, ecological visualization and administration (Yakhou & Dorweiler, 2004).

Ecological costs comprise of both interior and exterior costs, and relate to all costs of relative environmental impairment and defence. Environmental defence costs encompass costs for prevention, disposal, designing, command, moving actions and impairment repair that can happen at companies and sway authorities or persons (UN 2001). (Pramanik, 2002) states that companies have divided environmental costs into six broad categories – capital investment, operating cost, research and development cost, environment administration and planning costs, expenses for remediation measures and recovery expenses.

The IFAC, 2005 categorizes environmental related charges into four kinds as follows:

  1. Environmental activity type costs such as waste prevention and control.
  2. Costs that represent traditional accounting such as labour and materials.
  3. Environmental domain type costs such as land, air or water.
  4. Costs which reflect data visibility in the accounting records such as hidden and obvious costs.

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