China's haze hits market

As China’s air pollution levels hit hazardous new highs, the University of Melbourne Accounting Department’s Naomi Soderstrom joined forces with researchers in Australia and China to investigate the economic impact of environmental regulations.

A recent study, by the University of Melbourne’s Professor of Accounting Naomi Soderstrom, the University of New South Wales’ Chao Kevin Li and Xiamen University’s Jin-hui Luo, examined the stock market reaction to a December 2013 haze event, when the Chinese air quality index crossed the threshold from ‘very unhealthy’ to ‘hazardous’ for the first time.

The research team wanted to see how the local stock market viewed the event given it was caused by an unlucky combination of weather and normal industrial and commercial activity, as opposed to the actions of a single company.

“This was an event where you couldn’t punish a single company, so the only real response would be increased regulation,” Prof Soderstrom says.

She says that in the days after the 2013 haze event, the market seemed to expect that state owned companies or those from high polluting industries, as well as those providing corporate social responsibility reports, would be shielded from higher regulatory costs.

Man cycling bike through Beijing haze
Man cycles through Beijing's haze

She says this expectation seems to reflect the Chinese government’s historical position of valuing industrial activities over environmental concerns. But, as national and international pressure grew, the market valuation of firms in these industries fell further than for firms in less environmentally-exposed industries.

"Although regulatory enforcement has been somewhat problematic in China historically, our research found that in the end, the market anticipated that regulations were going to be enforced," she says.

Consistent with market expectations, five months after the haze event, the Chinese government passed its most comprehensive changes to its environmental protection laws in 25 years. The changes included increased fines on polluters and potential jail time for executives who failed to adhere to environmental regulations.

Prof Soderstrom says a similar revision in market expectations occurred for firms located closer to Beijing, which were also initially expected to be shielded from increased regulatory costs before the expectation reversed over time.

Our study underscores the existence of material impacts on firms related to environmental events that are beyond their control. Prof Naomi Soderstrom

With a paper based on the study - ‘Market Response to Expected Regulatory Costs Related to Haze’ - to appear in the Journal of Accounting and Public Policy later this year, Prof Soderstrom says interest in environmental issues within accountancy is growing.

“Typically, sustainability issues were seen as an externality,” she says.

“But with the rise of climate change, we are seeing these issues being increasingly internalized and viewed as important by many different types of stakeholders.

“The fact that this paper is to appear in a mainstream accounting journal’s special issue on sustainability is further evidence of that.”

Find out more about the project and about Prof Soderstrom's research.