Which environmental measures matter more to real estate firm’s financial performance? : a case in Hong Kong

Abstract

This study aims to investigate the relationship between environmental performance (EP) and financial performance (FP) of real estate firms in Hong Kong, with a focus on comparing the two most adopted environmental measures, namely 1) GHG intensity and 2) environmental score from ESG rating agencies (E score). To my knowledge, it is the first study to compare GHG intensity which is a more straight-forward EP measure that reflects current EP, with the E score which is a more comprehensive EP measure that reflects both current and future EP in the literature that studies the EP-FP relation in the real estate industry. The comparison is important because a firm’s FP –either accounting-based (return on assets and cost of debt) or market-based (Tobin’s Q) – could be sensitive to the choice of EP measures. To investigate the above relationship, regression analyses using data from 20 real estate firms that are listed in the Hong Kong Stock Exchange market over the period 2011-2021 are conducted. It is first found that while the return on assets of real estate firms is boosted by better EP, in other words, lower GHG intensity or higher E score, it is more sensitive to GHG intensity than the E score. When the EP measures adopted are lagged by one year, both show no significant relation with return on assets. These results suggest that the return on assets, as a measure of a firm’s profitability in the current year, is largely affected by the current EP as reflected in the current level of GHG intensity and E score. Second, it is found that when real estate firms’ GHG intensity is lower, their cost of debt is also lower. However, the cost of debt of real estate firms shows no relation with the E score. When the EP measures are lagged by one year, lower GHG intensity would also lower the cost of debt for the next year, while a higher E score surprisingly increases the cost of debt. One potential reason for the surprising result is that a higher E score means more commitments for future EP, and therefore real estate firms are borrowing more capital (which incurs higher interest rates) the next year to support the achievement of the commitments (e.g. meeting emission targets). Third, Tobin’s Q which equals the firm’s market capitalization divided by total assets, is largely determined by the securities parties who make investment decisions based on the firm’s past, current and future performance on various aspects including EP. It is found that Tobin’s Q of real estate firms are positively related to their E score but is not correlated with the level of GHG intensity. The same conclusion is found when the EP measures are lagged by one year. In general, the results suggest that the accounting-based FP is more sensitive to GHG intensity while the market-based FP is more sensitive to the E score. The results lead to several implications for real estate firms in Hong Kong. Firstly, they should focus on reducing GHG intensity instead of boosting the E score to enjoy a lower cost of debt from the lenders. Moreover, lower GHG intensity being more sensitive to improving return on assets does not necessarily mean real estate firms should put more resources into the reduction of GHG intensity. They should also consider the expenses of improving the GHG intensity and compared them to that of improving the E score, to determine the most cost-effective way to enhance the return of assets. On the other hand, if the real estate firms concern about the market valuation as depicted by Tobin’s Q, they should concentrate on ESG reporting to increase the E score for potential future opportunities on financial return.