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The impact of environmental management on firm performance

Abstract

There is a long-standing debate on the impact of environmental performance on firm performance. Although previous studies have reported mixed results and gap of the important variable of environmental sustainability that we mean Corporate Social Responsibility (CSR). The prime objective of this study is to examine the impact of environmental management, environmental performance and corporate social responsibility on firm performance in Pakistani manufacturing and food firms. A survey methodology was employed involving a selected sample of information users, i.e., manufacturing and food industry. The study was designed to test the hypotheses which were developed to find out the strength of relationship among environmental management, environmental performance, corporate social responsibility and firm financial performance. The first three were independent variables and the last one was dependent variable.

Key words: Environmental Management, Performance and Financial Performance.

Introduction

Environmental Management is playing a crucial role in the financial performance of the firm. There are different views on this research. Many suggests that profitability is hurt by the higher production costs of environmental management initiatives, while others are of the views that it is not always accurate evidence. Previous studies show strong environmental management has improved future financial performance by stock market performance. The relationship to firm performance with respect to environmental management is tested and showed strong impact on each other. Individuals are now paying more attention on the importance of natural environment and willing to pay more for products that save the environment. Many national and international firms now a days publish separate annual environmental performance report, so the shareholders shows similar opinions for environmental management and safer products. These above factors enable the need for research into the relationship between environmental management and firm performance. Environmental management comprises of all important efforts to minimize the negative environmental impact of the firm’s products throughout their life cycle. Environmental performance measures that how a successful firm is taking crucial steps which are very necessary for a firm in reducing and minimizing environmental impact on products and relative industry. Many managers however view environmental management as compliance environmental regulations and economic performances (Walley 1994). Polluted air calls for environmental improvement and its impact increasing the operating cost and hurt profitability of the firm (Marlin 1972).

The nature of empirical relationship between environment performance with respect firm financial performance is important because by having a positive relationship between these improves the product efficiency and firm performance in terms of profitability. Consequently, we are going to conduct this research of relationship between environmental performance and their financial performance of Pakistani firms

Until only a few decades ago, many managers saw ‘environment’ and ‘enterprise’ as antagonistic terms. It was assumed that both environment protection measures and the regulation were hindrances to competitiveness because they required costly investments and the introduction of clean techniques, all of which made the enterprise's fixed costs grow. Some studies have been carried out with the purpose of changing this attitude.

However, the conclusions obtained have been very varied. On the one hand, we can find a group of research works that identified a positive relationship between these variables (Russo and Fouts, 1997; Sharma and Vredenburg, 1998). On the other hand, several studies showed a negative relationship between environmental activities and economic performance (Cordeiro and Sarkis, 1997; Thornton et al., 2003; Williams et al., 1993). In this context, the nature of the empirical relationship between environmental performance and firm financial performance is important.

The relationship between Corporate Social Responsibility and firm performance has evoked much interest among researchers. Some are of the opinion that CSR has no relation to firm financial performance and others have different view of this. Our study will come to know the actual relationship between the two after completion of research. We through our research will know the corporate social responsibility towards primary stakeholders influences the firm financial performance.

Corporate social responsibility is predominantly considered as a western phenomenon due to strong institutions, standards, systems which are not as much in developing countries so we want to know its influence in Pakistani context. Dimensions of corporate social responsibility include sustainability, pollution control measures taken by directors and top managers.

An environmental policy encompasses all efforts to minimize the negative environmental impact of the firm’s products throughout their life cycle. Environmental performance measures how successful a firm is in reducing and minimizing its impact on the environment.

Literature Review

Corporate Social Responsibility

The relation between corporate social responsibility (CSR) and firm performance has evoked much interest among researchers. Some studies reveal a positive relation between two constructs (Graves and waddock, 1994; griffen and Mahon, 1997). Some others indicate a negative relation (bromiley and Marcus, 1989; wright and ferris, 1997), and still others (Aupperle et al, 1985; teoh et al, 1999) establish no relation between two construct. Though a positive relation between CSR and firm performance has prevailed in many studies (Margolis and Walsh, 2003), results still remain inconclusive (Margolis and Walsh, 2003; Vogal, 2005). Such inconclusiness creates ground for further investigation.

Corporate social responsibility is predominantly considered as a western phenomenon due to strong institutions, standards and appeal systems which are weak in developing countries of Asia (Chapple and Moon, 2005). Such weak standards pose considerable challenge to firms for practicing CSR in developing countries of Asia including Pakistan. Though, extensive research on CSR’s influences on the firm performance has been carried out in developed countries (Bilal, 2001). There is dearth of such studies in Pakistan. Current research on CSR is mostly limited to self reported questionnaire surveys on CSR (Kirshna, 1992), and policies and practices of multinational corporations (MNCs) towards CSR (CREM, 2004) without linking it with firm performance. This study intends to fill that gap.

Recently, McWilliams and Siegel (2001) have argued that optimal level of investment in corporate social responsibility for a firm can be evaluated in the same way as any other investment by considering the marginal cost and benefits. Firms that do not invest in social responsibility will have lower cost and lower price, while those firms that focus on social characteristics to their product will incur higher cost, but their consumer will be willing to pay higher prices (Mcwilliams and Siegel, 2001).

There is long debate on the impact of environmental performance on firm performance. Some authors such as Porter (1995) porter and Vander Linde (2000) have argued that more stringent regulation can often provide a long run boost to firm profitability by forcing firms to focus on reducing production costs and increasing consumer satisfaction and sales. In other words, environmental investment may be a ‘Win- Win’ solution for society.

In this context, nature of empirical relationship between environmental performance and firm financial performance is important. Specifically, a finding of a positive relationship between the two variables could be interpreted as providing support for Win-win argument. The belief of win-win scholars (Porter and Vander linde) is that environmental improvement or protection can be in the interest of the firm as well as helping wider society. Researchers such as (hart, 1998) shrivastava (1999) and Karagozogluand Lindell (2000) have attempted to provide a theoretical basis for win-win perspective, arguing that stringent environmental regulations lead to more competition and stimulate innovation and efficiency. As a result, firms, through environmental improvements, can win by improving productivity and profitability and at the same time environmental resources can be protected.

The relation between CSR and firm performance are mostly inconclusive, but positive relations between the two have been reported in most of the studies (Margolis and walsh, 2003) suggesting an instrumental orientation of CSR initiatives. An instrumental orientation towards CSR suggests the alignment of the social goal with the business goal where CSR is considered as a strategic tool to promote the financial objective of the firm. Managers foresee the significant value additions in firm performance due to strengthened stakeholder relations. Management theorists argue that by improving CSR towards stakeholders, firm performance is augmented (wadock and Groves, 1997). Strategy literature highlights social responsibility including environmental management as an important function of board of directors (Arlow and Gannon, 1982). Cost of environmental management is minimal and generates other management benefits and increases productivity and efficiency by providing pollution free products is directly linked to the decisions and responsibilities of Corporate Social Responsibility team. Researchers have used different measures to operationalize the constructs of social responsibility, environmental performance and financial performance. The environmental reputation often used to assess social responsibility (Alexander, 1978). Poor social responsibility caused negative market reaction and reflected the negative impact on the future earnings (Jarrel and Peltzman, 1985).

Environmental Management and Firm Performance

Environmental management and policies exert great deal of influence in firm performance (Miles and Coven, 2000). Environmental management impacts in terms of pollution prevention, protection of natural environment, and waste minimization and recycling. Enterprises that supply clear and accurate environmental information on its products, services, and activities to customers, suppliers, local communities improve firm performance and market exposure in terms of profitability and number of shares.

Environmental management includes those policies and substantial positive programs such as the use and encouragement of recycling, alternative energy sources, waste reduction etc., which are of prime importance for controlling environmental hazards products. Environmental management indicates that business strategy must consider the environmental impact of manufacturing processes and products, environmental regulations, and initiatives undertaken in environmental management and technology, which is important for the sustainability of the firm. Environmental management, in turn, is one of the significant components of functional strategies, particularly operations of the firm. Environmental management effects environmental performance which directly is linked with profitability of the firm and market reputation. Relationship between environmental management and financial performance is viewed as a pattern of structural (Plant and Equipment) and infrastructure choices in keeping in mind the important factors like production planning, performance measurement and product design that guide decisions and operations to support overall firm’s performance (Wheelwright 1984). Environmental management affects both structural and infrastructural components as it involves choices of product and process technology and underlying the importance of management systems. The product technology includes the use of recycled raw material and efficient product system and control technology. Environmental management systems encompass programs such as continuous of monitoring any process discharges, worker training and environmental audits and environmental performance is therefore affected by all these choices. Environmental management provides total quality management (TQM) therefore total quality management is one of the most important dimensions of the environmental management (Klassen and McLaughlin 1993). Like quality, the long term goal of environmental management is to take step towards proactive instance keeping in mind the important factors of environment like entire manufacturing process, product design, marketing, product delivery and use, customer service and post consumer product disposition (Hunt and Auster 1990). Effective quality management is directly related to higher profits (Capon et al. 1990). Financial performance of the firm is affected by strong environmental performance through firm’s management decisions in revenue and cost. On the revenue side, customers are showing preferences for environmentally oriented products. Manufacturers who take efforts to minimize the negative environmental impacts of their products and processes, recycle post consumer waste, and establish environmental management system have greater chances to expand their markets then their competitors who fail to promote strong environmental performance. On the cost side, firms who are investing heavily in environmental management system and safeguards and prevention measures are in a position to avoid future environment crisis and liabilities. Costs result from market waste and inefficient processes should be minimized by effective environmental management (Schmidheiny 1992). The firms that move their operations to minimize the impact of their products on the environment are in better position to meet strong standards in future because environmental requirements are often based on best available technology and industry leader can competitive advantage by establishing environment prevention measures and delivering environment free products (Barrett 1992 and Karischner 1993).

Environmental Performance

Firm performance is our dependent variable. There is a wide literature on the appropriate measurement of performance and this literature has led to little consensus on the best approach to take. A key independent variable is firm environmental performance. One of the most commonly used measures of environmental performance (Spicer, 1998, Himalton, 1998 and Konar and Cohen 1997) is the pollution database of the Toxic Release Inventory (TRI) and the Council on Economic Priorities (CEPs). However, the use of firm’s pollution emission as an indicator of environmental performance has some flaws. Stanwick and Stanwick (1998) assert that the use of pollution emissions does not take into account the environmental performance of firms that are in low polluting industries.

Specifically, environmental performance appears to have different impact positive and negative depending upon type of industry. Environmental performance can vary from short term to long term. A long term orientation includes the integration of manufacturing, marketing and legal departments around environmental issues and measures to improve product and processed design (Hunt and Auster 1990). The important considerations of environmental issues includes product and process design lies in environmental responsibilities of senior level managers to monitor and improve environmental performance and participative programs with customers, government agencies and third parties to improve standards of products. Keeping view the environmental performance in mind, environmental award is given after an extensive examination of product design, process operation and management systems. Positive environmental performance leads to market gains and cost saving. Previous studies reflect that improved environmental performance leads to the improvement of market share gains, environmental product or process certification, higher product contribution margins, establish industry-wide standards for technology and management practices, reduced material and energy consumption, strong competitive positioning for lower costs, avoided costs, penalties and management time and greater productivity, which in turn improve financial performance of the firm. Environmental performance, determined by environmental management initiatives, affects the financial performance and market valuation of firm. More specifically, strong environmental performance positively affects the financial performance of the firm and conversely weak environmental performance has a negative effect. The financial markets may be expected to react differently to industries that historically are viewed as environmentally clean or dirty for example, indications of improved environmental performance for firms in dirty industries such as petroleum may be treated with skepticism, leading the financial markets initially to reward strong environmental performance only in clean industries. On the other hand, environmental compliance costs are much larger for environmentally dirty industries (Ullmann 1985). Strong environmental performance is increasingly valued by financial markets.

Methodology

A questionnaire survey was designed where respondents were asked to determine the level of importance of each variable used to impact the firm financial performance. Questionnaire consisted of likert type 4 and 5 scales were used to test statistically in order to fulfill the objectives of this research. An extensive review of the relevant literature was undertaken to form information potentially used by financial statements’ users. Moreover the dimensions of environmental management were assessed by using this scale. Target location included Karachi, Islamabad, Lahore and Peshawar, in which main manufacturing industries were targeted.

Hypothesis

This study aims to assess the impact of environmental management on firm financial performance. Moreover, the variable related to the environmental management improves the environment performance which in turn improves the firm financial performance. Furthermore, to enhance the firms’ financial performance, following hypothesis were developed and are tested.

1. CSR towards environment and Firm Performance

H1: The favorable CSR towards environment has positive impact on Firm Performance

2. Environment Management and Firm Performance

H2: Environment Management has strong impact on Firm Performance

3. Environmental Performance

H3: Environment Performance has positive impact on Firm Performance

Details of the Study

The purpose of this study was to test the designed hypothesis in order to find the above mentioned relationship by using statistical tools and running the collected data on SPSS software. This study measured the co relational impact of the independent variable on the dependent variable. Moreover, the study was done in the non-contrived type of setting in which the field study was done through questionnaire survey. The unit of analysis in this study was firms who were supposed to fill the questionnaire about environmental management and firm performance. The level of interference of the researchers was minimal as it was done in non-contrived setting.

Model of the study

After reviewing the literature work in detail and analyzing the previous model of the study, a new model was proposed to fill the gap of the previous studies. This model was then designed to depict the aims of the study in a precise way. The model consists of two independent variables which are environmental management and environmental performance and one dependent variable firm financial performance. We added one extra independent variable that is corporate social responsibility (CSR). The model attached here, clearly depicts the relationship of the variables and the purpose of the study. The final model is as follow:

Environmental

Management

Environmental

Performance

Corporate Social

Responsibility

Firm Financial

Performance

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