This dissertation consists of three chapters centered on the topic of sustainable finance. Sustainable finance is broadly defined as the process of taking into account environmental, social, and governance considerations when making investment decisions. This work explores the interplay between environmental regulations and firm pollution, and their impact on mutual funds' portfolio choices, corporate philanthropy, and shareholder wealth.
The first chapter, "Environmental regulatory risks, firm pollution, and mutual funds' portfolio choices", examines how mutual funds' portfolio holdings respond to environmental regulations. Using county-level ozone nonattainment designations induced by discrete policy changes in the National Ambient Air Quality Standards as a source of exogenous variation in local regulatory stringency, we find that funds underweight (overweight) those polluting stocks whose cash flows covary negatively (positively) with the regulatory shock. Our results are consistent with active portfolio rebalancing in response to expected changes in firm fundamentals due to negative cash flow shocks stemming from the costs of nonattainment regulation. Further analyses in the post-nonattainment period show that stocks with high exposure to nonattainment designations exhibit worse operating performance and increased regulatory compliance costs. The most underweighted of such firms also exhibit worse abnormal stock return performance. Funds that reduce their portfolio exposure to nonattainment designations see an improvement in their investment performance.
In the second chapter, "Every emission you create--every dollar you'll donate: The effect of regulation-induced pollution on corporate philanthropy" (with Seungho Choi and Raphael Jonghyeon Park), we investigate the insurance-motives of polluting firms' charitable giving by analyzing donations from philanthropic foundations to nonprofit organizations in the local community. Our empirical setting exploits the National Ambient Air Quality Standards as localized exogenous shocks to pollution. Using regression discontinuity, we find that firms with more pollution subsequently donate more to local nonprofits. Firms maximize the insurance value of donations by reallocating donations to areas where they pollute the most. Potential mechanisms include firms' local media coverage, reputational risk exposure, and history of regulatory noncompliance. Welfare analysis indicates that firms underpay for the insurance value of corporate philanthropy at the cost of society. Overall, the evidence suggests that firms leverage their reputation in local communities through corporate philanthropy as a form of insurance.
The third chapter, "Environmental regulation, pollution, and shareholder wealth" (with Seungho Choi and Raphael Jonghyeon Park), examines how stock markets react to changes in environmental regulation and firm pollution. Using a similar empirical setting from Chapter 1, we exploit county-level ozone nonattainment designations induced by discrete policy changes in air quality standards as part of the Clean Air Act. On the extensive margin of pollution, investors react positively to ozone-emitting firms impacted by nonattainment designations. However, in the cross-section, heavy ozone-polluting multi-plant firms experience less favorable stock price reactions. In contrast, during attainment redesignations, the overall stock market reaction is negative on the extensive margin of pollution, but investors revise upwards the valuation of heavy ozone-polluting multi-plant firms. Our results suggest that the stock market internalizes the perceived benefits and costs of local environmental regulation. Further analysis of the underlying market forces reveals that while nonattainment designations benefit incumbent firms by decreasing competition and improving environmental performance, they also impose additional compliance costs.
