The investment patterns of capital markets shape future development and, thus, consequential environmental pressures, it is vital to reform capital market processes to promote environmentally sustainable, long-term investment. These reforms may be a h ...
The investment patterns of capital markets shape future development and, thus, consequential environmental pressures, it is vital to reform capital market processes to promote environmentally sustainable, long-term investment. These reforms may be a highly efficient and effective means for deterring unsustainable development, which could result in enterprises, whose activities meet requirements of sustainability, being valued more highly by markets. There is uncertainty, however, regarding the viability of harnessing investment systems to promote sustainable development, and some research suggests that environmentally responsible investment may yield a lower financial return or that institutional investors may lack sufficient incentives and means to influence corporate environmental behavior. Conversely, there are indications that markets are increasingly interested in information regarding businesses' environmental activities as evidenced by the movement for ethical investment.
In recent days, there has been a flood of institutional savings as people make private provisions for old age in the face of declining state welfare entitlements. Therefore institutional investors increasingly dominate capital markets. Since sustainable development emphasizes maintenance of natural and human capital for future generations, the role of capital markets is plausibly of central underlying relevance to sustainability strategies. Although there is obviously a difference between financial capital and the broader notion of capital in sustainable development, financial capital is relevant, since it enables major investments to occur, such as technological and product innovations, which invariably have environmental effects of some kind. The institutional and policy frameworks of capital investment systems are crucial to the building of sustainable productive capacities.
Information regarding corporate environmental performance is emerging as a salient factor in investment calculations. When new information about a company's increased future production costs or reduced revenues arise from environmental regulation changes, investors may revise their expectations. A shift in market values may create strong incentives for investment in environmental care since losses of market value, the "reputational penalty," may be larger than concomitant regulatory sanctions. Changes in share values may, thus, reflect estimates of changes in the net present value of expected profits. Evidence of good environmental performance may indicate to capital markets a superior ability to generate costs savings and improve revenues, whilst evidence of pollution violations and prosecution may result in markets down-grading a profits forecast.
Existing research suggests that environmental liabilities are regarded as more salient to market valuations than "beyond compliance" efforts. Company environmental policies and procedures also tend to be less useful to financial analysts than environmental information translated in terms of its impact on firm earnings and profitability. Current research suggests a correlation between sound environmental practices and improved market value. Investors infer that because of poor environmental performance a culpable firm will incur various costs that will diminish its profitability. The increased price of capital, thus, provides a mechanism for articulating the social and environmental costs of corporate risk-generating behavior. Nevertheless, despite more investor awareness of the salience of environmental performance to market valuation, no model has yet been formulated that systematically charts the relationship between corporate environmental practices and market value. The role of institutional investors will be crucial to the future response of capital markets to environmental performance.