Haas School of Business, UC Berkeley, USA

Environmental regulatory risks, firm pollution, and mutual funds' portfolio choices

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Abstract

This paper examines how mutual funds' portfolio holdings respond to environmental regulations. Using county-level ozone nonattainment status as a source of exogenous variation in environmental regulation, we find that funds underweight heavy ozone-polluting stocks exposed to nonattainment designations, which is further reinforced when there is an increase in regulation intensity. An ease in regulation due to attainment redesignations leads to an overweighting of such stocks. Our results are consistent with funds hedging against environmental regulatory risks, based on expected changes in firm fundamentals due to regulatory costs, by underweighting those polluting stocks whose performance covaries negatively with the regulatory shock. Further analysis shows that heavy ozone-polluting firms exposed to nonattainment designations experience worse profitability. The most underweighted of such firms also exhibit worse abnormal stock return performance, with no signs of return reversals, and are subject to more regulatory enforcement. Such underweighting translates into better fund portfolio performance.

Biography

Simon is a Finance Ph.D. candidate at the Haas School of Business, UC Berkeley. His research interests include sustainable finance and corporate social responsibility. His current projects focus on the interplay between environmental regulations and firm pollution, and their impact on mutual funds’ portfolio choices, shareholder wealth, and corporate philanthropy. His Pre-Ph.D. research has been published in journals such as the Review of Finance, Journal of Financial Markets, Journal of Empirical Finance, Quantitative Finance, and European Journal of Operational Research.