Hitting the violators where it hurts? Stock market reaction to USEPA press releases

Hitting the violators where it hurts? Stock market reaction to USEPA press releases Elisabeth Newcomb Sinha University of Maryland LucijaMuehlenbachs Resources for the Future Nitish Ranjan Sinha University of Illinois at Chicago Camp Resources August 7, 2012

Why consider EPA press releases? • Information disclosure allows markets to react to enforcement actions and provides a potential mechanism for deterrence • Toxics Release Inventory results in negative returns (Hamilton 1995; Khanna et al. 1998; Konar and Cohen 1997, 2001) • Effects of environmental disclosures more ambiguous (Muoghalu et al. 1990; Klassen and McLaughlin 1996; Bosch et al. 1998; Dasgupta et al. 2001) • Advantages of press releases • EPA has an active newsroom • Press releases are not limited by media or TRI coverage • EPA controls content and timing

EPA’s choice of words • EPA chooses the ‘tone’ of the press release: • “The company cooperated with EPA’s inspection, and promptly filed the reports after being notified of the alleged violations.” Effect of these ‘soft’ enforcement tools is not easily quantified without text analysis

Supplemental Environmental Projects “In addition, ExxonMobil has agreed to spend $2.2 million on environmental projects near the Joliet refinery including $1 million to expand and restore the Midewin Tall Grass Prairie; $100,000 on emergency response equipment for Will County; $800,000 for the Joliet Heater Control Project; and $250,000 towards retrofitting diesel engines in Joliet city vehicles with lower-emissions technology.”

Stock price and EPA press releases • What happens when the EPA announces an enforcement action? • Stock prices fall 1.31% during that week • What happens if the EPA uses more negative words in the press release? • Stock prices fall (after controlling for fine amount) • Does it matter if fines are paid directly to the EPA or earmarked for special projects? • Stock prices rise when settlements include a Supplemental Environmental Project

Examples of press release headlines Our data includes 21,493 EPA press releases published online between 1994-2009. Of these, 525 are about enforcement actions, and mentioned between one and three publicly traded companies.

Extracting information from press releases: four data challenges • Identify the subject • Is it about enforcement actions? • Identify publicly traded companies • Nomenclature is not consistent across press releases (no tickers); companies also merge, change names over time • Identify the sentiment (tone) • Is the language negative? • Identify the dollar amount of fines We use text analysis and a free online entity-extraction service, OpenCalais

Measuring press release content: naïve Bayesian classification

Identifying companies in press releases

Identifying companies: Open Calais Output

Open Calais Output We match the companies to financial data from CRSP.

Calculating the sentiment of a press release • We use the Notre Dame dictionary (Loughran and McDonald 2011) of negative words. • We count the number of occurrences of negative words in each press release, and divide by the word count to get a percentage of negative words. • Enforcement press releases have 3.6% negative words

Identifying the fine amounts • We searched all enforcement action press releases for a dollar sign ($) • We then manually entered the dollar amounts from these press releases: • There were 232 press releases with fine amounts (paid to EPA). Mean fine: $4.3 million • There were 71 press releases with Supplemental Environmental Projects (SEPs). Mean SEP: $5.3 million

Event study: what happens when EPA issues a press release? • Match press releases to financial data • Outcome variable is excess returns: percent change in stock price adjusted for market return • Examine trading volume and prices in the days surrounding the press release • Information leakage • Market reaction to information disclosure

What day does the EPA’s information arrive in the market?

Industry-Adjustment and Value-Weighting • Value-weighted: larger companies count more • Industry-adjusted: subtract value-weighted returns for rest of industry

Cumulative excess returns, press release issued on Day 0 Value-weighted and industry-adjusted returns. Based on 525 press releases.

Effect of sentiment on a representative firm’s returns Total fine is the sum of fines paid to the EPA and SEPs. It is not significantly different from zero. Net effect is -0.12% on Day 0, -0.51% for the week. Negative Sentiment is the fraction of negative words in the press release.

Effect of fine and SEP amounts on a representative firm Summary of effects of $4.3 million fine and $5.3 million SEP . Fine amounts are not significantly different than zero.

Conclusion • EPA press releases about enforcement actions can have a large effect on stock returns over a week (-1.31%) • How the EPA describes its enforcement can be more important than the amount of the fine.

Hitting the violators where it hurts? Stock market reaction to USEPA press releases