Revisiting the relationship between financial and environmental performance: Does Granger causality matter?

Abstract

This study rigorously investigates two ongoing issues about the relationship between environmental performance and financial performance: its sign (negative or positive) and direction of causation. The results from the longitudinal sample of US heavy-polluting industries between 1991 and 2005 support the positive relationship between EP and FP. We also test the Granger causal relationship by applying Arellano-Bond estimator. The results present that the causal direction is contingent on the selection of financial performance measures and on the characteristics of sub-groups classified by environmental performance. Namely, we find that the causality is valid only in high pollution-intensive industry group in terms of the one-year lagged accounting-based FP. A weak reverse direction was found only in the pollution-intensive industry group with Tobin’s q. The findings clearly suggest that it is necessary to use a consistent estimator when examining causality with longitudinal data in a dynamic setting.