Conventional wisdom argues that when firms violate environmental rules, customers and suppliers who value environmental amenities will punish the polluters through the marketplace. Some customers, for example, will stop doing business with polluters, while potential employees may refuse to work for them, and suppliers may even decline to sell their goods to them. Hence, it is argued, polluters will face lower revenues and higher costs. The resulting lower profits are called a "reputational penalty." For a publicly owned polluter, any such reputational penalty should be manifest in a lower share price for the company's stock (Klein and Leffler 1981).
To determine whether firms suff er reputational penalties when they violate environmental laws and regulations, Karpoff et al. examined the consequences of 478 environmental violations by publicly traded companies for the years 1980 to 2000. They found that although the companies' share prices dropped measurably (about 1.5 to 2 percent) when the companies were charged with such violations, all of this decline is attributable to the direct legal penalties and the remediation and compliance costs imposed on them by regulators. Because the firms' stock prices did not fall in excess of the legal penalties, the researchers concluded that the firms' reputations were unsullied. . . .