The potential for increased profits via cost-reducing Energy Management Projects (EMPs) exists in nearly all firms. However, when allocating capital, priority is often given to revenue-enhancing projects, such as starting new product lines or joint ventures. Frequently, these projects are perceived to be superior to EMPs, even though they may yield the same increased profit and present value. A justification is that revenue-enhancing projects are more likely to attract publicity and investor attention. Investor speculation and reaction to announcements can increase the firm’s stock price. Most EMPs do not generate as much publicity as joint ventures or new product lines.
If “publicity-gaining” potential is a decision factor during project selection, then a new product line or joint venture would usually be selected over an EMP. But is this a fair comparison? There has not been any research to determine if an EMP announcement increases a firm’s stock price. In theory, it should because most EMPs increase profits (via cost reduction instead of increased revenues). From a cash flow perspective, an EMP is equivalent to any other profit-enhancing project.
This paper seeks to determine whether an EMP announcement correlates with an abnormal increase in a firm’s stock price. If such announcements positively impact stock price, then the firm has one more incentive to implement EMPs.
LITERATURE REVIEW The purpose of this literature review is three-fold:
1. To demonstrate that EMPs are credible investments, with relatively low risk; 2. To present some background on stock price reaction to announcements of typical capital investments; and 3. To show that abnormal increases in stock prices from EMP announcements have not been measured.
Public announcements (such as mergers, joint ventures or new product lines) correlate with abnormal stock price returns. , When a firm announces a joint venture (or other revenue-enhancing project) it is trying to attract publicity, which can raise the stock price based on expected future profits. However, since such projects can also be unprofitable, the anticipated cash flows are at risk.
When firms implement EMPs, they also expect improved profits by becoming more cost-competitive. EMPs and equipment replacement projects usually have more predictable cash flows (less risk) than many other types of capital investments, especially new product lines or joint ventures. Today, the risk from most EMPs is so low there are many third party lenders who are eager to locate and finance EMPs. In 1995, leasing (which does include third party leasing and performance contacting) accounted for nearly one third of all equipment utilization. Thus, EMPs and other facilities improvement projects are recognized as credible investments, however they are frequently put on the “back burner” relative to revenue-enhancing projects.
Maximizing stock price should be a goal of the corporation. Increasing productivity, offering new product lines, and increasing profits are examples of tangible factors that can increase the firm’s stock price. However, stock price may also increase due to intangible factors; such as investor speculation and reaction immediately following an announcement. Executives may incorporate this investor reaction when deciding which projects to implement.
Although investor reaction has not been assessed for EMP announcements, there has been some research in this area. It has been shown that firms increasing expenditures on general facility and equipment improvements had a 1.98% abnormal stock increase immediately after the announcement. Announcements of joint ventures correlated with a positive abnormal return of 1.95% over a twenty-one day interval, (-10 days to +10 days) centered on the announcement day (day 0). However, not all joint ventures correlate with positive abnormal stock returns.
The correlation between EMP announcements and stock price has not previously been investigated. This paper will examine whether EMP announcements correlate with positive abnormal stock price returns. If they do, then perhaps the capital budgeting process should incorporate this benefit.
METHODS Using the Nexis/Lexis database, the World Wide Web, and other resources, a search for EMP announcements resulted in over 5,500 citations. Of the 5,500 citations, only 23 announcements fit the following criteria:
1. The firm announcing the EMP was publicly traded and its returns were available on the data files of the Center for Research in Security Prices (CRSP).
2. The announcement was the first public information released about the EMP.
3. The EMP must be large enough to represent a significant investment for the company. For example, if a large fast-food chain was announcing an EMP at only one restaurant, it was deleted from the sample. However, if the EMP was company-wide, it would be included in the sample.
4. The announcement was made in a major US newspaper, newswire service or a monthly trade magazine between 1986 and 1995.
The 23 announcements which represented the “Complete Sample”, consisted of several sub-samples:
• 16 Announcements made within daily newspapers or via electronic wire (“Daily”)
• 3 Announcements within monthly trade magazines (“Monthly”)
• 4 Announcements of post-implementation results (“Post-Implementation”)
An additional sub-sample was created (“Daily + Monthly”) to maximize the sample size of pre-implementation announcements.
For each announcement, the firm’s name, CRSP identification number and announcement date were entered into the Eventus computer program, which tracks daily stock price performance for every U.S. stock listed within the CRSP. Eventus uses a common “event-study” methodology to calculate abnormal stock returns, and indicates statistical significance levels. Statistically, a null hypothesis (Ho) was proposed and tested against an alternative hypothesis (Ha):
Ho = EMP announcements have no impact on stock price.
Ha = EMP announcements have a positive impact on stock price.
Analysis Intervals Usually, a firm’s stock price performance is analyzed over several time intervals around the announcement date. Often, a stock price improvement can be noticed between the day of the announcement (day 0) and the next trading day (day 1). In this interval, the range is represented by the following notation: (day 0, day 1) or (0,1). Another typical interval for event-study analysis is a two-day interval, one day before the announcement to the announcement date (-1,0).
EMP announcements frequently appear in monthly trade magazines, which are distributed to readers on different days in different geographic locations. In this case, an exact announcement date can not be determined. Thus, analysis of the stock performance over a wider interval is appropriate. The (-10, 10) interval represents the period at which EMP announcements would most likely be noticed through monthly trade magazines. In addition, since EMP announcements may not capture as much publicity as other announcements, they require a longer period for the market to “learn” about them.
The (-10,10) interval is useful for identifying if an abnormal stock price increase correlates with an EMP announcement. However, to observe the long-term stock impact, the sub-samples were analyzed over additional intervals, such as (1,100), (1,150), etc.
Applying the aforementioned hypothesis tests to the sub-samples yielded the results that are presented in the following section of this paper. A more detailed explanation of the “event-study” methodology (statistical analysis) is included in the Appendix.
RESULTS Tables 1 and 2 present the short-term and long-term abnormal returns. The returns are categorized by interval around the announcement date. The level of significance at which Ho was rejected is also indicated.
The Daily + Monthly sub-sample is the most appropriate sample because it is the largest sample possible that excludes Post Implementation announcements. The Post Implementation sub-sample is substantially different in nature because it represents firms announcing cost savings (increased profits) from projects already implemented.
Using the Daily + Monthly sub-sample, EMPs correlate with a 3.90% increase in stock price, measured from ten days prior to the announcement to ten days after the announcement, (-10, 10). The level of significance was 0.01. See Table 1.
Table 1. Abnormal Return of Firms Announcing Energy Management Projects
Table 2. Long-Term Abnormal Return of Firms Announcing Energy Management Projects
Table 2 shows the long-term performance, where the Daily + Monthly sub-sample correlated with a 21.33% abnormal return over the (1,150) interval, at the 0.001 significance level. Figure 1 is a graphical illustration of the abnormal returns over the long-term interval.
Figure 1. Long-Term Abnormal Return of Firms Announcing Energy Management Projects
CONCLUSION The results from this study indicate that EMP announcements correlate with significant abnormal increases in a firm’s stock price. On average, an EMP announcement correlated with a 21.33% abnormal increase in the firm’s stock price. This increase was experienced from the day after the announcement to 150 days after the announcement. This increase is in addition to the risk-adjusted return the firms would normally experience. For example, during a “bull market” a firm’s expected return was 10%. After the announcement, the return would increase by 21.33%, for a net return of 31.33%. Because these EMPs were announced by a diverse group of firms at various periods over a ten-year time span, the significance of these results is impressive. In other words, the EMP is probably the only event that all firms within the sample have in common.
From these results, it appears that shareholders recognize EMPs as low-risk investments that should increase profits and add value to the firm. With the new information presented here, firms may have an additional strategic incentive to implement EMPs.
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Eric A. Woodroof
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