Advances in Environmental Accounting and Management, Volume 2 (Advances in Environmental Accounting & Management) (Advances in Environmental Accounting & Management)

CONTENTS LIST OF CONTRIBUTORS

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EDITORS

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AD HOC REVIEWERS

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EDITORIAL Martin Freedman and Bikki Jaggi

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THE IDENTIFICATION, MEASUREMENT, AND REPORTING OF CORPORATE SOCIAL IMPACTS: PAST, PRESENT, AND FUTURE Marc J. Epstein

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LEGITIMACY AND THE INTERNET: AN EXAMINATION OF CORPORATE WEB PAGE ENVIRONMENTAL DISCLOSURES Dennis M. Patten and William Crampton

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POLLUTION DISCLOSURES BY ELECTRIC UTILITIES: AN EVALUATION AT THE START OF THE FIRST PHASE OF 1990 CLEAN AIR ACT Martin Freedman, Bikki Jaggi and A. J. Stagliano

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FINANCIAL ANALYSTS’ VIEWS OF THE VALUE OF ENVIRONMENTAL INFORMATION Herbert G. Hunt III and Jacque Grinnell

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THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY ON THE INFORMATIVENESS OF EARNINGS AND ACCOUNTING CHOICES Ahmed Riahi-Belkaoui

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AN ASSESSMENT OF THE QUALITY OF ENVIRONMENTAL DISCLOSURE THEMES W. Darrell Walden and A. J. Stagliano

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LIST OF CONTRIBUTORS William Crampton

Department of Accounting, Illinois State University, Normal, Illinois, USA

Marc J. Epstein

Jones Graduate School of Management, Rice University, Houston, Texas, USA

Martin Freedman

Department of Accounting, College of Business and Economics, Towson University, Towson, Maryland, USA

D. Jacque Grinnell

School of Business Administration, University of Vermont, Burlington, Vermont, USA

Herbert G. Hunt III

Accountancy Department, College of Business Administration, California State University, Long Beach, California, USA

Bikki Jaggi

School of Business, Rutgers University, New Brunswick, New Jersey, USA

Dennis M. Patten

Department of Accounting, Illinois State University, Normal, Illinois, USA

Ahmed Riahi-Belkaoui

Department of Accounting, College of Business Administration, University of Illinois at Chicago, Chicago, Illinois, USA

A. J. Stagliano

Department of Accounting, Ervian K. Haub School of Business, Saint Joseph’s University, Philadelphia, Pennsylvania, USA

W. Darrell Walden

E. Claiborne Robins School of Business, University of Richmond, Richmond, Virginia, USA

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EDITORS Martin Freedman Towson University

Bikki Jaggi Rutgers University Associate Editors

A.J. Stagliano St. Joseph’s University

Sara Reiter Binghamton University Editorial Board Arieh Ullmann Binghamton University Ora Freedman Villa Julie College Rob Gray University of Glasgow, Scotland Carlos Larrinaga University of Seville, Spain Cheryl Lehman Hofstra University Glen Lehman University of South Australia Lee Parker University of Adelaide, Australia Dennis Patten Illinois State University Bill Schwartz Indiana University at South Bend Tony Tinker Baruch College

Bruce Avolio University of Nebraska Walter Blacconiere Indiana University Nola Buhr University of Saskatchewan, Canada Jeffrey Cohen Boston College David Cooper University of Alberta, Canada Charl De Villiers University of Pretoria, South Africa Jesse Dillard University of Central Florida Marc Epstein Rice University Paul Shrivasta Bucknell University ix

AD HOC REVIEWERS Kathryn Bewley

York University

Yue Li

University of Toronto

Arline Savage

Oakland University

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EDITORIAL Since the publication of the first volume in this series in 2000, there have been advances as well as retreats in the areas of both environmental performance and environmental disclosures. The Kyoto Protocol will become reality if 55 nations and the industrialized nations that produce at least 55% of the world’s output of carbon dioxide ratify the treaty. With the European Union’s ratification in 2002 and with Russia and Canada poised to ratify the treaty, the Kyoto Protocol is expected to become effective shortly. Even without the treaty being in effect, the EU countries have instituted a carbon dioxide trading scheme to limit the emission of greenhouse gases. These endeavors constitute progress toward making the contents of the Kyoto Protocol effective. In the U.S., the Bush administration’s choice of ignoring Kyoto and relaxing the requirements of certain environmental laws, however, constitute steps backwards in the battle to keep the planet clean and safe for future generations. In the wake of Enron debacle with the resulting dissolution of Arthur Andersen and other accounting scandals including those involving WorldCom and Xerox, the quality of financial reporting and auditing has been called in to question. Thus, as a result of various accounting scandals, financial disclosures have suffered a great setback. There is, however, a silver lining in the gloomy financial disclosure landscape. It has been observed that reporting of corporate environmental and social accounting information has increased despite the setback in overall financial disclosures. There may, however, be a credibility problem because of the accounting scandals and because of the voluntary nature of these disclosures that cast doubt on the reliability of information content of environmental and social disclosures. In the first article in this volume, Marc Epstein traces the history of social accounting from its hopeful beginnings in the late 1960s and early 1970s until the present day. Being one of the pioneers of social accounting, Marc Epstein is in a unique position to provide us with a picture that presents important milestones in corporate recognition of the importance of social and environmental performance and disclosures. The author argues that although the number of companies disclosing social and environmental information has increased and the quality of such disclosures has not improved. He makes valuable suggestions for increasing the integration of social and environmental impacts with managerial decisions and for improving social and environmental disclosures. xiii

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In the article on Legitimacy and the Internet, Dennis Patten and William Crampton present evidence that companies have used their websites as an additional source of environmental information. However, their findings show that corporate web page environmental disclosures by a sample of U.S. firms do not appear to add any additional, non-redundant environmental information beyond what is provided in the annual reports. The authors therefore conclude that that “the focus of internet disclosures may be more on corporate attempts at legitimization than on moving toward greater corporate accountability.” In the U.S., the Clean Air Act (CAA) of 1990 was considered a major advance in the fight to reduce air pollution especially those emissions that cause acid rain. A key part of the legislation was an emission-trading scheme that allowed electric utilities to find a least cost method to meet the emission standards. The article by Martin Freedman, Bikki Jaggi and A. J. Stagliano examines the extensiveness of the CAA disclosures by firms directly impacted by the first phase of the 1990 Act. Firms that needed to reduce their sulfur dioxide emissions the most tended to provide the most extensive disclosures. However, the authors conclude that relying on voluntary disclosures to meet the information needs of stakeholders is not a successful strategy. Mandating these environmental disclosures would be a better public policy choice. In a survey of financial analysts, Herbert Hunt and Jacque Grinnell find that financial analysts are not enthusiastic about the current state of environmental reporting. The analysts tend not to use environmental information in their decision models. Those that do use the information, do it to assess the downside risk. One of the key reasons given for not using environmental information is the lack of reliable data (especially since their major source of the data is the annual report). The authors conclude that firms need to disclose more relevant and reliable environment performance information so that this information can be better used by the investment community. Ahmed Riahi-Belkaoui’s findings show that investors are more likely to rely on earnings reports from firms that have a reputation for corporate social responsibility (based on Fortune’s rankings). The author, however, concludes that social responsibility which enhances the relevance of reported earnings, may also have been encouraging management to be more aggressive in manipulating the reported earnings through the use of discretionary accruals. Thus, the findings of this study cast doubt on the reliability of reported earnings by firms that are considered to be socially responsible. The last article in this volume authored by Darrell Walden and A. J. Stagliano deals with quality and placement of environmental disclosures in annual reports to shareholders. The study is, however, based on data from 1989, the year of the Exxon Valdez oil spill and therefore it is related to a time period of heightened

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environmental awareness. It has been reported that environmental information is disclosed throughout the annual report, though it varies from firm to firm, but the information content of these disclosures in general is of limited usefulness. It is possible that variability in environmental disclosures may be due to firms belonging to different industry groups. The bottom line seems to be that there is little relationship between environmental disclosures and environmental performance. Marty Freedman Bikki Jaggi Editors

THE IDENTIFICATION, MEASUREMENT, AND REPORTING OF CORPORATE SOCIAL IMPACTS: PAST, PRESENT, AND FUTURE Marc J. Epstein ABSTRACT This paper provides a review of the progress made in both academic literature and corporate practice over the last forty years. Although there has been an increase in the number of companies producing social and environmental reports, the quality of the disclosures has not increased. Further, there is little evidence of progress in the integration of social and environmental impacts into management decisions. The paper provides suggestions on research needs to increase the integration of social and environmental impacts into management decisions and improve both the internal reporting and external disclosures and accountability of corporations.

INTRODUCTION In recent years there has been a proliferation of academic and managerial publications concerned with the subject of social reporting and the integration of social, environmental, and economic impacts into managerial decision-making. This trend parallels a similar surge of interest in social accounting during the Advances in Environmental Accounting and Management Advances in Environmental Accounting and Management, Volume 2, 1–29 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-3598/doi:10.1016/S1479-3598(03)02001-6

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1970s; it reflects a renewed academic and corporate concern for principles of corporate social responsibility. To the potential detriment of its longevity, however, this sense of responsibility has not as yet been fully integrated into corporate decision-making. In the 1970s this lack of integration resulted in a failure to bring about enduring and substantive social impacts. Thus, the present context begs the question: Will the current discourse engender lasting changes in corporate action or will these progresses simply dissipate as in the 1970s? This paper reviews and reflects on the development, current state of the art, and future prospects for the identification, measurement, and reporting of corporate social impacts. It provides insights into the developments that occurred over the last four decades, describing the path that social accounting1 has taken and examining the reasons for that path. It investigates the organizational barriers that were created and the impacts of the organizational environment on social accounting development. Additionally, a research and management program to improve the implementation of social accounting in corporations is provided. This investigation is based on reviews of both the academic and managerial literature and extensive field research by the author throughout this period. Other recent reviews of the development of social accounting include Mathews (1997), Woodward (1998), and Gray (2001). This paper is also based on the author’s extensive involvement in the development of social accounting in both academia and business over the last thirty years in both the United States and Europe. Though I have engaged in an earnest attempt to be objective, my extensive involvement has certainly impacted my views of these developments. Though beginning my research in the area in the late 1960s and writing in the early 1970s, my role as both an external consultant and as a full time employee as Director of Social Measurement Services at Abt Associates, Inc. during the 1970s has certainly impacted my understanding of the early developments. Abt Associates, as discussed later in this paper, produced social audits for their own annual reports and for both internal and external reports for many clients. I was involved in most of those activities and directed the social audit efforts. I have also been involved in research and consulting in the identification, measurement, and reporting of social, environmental, ethical, and economic impacts in for profit and not-for-profit entities for more than thirty years with both North American and European based companies. My books and articles (some of which are referenced in this paper) reflect some of my thoughts and experience along with reporting on extensive field, survey, and other research. Though much of the popular press has suggested that the increased social disclosures reported by companies is significant, I see little evidence that in many cases it is much more than public relations or that it has fundamentally changed the organizations’ culture, concern for social issues, and social performance. Further, though European

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based companies have a higher level of social disclosures than North American companies, I have seen little evidence that they integrate social and environmental impacts into either operational management or capital investment decisions to any greater extent. Globalization and the global capital markets have caused the concern for shareholder value to be preeminent. Companies are focused on short term earnings to meet financial markets’ expectations and many companies are reluctant to invest in social and environmental improvements that have a speculative long term gain when other investments have a more identifiable short term profit. Social and environmental managers have largely been unsuccessful in convincing their leaders that there is a payoff from social investments – especially when budgets are tight. Neither academic researchers nor corporate managers have provided

Fig. 1. The Stages of Evolution in Social Accounting.

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enough compelling measurements, analysis, and justifications to convince CEO’s to allocate the necessary funds to make significant improvements in corporate social performance. Although many observers have presented optimistic views of current developments in corporate social accounting (ACCA, 2001; Watts & Holme, 1999), others in increasing numbers are concerned whether the changes in corporate culture and disclosure are (a) institutionalized and (b) likely to be maintained. This paper recommends caution for those optimistic views, arguing that despite an increase in the quantity of companies that provide social disclosures, the quality of those disclosures has not improved, nor have companies integrated social and environmental information into managerial decision-making or institutionalized it sufficiently to change corporate culture. Ultimately, then, increased social disclosures may have improved corporate accountability but may not have improved social and environmental performance. Using an historical perspective, this paper analyzes both recent and prior developments from 1960 to the present, which can be broken down into five stages (Fig. 1).

THE DEVELOPMENT, DECLINE, AND REVIVAL OF SOCIAL ACCOUNTING: ACADEMIC AND CORPORATE CONTRIBUTIONS IN THE 1960s, 1970s, 1980s, AND 1990s Stage 1 – 1960–1969 – Antecedents of Social Accounting During this stage, the focus in both academic research and managerial practice was primarily on the evaluation of government sponsored social programs and their contributions to social welfare. Social science measurement techniques, including those developed for the evaluation of military efficacy, were refined and applied to social programs. This was accompanied by increased academic and government emphasis on both the efficiency and effectiveness of government spending (Dunlap & Catton, 1979). Attempts to broadly define and measure the growth and improvement in societal wealth and welfare were often included in discussion under the rubric of social accounting (Terleckyj, 1970; U.S. Dept of H.E.W., 1970). This occurred within a context of significant community pressures and protests of various corporate and government activities. Corporations were challenged on issues such as the manufacture of weapons, environmental emissions, civil and human rights practices, community contributions, and employee diversity (Boyer, 1984; Hammond, 1987). The role of corporations in society became an issue of concern, and corporate leaders began making it an important point of discussion. Incongruously, significant discussion did not equate to significant action, despite

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the development of many tools for implementation of programs intended to ensure corporate social responsibility (Wilson, 2000).

Stage 2 – 1970–1977 – Birth and Initial Development of Social Accounting Many of the current developments in social accounting can be largely attributed to the contributions of Ray Bauer, a Harvard management professor, and Dan Fenn, who coauthored The Corporate Social Audit (1972). Their work was based on extensive field research on the implementation of corporate social responsibility and the development of social audits. Also contributing to the genesis of the field were John Corson and UCLA professor George Steiner, who wrote Measuring Business’s Social Performance: The Corporate Social Audit (1974), a book based on a survey of corporate activities focused on evaluating social performance. Academic researchers and practicing accountants were also involved in the early developments of the field. The American Institute of Certified Public Accountants conducted a seminar on social measurement. Following the seminar, the institute formed a committee to investigate the potential role of accountants in the further development and evolution of social accounting. The committee’s report The Measurement of Corporate Social Performance: Determining the Impact of Business Actions on Areas of Social Concern (1977) presented extensive material on both measurement and reporting of social impacts, including areas such as customers, environment, nonrenewable resources, suppliers, and employees. It examined objectives, measures, and data collection. The American Accounting Association also established and published works related to the topic (AAA, 1975, 1976). The National Association of Accountants supported a field research study that examined social accounting at General Electric, First National Bank of Minneapolis, and Atlantic Richfield (Epstein et al., 1977b). The research also included a survey of corporate activities in this area and was part of a series of three studies sponsored by the NAA that also included an environmental study (Nikolai, Bazley & Brummet, 1976) and a human resources study (Caplan & Landekich, 1974). Other accounting academics and practitioners were also working on the development of models for the measurement of corporate social impacts. Estes (1973, 1976), Seidler and Seidler (1975), Linowes (1972, 1974), Epstein et al. (1977a, b), Dierkes and Bauer (1973), and Dierkes and Preston (1977) all provided early contributions with field studies, theoretical classifications, measurement frameworks, and reporting formats. Reports of both survey and field research in the application of social accounting to product and service contributions were reported in Epstein et al. (1977b).

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In addition, numerous corporations advanced the development of social accounting by implementing it within their companies. Most notable among these were Abt Associates, First National Bank of Minneapolis, Eastern Gas & Fuel, Scovill Manufacturing, First Pennsylvania Bank, and Phillips Screw (see Epstein et al., 1976, 1977a, b). During this stage, much of the methodology for the social audit was developed, and over 100 such audits were conducted, many in consultation with Cambridge, Massachusetts based social science research and consulting firm, Abt Associates, Inc. In a few cases, complete social income statements and balance sheets were constructed. More often, data was aggregated to improve managerial decisions in a particular context, rather than attempting to fit it into a standard reporting format. Since the reports were customized for clients, some reports were distributed externally but more often they were for internal management evaluations only or for use with particular stakeholder groups. Many were developed for specific purposes, such as communicating more effectively with certain stakeholders and aiding managers with particular decisions. These included evaluations of potential facility locations and the impact of plant closure on community wellbeing, as well as the evaluation of product labeling practices, employee benefit programs, and the value of company products and services to the community. The reports also examined issues related to management control systems that could be used to systematize social responsibility in ways that might substantively link strategy to action. Social accounting was the mechanism by which senior executives intended to implement various strategies for social responsibility. During this stage, new techniques for measurement were developed and others from the social sciences were adapted, refined, and applied to the evaluation of corporate social impacts. Many of the techniques, based on economic, sociometric, and psychometric approaches, are still used today to evaluate the impacts of corporate products, services, processes, and activities on a company’s various stakeholders. One of the most important developments was the work completed in the early 1970s at Abt Associates. Abt utilized a constituent impact approach to construct social income statements and social balance sheets for inclusion in its own corporate annual report and for many of its clients. Client social audits included evaluations of corporate social programs, broad evaluations of corporate social impacts, and evaluations of the impacts of both profit and not-for-profit organizations on society. Also, these social audits often included evaluations of the impacts of products, services, corporate social programs, and of corporate philanthropy.2 The social audit that was included in Abt Associates, Inc.’s corporate annual reports in the early 1970s focused on reporting the impact of the company on its various stakeholders including employees, customers, the community, and

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shareholders (Epstein et al., 1976). All items were reported in monetary terms and in a balance sheet and income statement format with extensive footnotes to provide details on the measurements used for each of the line items. The social balance sheet included a subtraction of social liabilities from social assets to calculate “society’s equity” in the social resources of the company. The social income statement reflected a netting of the social benefits and social costs of the company’s activities on society. Abt’s reports also made progress by calculating the financial returns on social investments patterned after traditional corporate return on investment calculations. These practices reflected the company’s belief that the financial earnings of the company are the result of both its financial and social assets. The academic literature in management also made progress in the identification and measurement of social and environmental impacts. Post and Epstein (1977) developed a framework for the development of a social accounting information system capable of continuous identification and monitoring of actual social demands and public expectations. One of the more interesting European implementations of social accounting was the 1976 report by Gr¨ojer and Stark (1977) of the social performance of Swedish based Fortia Group. The authors discussed both the theoretical underpinnings of the model and a description of the implementation. Like the Abt report in the U.S., the Fortia report looked at constituent impacts and examined the return that various stakeholders (including employees, shareholders, and the community) received from the company. In addition to the monetary measurements, the authors included descriptive discussions of those items they believed could not or should not be measured in monetary units. Consequently, unlike Abt, they were unable to calculate a social profit and loss. Nonetheless, the disclosures were substantial and provided more information than is typical of company reports today.

Stage 3 – 1978–1986 – Decline of Social Accounting During this period, government and businesses became increasingly focused on economic prosperity, relegating social concerns to the periphery. Thus, there was a lull in both academic development and corporate implementation (Purser et al., 1995). Those few still making progress discovered the transience of non-institutionalized changes as CEOs quickly eliminated programs, a purge reflecting both a primarily profit-driven corporate temperament and a failure to operationally integrate social accounting within corporate culture. Without institutionalized practices and protocol, social responsibility derives sustenance

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from corporate focus, and when that focus shifted to profitability, preservation of these concerns could no longer be ensured. By early in this stage, the regression was so complete as to leave almost no evidence of social accounting’s progresses. Both academia and business seemed to have lost interest. Not until concern for improved management of corporate environmental costs increased did environmental accounting again become of significant interest (Bennett & James, 1998a; Epstein, 1996b; Parker, 2000a, b). Also, external support and demand for information on environmental and social impacts declined, and by consequence, companies’ perceptions of the need for additional accountability to the public also declined. There was no systematic and organized measurement and reporting framework developed that would provide continuous support and acceptance of social accounting and no grassroots support for the external reporting of social impact information by external stakeholders. Thus, with insufficient internal impetus and waning external demand for the continued supply of information, corporate interest in the identification, measurement, and reporting of environmental and social impacts subsided. In academia, social accounting was not accepted as a discipline by the academic establishment, thereby depriving institutional support to those who would contribute research but needed to obtain tenure and promotion at their institutions. Not until the development in 1976 and increasing importance of Accounting, Organizations, and Society was there a respected outlet for research contributions in this area. Also, due to the decline in industrial support, some researchers lost sites for field visits and data for empirical studies.

Stage 4 – 1987–1998 – Revival of Interest in Social Accounting Although a marked burgeoning within the environmental movement may be traced to the first Earth day in 1970 (Dunlap & Catton, 1979; Freudenberg, 1986), it was not until the late 1980s that social and environmental accounting came again to the forefront. Significant environmental regulations enacted in the 1980s in conjunction with increased enforcement made companies recognize substantial environmental liabilities on their financial statements and required large expenditures for remediation of prior emissions. Numerous publications in both the academic and managerial press revealed the benefits of preventing negative environmental impacts rather than dealing with clean-up costs and fines (Berry & Rondinelli, 1998; Neu et al., 1998). In 1996, a major research study reporting the state of the art and best practices of corporate environmental management and accounting was published. Entitled Measuring Corporate Environmental Performance: Best Practices for Costing and

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Managing and Effective Environmental Strategy, the book reported the findings of the largest field research study ever conducted in this area (Epstein, 1996b).3 Although the study included a review of external reporting and auditing, it focused on the internal corporate systems and culture conducive to the implementation of effective social and environmental impact management strategy, structures, and systems. This book and numerous other contemporaneous developments directed attention to the field of social and environmental accounting, effecting its addition within the mainstream discourses of both managers and academics. Discussions about the ways in which social responsibility issues might be integrated within existing accounting and control systems and the appropriate breadth of stakeholder concerns included in the management decision-making process followed. Together, increased environmental regulation, mounting pressure from internal and external stakeholders, and a variety of both cost and revenue imperatives brought corporate environmental responsibility to the attention of managers and researchers alike. Professional accounting associations, academics, and other non-profit organizations and industry associations also made significant contributions to the literature on both internal and external environmental accounting (Bennett & James, 1998a; CICA, 1993, 1994, 1997; Ditz et al., 1995; Epstein, 1996b; Gray et al., 1987, 1993; Ilinitch et al., 1998; Schaltegger et al., 1996; SMAC, 1995, 1996). These contributions advanced the discussion of the state of the art and best practices, but the discussion was not accompanied by substantial improvements in corporate practice, nor did it lead to the advancement of theories, frameworks, or tools to identify, measure, and report social and environmental impacts. Also, there were few field based research projects that examined the corporate integration of social or environmental impacts into management decisions and their relation to both management accounting and management control until Epstein’s study of corporate environmental performance in 1996. Even Epstein et al.’s (1976) AOS article was primarily focused on external reporting. Though this was part of a major research project that did investigate the integration of social and environmental impacts into management decisions generally and product and service contributions specifically and was funded by the National Association of Accountants (an association of management accountants), external reporting was the primary focus. That social accounting in the 1970s was directed towards innovative attempts to provide additional external disclosure of the impacts rather than institutionalization of these concerns into day-to-day management decisions is one explanation for this focus. Thus, Stage 4 was characterized by a proliferation of corporate environmental reports, most of which were intended for external rather than internal distribution. Some of the reports included extensive disclosures of environmental liabilities,

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operating expenses, and capital expenditures, and others included detailed synopses of company programs aimed at the reduction of future environmental impacts. Some of the reports were also verified by environmental consulting firms or the company’s independent auditors (Epstein, 1996b). Organizational structures evolved, decentralizing the function of environmental management to individual business units, thereby allocating environmental responsibility and performance expectations to all levels of management. This dramatic increase in environmental measurement and reporting and the concurrent evolution of environmental management was not, however, complemented by similarly significant advances in the measurement, reporting, and management of broader social impacts. More progress on these issues has been made during stage 5.

Stage 5 – 1999–Present – Redevelopment of Social Accounting When the 1990s began there were few environmental reports produced, but as the decade progressed, hundreds of companies began producing corporate environmental reports. By the late 1990s an increasing number of companies began producing social or sustainability reports as substitutes for, or in addition to, their environmental reports indicating a shift back to broader social issues as companies have begun to determine that the analysis and integration of broader social impacts provides information necessary for improved decision-making by both internal and external stakeholders. A broad analysis of social impacts allows corporations to more accurately evaluate stakeholder needs and anticipate their responses, which then enables them to more effectively manage their relationships with the community and their customers, thereby driving increases in revenue. Additionally, the consideration of broad social impacts in day-to-day operational capital decisions can improve cost management. Leadership in external social reporting during this period was coming primarily from Europe, followed by North America, Australia, and Asia (Epstein, 1996b; Kolk, 1999; KPMG, 1999; SustainAbility, 2000). An increase in the number of social reports accompanied this shift in concern to broader social issues. The reports were often produced often under the rubric of sustainability, a broader framework than the predominately environmental perspective of the previous period. Public accounting and consulting firms began to offer services in this area with such titles as PriceWaterhouseCoopers’ “reputation assurance” (Peters, 1999) and KPMG’s “sustainability services.” These services focused on reducing organizational risk by minimizing negative social impacts and enhancing reputation, and the reports often responded directly to corporate concern with determining the payoffs associated with specific investments in corporate social responsibility. Yet despite the growing number of

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reports, the development of measurement and reporting frameworks still has not surpassed the progress made in the 1970s.

THOUGHTS ON THE DECLINE AND REVIVAL OF SOCIAL ACCOUNTING Thus, although twenty-five years have passed since major developments occurred in the field during the 1970s, little progress has been made in social accounting. In 1976, Epstein, et al identified seven classes of social reports: (1) internal reports; (2) external reports; (3) descriptive reports; (4) quantified reports; (5) monetized reports; (6) partial social accounting reports; and (7) comprehensive social accounting reports. Currently, these seven categories of social reports remain effective and, as was the case twenty-five years ago, very little activity exists in producing the comprehensive reports, which examine a broad range of social impacts and provide the most useful information for the effective management of the full scope of corporate impacts on both internal and external stakeholders. An examination of the coverage of social accounting in academic journals such as Accounting, Organizations and Society and Accounting, Auditing, and Accountability Journal provides insight into and a reflection on the developments in social accounting in both academia and industry. Beginning with Epstein et al.’s (1976) article in its first issue, AOS published numerous articles on social accounting over the next few years. Most of these articles provided an examination of the disclosure of corporate social and environmental impacts, but these articles were focused primarily on the external reporting of these impacts rather than internal reporting and decision-making.4 In many ways, a discussion of the reports analyzed in the current accounting literature is similar to the discussion of the state of the art and social accounting in the 1970s. The reports included discussions of intentions, concerns, policies, and results. Again, however, there is little evidence that this concern for social or sustainability issues has been well integrated into the strategies, structures, systems, and cultures of the companies. The failure of social accounting, then, can be traced to the lack of institutionalization of improvements in measurement and reporting for social and environmental impacts in either the organizations or the public. Without integration of these impacts into routine management decisions, organizational change cannot be effective. In order for current developments in social accounting to be sustainable, it is necessary that the information such analyses provide be reported to both internal managers responsible for day-to-day operational decisions and external stakeholders who provide external accountability.

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Notably, environmental issues appear to be better integrated into operational and capital decisions. Managers are expected to operate in environmentally responsible ways and make decisions that are consistent with this responsibility. Capital investment decisions typically require scrutiny and approval by environmental professionals. This is the result of extensive regulations, a decade of corporate concerns that are becoming more institutionalized, large liabilities that must be disclosed, and substantial cost savings from environmental improvements that are easier to both calculate and justify (Shrivastava, 1995). Still, social and sustainability disclosures are usually not widely distributed and are not typically written in such a way as to be useful to stakeholders. Ultimately, these disclosures appear in too many cases to be prepared for external distribution for public relations purposes rather and are not necessarily evident of integration and institutionalization of social and sustainability issues into corporate culture. Neither does it appear to be evident of concern for a more complete accountability to the diverse set of corporate stakeholders. The survival of interest in social reporting, however, requires that it not be focused primarily on external disclosure but rather that it operate as an integral part of a larger corporate and societal shift toward emphasizing the social roles of corporations. As part of this shift, corporate focus expands to include the recognition of multiple stakeholders in the corporate decision-making process. Social accounting cannot be constructed primarily to provide public relations material intended to placate community concerns but rather should be used to change daily decisions made within organizations (see Doane, 2000; Neu et al., 1998). Also, readers of social reports need to evaluate them to determine underlying changes in the corporations, managerial decision-making and corporate culture before assuming that lasting changes have been achieved. Of course, there are exceptions. Just as in the 1970s there were leaders in social reporting, there are leaders today. Still, there remains a significant amount of work that needs to be done by both managers and researchers to improve the identification, measurement, reporting, attestation, and management of corporate social impacts. Among the research contributions to the literature are recent collections of articles that provide an overview of some of the issues and developments in social accounting. These contributions include Bennett and James’ (1986b) collection of articles on management accounting issues related to the environment, their collection of articles on measurements for sustainability (Bennett & James, 1999), and Zadek et al.’s (1997) collection related primarily to external disclosure of social impacts. More of these contributions are likely in the near future as this area continues its rapid development.

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USING SOCIAL ACCOUNTABILITY FOR IMPROVED EXTERNAL STAKEHOLDER DECISIONS AND CORPORATE ACCOUNTABILITY Much of the focus over the last decade, as was the case in the 1970s, has been on the measurement, reporting, and verification of social indicators for disclosure to external stakeholders. In an attempt to provide guidance and comparability to both information preparers and users, numerous organizations have promoted standards of social reporting as an attempt to satisfy various stakeholders’ needs and improve corporate accountability. Examination of these organizations and standards provides an understanding of both the state of the art and best practices in external social reporting. The ISO 14000 series of standards were published in 1996 to improve both environmental management and environmental performance (SMAC, 1998). They provide guidance for certification and improvement in such areas as performance evaluation, auditing, labeling, and life cycle assessments. The only standard subject to certification, ISO 14001 is a process standard, rather than a performance standard, and thus does not prescribe a minimum level of environmental performance. Rather, it describes a system that will ensure that companies can measure their environmental performance and it is hoped that this will lead to improved performance. This is in contrast with EMAS (Europe’s Eco-Management and Audit Scheme), which is a performance standard and requires minimum levels of environmental performance. In 1997, the Council of Economic Priorities established SA 8,000 (Social Accountability 8,000) as a standard focused on workplace conditions. An affiliated accreditation agency was established to develop and verify the implementation of the standards and to accredit firms to be external auditors. The Institute of Social and Ethical Accountability, founded in 1996 and based in England, has developed AA1,000 (Accountability 1,000) as a set of standards of practice for the external disclosure and verification of social, ethical, and environmental information. Another recent development is the Global Reporting Initiative (GRI). Established in 1997 with the participation of numerous corporations, consulting firms, and non-governmental organizations, the GRI’s mission is to design globally applicable guidelines for corporate sustainability reports. In the pilot phase, some companies used the GRI framework in their sustainability reports. The World Business Council for Sustainable Development (WBCSD), an industry coalition of 120 international companies based in Geneva, Switzerland, has made some progress in the development of frameworks to promote, measure, monitor, and manage corporate sustainability.

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The WBCSD has been rooted in the belief that “performance in the social area is inevitably more difficult to quantify than commercial or even environmental performance” (Watts & Holme, 1999). This is a view commonly held in industry and offers one explanation for the lack of progress in the measurement of social and environmental impacts. Misconceptions about traditional accounting reports endow them with unrealistically high levels of precision and reliability, provoking expectations of similarly unrealistic levels of empiricism in social accounting. These expectations deprive corporate social accounting of numerical legitimacy and, by consequence, hamper the integration of social and environmental responsibility into day-to-day corporate decisions. Yet, social science techniques that provide reasonable estimates for social and environmental performance do exist. These measures, though requiring further development, nonetheless provide substantial and valuable information, which enables managers to more accurately evaluate the tradeoffs made in day-to-day management decisions. Thus, definitions of corporate profit and performance need to be expanded to include the increase or decrease of welfare for all stakeholders due to corporate action, rather than the easily monetized impacts on financial stakeholders alone (Epstein & Birchard, 1999). A perpetually increasing demand for reporting to both internal and external stakeholders Epstein and Freedman (1994) has generated a market for numerous consulting firms who have developed practices around the measurement, reporting, attestation, and management of corporate social and environmental impacts. One such consulting firm, PriceWaterhouseCoopers has developed a framework, a principles matrix, and a set of effectiveness indicators for stewardship, environment, health and safety, and communication. Notably, the framework and the indicators are focused on the effect of social and environmental issues on corporate reputation (Peters, 1999). Arguing effectively for the relevance of social and environmental concerns to long-term stakeholder and shareholder value, London-based consulting firm SustainAbility has also developed a framework for the integration of these and economic concerns (Elkington, 1998). Recent research has focused on the impact of a reputation for social performance on stock price (Schnietz & Epstein, 2003). Additionally, in an attempt to develop standards of corporate social responsibility, the Social Venture Network published a set of nine principles in 1999, including: (a) global principles of corporate social responsibility; (b) a guidance document to more carefully articulate the components of the principles; and (c) a measures document that began to identify possible measures for each of the principles (SVN, 1999). The SVN project was intended to be the first phase of a major research project that observed the strengths and weaknesses of the strategies, structures, people, culture, organizational change efforts, and management control systems that are necessary for the successful implementation of corporate social responsibility. Though never completed, the work contributed to efforts to

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change corporate priorities and formalize the identification, measurement, and reporting of corporate social impacts. The New Economics Foundations (NEF), a non-profit U.K. based organization, has focused much of its attention on the development of a framework and tools for social accounting. In Social Auditing for Small Organizations: A Workbook for Trainers and Practitioners (Pearce et al., 1998), NEF provided a guide to the internal integration of social impacts, the disclosure of those impacts to external stakeholders, and the verification of the measures and disclosures by independent auditors. The workbook provides both a framework for beginning to perform a social audit and guidance on the development of indicators and benchmarks for evaluation of performance. Ralph Estes, who contributed much to the early development of social accounting in the 1970s, has proposed The Sunshine Standards and The Corporate Accountability Act, the latter of which mandates the disclosure of more comprehensive information sets to the public (Estes, 1996). Estes emphasizes the way in which traditional assessments of corporate performance have overemphasized the value of shareholders’ interests to the exclusion of other stakeholders’ interests, making accounting complicit in the irresponsibility of corporate behavior. Standard setters, in attempting to make these various standards operational, have sought to establish a standard set of disclosures and approach performance metrics that permit comparisons of corporate social and environmental performance across industries. Differences in company size, geographic diversity, complexity, and nature and level of environmental and social impacts of products and activities complicate this task. Nonetheless, a broad set of measures that successfully integrates social, environmental and economic impacts would greatly benefit both internal and external stakeholders. In response to the requests for input from the Global Reporting Initiative, a number of organizations including the New Economics Foundation and PriceWaterhouseCoopers have developed social indicators for use in the proposed external sustainability reporting guidelines. Another important recent development is the establishment of the Dow Jones Sustainability Group Indexes in 1999. These include global indexes based on a systematic methodology that tracks sustainability performance and provides investors and companies a way to compare performance. Another company attempting to provide services to the investment community and corporate managers on sustainable performance is Innovest. With their tool, EcoValue21, the company tries to combine financial and environmental performance and “exploit the risk migration and investment out-performance opportunities in the substantial but largely unrecognized differentials in the ‘eco-efficiency’ of major industrial corporations.” These all further the developments of probably the best known of these indexes, the Domini Social Index, established in 1990 and

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composite of 400 socially responsible corporations (Epstein & Birchard, 1999). These developments also relate to the increasing concern over the relationship between social and environmental performance and financial performance. Though numerous studies and analyses of these relationships do exist in the literature (Aspen Institute, 1998; Blumberg et al., 1997; Margolis & Walsh, 2001; Zadek & Chapman, 1998), a clear relationship cannot yet be specified. Pertinent to the further development of social accounting is the development of the internet. Where previously prohibitive costs of collection and distribution stymied general access to environmental and social impact information, no such barriers currently exist. External stakeholders or companies could create uni-dimensional reports by stakeholder, facility or impact, or alternatively, aggregate the information into a total impact report with the provision of links to related and more detailed information. Thus, information can be easily posted and accessed, resulting in a broader forum of stakeholders involved in its analysis and able to ensure accountability. Increasingly, investors are demanding this information and its concomitant social accountability. However, a comparison of corporate annual reports, environmental reports, and sustainability reports from over 200 companies with those reported by Epstein et al. (1976) reveals little substantive progress. Although the quantity of these reports has increased dramatically since 1976, current reports are still inferior to Abt’s report of thirty years ago, containing fewer useful measures than some other reports from that time period. Furthermore, there is little evidence to show significant integration of a social and environmental concerns or a broad set of stakeholder interests into management decision-making or corporate culture. Prior research has shown that the levels of environmental disclosure and the level of environmental performance are often not highly correlated (Rockness, 1985; Wiseman, 1982; also see Doane, 2000; Neu et al., 1998). Therefore, it is being suggested here that these are too often an exercise in public relations rather reflective of a deep concern for accountability and action. In order to ensure the continuation of the current interest in social accounting and further progress in the field, however, its developments must be integrated with the management accounting and control systems. Otherwise, the future of the field is likely to repeat its history, experiencing a surge of interest, as in the 1970s, followed shortly by a decline, as in the 1980s.

USING SOCIAL ACCOUNTING FOR IMPROVED MANAGERIAL DECISIONS Increasingly companies are examining how to fit social and environmental issues into existing management systems. This often includes accounting systems like

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activity based costing and strategic management systems like shareholder value analysis and balanced scorecard, which examine drivers of value in organizations (Epstein & Birchard, 1999; Epstein & Young, 1999). General managers achieve substantially better understanding and recognition of environmental and social impacts when they are measured in monetary terms since this allows them to integrate these concerns into operational and capital investment decisions and recognize where tradeoffs are necessary. Quantification in monetary terms also permits a more comprehensive understanding of impacts on various corporate stakeholders in both the short and long term. Life cycle assessment and life cycle costing are also being used in an effort to provide systematic evaluations of ultimate product responsibility during all phases of its life cycle, from product concept, material acquisition, R & D operations, manufacturing, customer use, to final disposal (Datar et al., 1997). Some community and environmental activists have been concerned that using economic value added or any other shareholder value metric acknowledges that shareholders are the primary stakeholders and denies the relevance of other potential stakeholders to management decisions. This particularly applies to those stakeholder impacts that are difficult to quantify and external impacts without clear methods of internalization. The most important issue, however, is that the identification and measurement of both the stakeholders and impacts must be broadened to encompass the impacts of capital investment decisions over the entire life of the investments, including product take back. Many companies currently do not consider broad life cycle impacts that will affect long-term corporate profitability (Epstein, 1996a; Epstein & Roy, 1997a). Thus, in order for social accounting to be an effective tool in sustainability, it must assess a wide range of stakeholder interests over the entire spectrum of product and service life, relating these issues directly back to profit over both the short and long term. This can be accomplished if the principles of corporate social responsibility and the processes of social accounting are fully integrated into corporate culture and management systems.

DISCUSSION AND ANALYSIS OF CURRENT EFFORTS IN SOCIAL ACCOUNTING FOR MANAGERIAL DECISIONS The earlier discussion attributed much of the decline of social accounting in stage 3 of the evolution to the lack of institutionalization within organizations. Current organizational efforts to primarily improve managerial decisions related to social impacts and concerned with external disclosure secondarily may have more permanence. Using some of the newest measurement and management

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systems, some companies have found that significant improvements can be made in the decision making process to improve both financial and social performance (Epstein & Wisner, 2001a; Wisner et al., 2002). However, many of these corporate systems are not widely promoted and are not tied to external disclosures, thereby inhibiting the realization of their full efficacy. Companies are nonetheless recognizing there are numerous opportunities to reduce negative environmental impacts and are adopting environmental management systems to improve their performances. Many are examining how these same approaches can be applied to broader social issues. In terms of structure, the corporate sustainability department is responsible for defining worldwide requirements and objectives and then measuring and reporting environmental performance. The central office has only a coordinating role, and individual business units are responsible for developing their own programs to meet the established objectives. In the early stages of integrating this system, though, strong central management is necessary to both monitor and motivate performance. As companies search for ways to improve their performance, determining the best ways to thoroughly integrate these improvements into all parts of the company still causes difficulty. In order to improve this integration of social and environmental impacts into day-to-day management decisions, companies must tie the measurement and reporting of these impacts into the decision-making processes already in place. Further, these impacts must be measured and reported in financial terms and then integrated into the traditional investment models. To reduce the negative social impacts of corporate activities, the drivers of the costs and benefits must be analyzed. Understanding these drivers is necessary in order to better identify, measure, and manage social impacts. Epstein and Roy (2001) have developed a model to better understand the drivers of sustainability, considering both the drivers of sustainable performance and the sustainable drivers of financial performance, along with the development of appropriate measures (also see Epstein & Wisner, 2001b). The model (see Fig. 2) begins with corporate and business unit strategy and examines the various ways that a company’s sustainability performance is determined. Among these are actions a company takes deriving from corporate strategy. There are various structures and systems the can be used proactively on issues of social concern. These could include a combination of the four levers of control described by Simons (1995) as boundary, belief, diagnostic, and interactive system. These systems and structures could also be developed out of strategy to impact sustainability performance or instead in a reactive mode to respond to the performance indicators before the stakeholders are impacted or see the impact. The available systems and structures could also include reactions to stakeholder concerns through feedback loops that are created to improve

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Fig. 2. Drivers of Sustainability.

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management of these issues and that may be directed to altering strategy or specific actions affecting sustainability performance. The model can be used to measure sustainability performance in either monetary terms or other metrics related to financial performance. Equipped with an enhanced understanding of the drivers of social costs and benefits, managers should be able to make better decisions regarding the tradeoffs that consistently must be made where corporate products and activities may have a positive impact on one stakeholder and a negative impact on another. Additionally, the model facilitates the inclusion of both leading and lagging indicators of performance. More information related to the strategies, structures, systems, and culture that are in place might enable better predictions of future sustainability. The information should then be of interest to both internal and external stakeholders. One of the major disappointments of social accounting in the 1970s was the lack of institutionalization within corporate culture. This allowed these concepts to die within corporations as senior leadership changed and the pressures to increase profitability and pursue other interests mounted. Thus, institutionalization of the vision and mission within corporate systems and structures is absolutely paramount.

THE CHALLENGE TO RESEARCHERS: THE DEVELOPMENT AND APPLICATION OF FRAMEWORKS AND MEASURE FOR SOCIAL ACCOUNTING Many have argued that a major impediment to the development of social and environmental accounting is the inability to measure impacts and performance in the same “objective” manner as financial accounting. Further, it is often argued that auditing of social and environmental information is hampered because standards of reporting have yet to be established and thus verification of reports cannot be accomplished as it can in the auditing of financial statements (Pruzan, 1998). Although generally accepted accounting and auditing standards have yet to be developed for the measurement and reporting of corporate social impacts, neither internal nor external reporting need be constrained. Economists for years have employed various techniques for translating human values into monetary terms to enable the evaluation of the performance of public and corporate social programs. Techniques like willingness to pay and contingent valuation methods have been used successfully in economics and can be used effectively in measuring social and environmental impacts of corporate actions. Thus, companies should be developing methods to improve internal reporting and decision making so as to improve their understanding of the issues and improve long term profitability.

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Further, government regulators (such as the SEC in the U.S.) establish regulations for minimum disclosures required of all publicly held companies. They do not specify maximum disclosures, so companies should disclose any information that will aid shareholders and other stakeholders in better understanding the condition and performance of the company and permit forecasts of future performance. Numerous measures have been developed for use in social accounting (Epstein, 1996b; Epstein et al., 1997a; Epstein & Birchard, 1999; Peters, 1999; SVN, 1999). These often draw on existing social science measurement techniques based on economics, psychology, and sociology (Freeman, 1993; Mishan, 1971). Accounting researchers must be involved in developing these techniques further and demonstrating how they may be applied to existing corporate evaluations because neither managers nor academic researchers have made much progress in the accounting or management of corporate social impacts over the last 25 years. They have not developed the techniques, reporting frameworks, or the systems and structures necessary to drive this through organizations. And if social accounting is going to provide relevance and reliability of information for management decisions, both internal and external reporting as well as systems for implementation of sustainability strategies must be improved. Managers need to better understand the drivers of success in organizations, but the traditional models of shareholder value do not sufficiently examine the interests of non-financial stakeholders. Broader analyses that cut across internal corporate functions, consider the interests of all stakeholders, and examine the drivers of long-term organizational success, are required (see Epstein & Birchard, 1999; Epstein et al., 2000; Epstein & Roy, 2001). Improved measurement is required. Improved internal and external reporting is necessary. Organizational leadership that recognizes the importance of a broad sensitivity to long term impacts and the systems necessary to implement these concerns in organizations is also required. Better analysis of the value of organizational relationships and the linkages between internal and external drivers of success is also needed. The measurements and the drivers must be brought together as companies evaluate both leading and lagging indicators of success. Thus, in evaluating corporate social performance, both lagging indicators of past performance and leading indicators of future performance related to the systems and structures in place to reduce future negative impacts are needed. This analysis is at the core of the work of Epstein and Roy (2001) described above. Developing a Model for Implementing Social Accounting As a response to the issues discussed in this paper, Epstein and Birchard (1999) have developed a model to integrate the internal and external components required

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Fig. 3. The Accountability Cycle.

for implementation of social accounting for both internal decision making and improved accountability in organizations. In Counting What Counts: Turning Corporate Accountability to Competitive Advantage, Epstein and Birchard (1999) provide a framework for accountability that includes four primary elements (see Fig. 3): (1) Improved corporate governance; (2) Improved measurements that include operational and social measures of performance along with a broadened set of financial metrics that include both lagging and leading indicators; (3) Improved reporting to a broad set of internal and external stakeholders of information relevant to decisions. This begins with internal reporting to managers and the selection of various voluntary disclosures to supplement the mandatory external disclosures that are currently the primary content of corporate reports; and

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(4) Improved management systems to drive these improvements through corporate culture and change the way managers make decisions to improve both corporate accountability and corporate performance. The book provides a framework for social accounting that integrates both internal and external reporting. It links all of the necessary elements to operationalize social accounting and provides, the mechanism to link social, environmental, and ethical concerns to financial performance. It provides a model for the integration of social concerns into day-to-day management decisions and does so in a format that examines the relevance of social issues to overall corporate performance. A new measure of corporate performance that supplements the lagging indicators that accountants have traditionally used with leading indicators is needed. This should include a broad recognition of those who have a stake in the equity of enterprises and the long term social impacts of company’s products, services, and processes, so as to provide a comprehensive portfolio of a company’s social and financial performance. Recognized stakeholders should include employees, customers, suppliers, and the community, in addition to financial stakeholders. By including these impacts in the measurement and reporting of an integrated measure of corporate performance and including the information in both internal and external reports and decisions, both corporate accountability and internal decisions related to the improvements of overall stakeholder value can be improved.

The Next Step – Current Needs In part, the failure of social accounting is due to the lack of an integrated model for both internal and external reporting and for the identification and measurement of a broader set of impacts and corporate performance. The model proposed by Epstein and Birchard is an attempt to rectify that failure and provide a broader concept and definition of the actions that lead to corporate accountability. They argue that the internal reporting and external disclosures must be part of an integrated system that includes governance, measurement, reporting, and management control systems. Studies summarized in this paper have described the state of the art and best practices in the measurement and reporting of sustainability in both corporate practice and academic research. Both academics and corporations have further developed frameworks and techniques that can be uses to implement sustainability in order to reduce both corporate social impacts and improve accountability. However, there remains much work to be done by managers, who must institutionalize the concern for sustainability and implement the structures and systems necessary to support it. These must include improved measurement and integration into

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day-to-day management decisions, including operating and capital decisions and performance evaluations. There is also substantial room for significant research contributions to both the theory and practice of corporate social accounting. Some of the current needs are: (1) Develop new techniques (and apply existing ones) for measuring social and environmental impacts; (2) Examine international differences in the state of the art and best practices in management of social and environmental impacts. Determine the causes for those differences and ways to improve corporate social and environmental performance; (3) Examine alternative frameworks for external reporting in corporate annual reports and sustainability and environmental reports. Determine the most useful measurement and reporting format for various external stakeholders; (4) Develop field research projects that test the success of various systems to identify, measure, monitor, report, and manage social and environmental impacts and determine the variables that drive success. Are these systems more successful in firms that are small/large, centralized/decentralized, global/locally adaptive, have high/low impacts, etc.? (5) Determine whether changing the information provided to managers is sufficient to change their decisions or whether it is necessary to change their decision-making models in order to facilitate the consideration of social and environmental impacts. Must the management of these impacts be a part of the performance evaluation and incentive systems in organizations in order to bring them into managerial decisions? (6) Develop, refine, and apply models and techniques for the implementation of social accounting and sustainability strategies and the management of social and environmental impacts in organizations. Are the accounting and control systems different for managing these impacts? (7) Test the effectiveness of models such as the Epstein-Roy sustainability drivers model to both describe drivers of sustainability and financial performance to improve managerial decisions; (8) Examine the relationships of stock price and cost of capital to corporate social and environmental liabilities and performance. Through projects like these, accounting researchers can aid in the integration of social and environmental impacts into management decision-making and the implementation of corporate sustainability strategies. This can result in high quality academic research, improved management decisions, improved corporate profits and reduced social and environmental impacts.

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Now, as in the 1970s, many CEOs are describing their profound interest in providing greater benefits to the community. As aforementioned, too often this has been either empty promises or an inability to deliver on the commitment. This is due to a lack of institutionalization and integration into day-to-day management decisions. If current activities are intended to be more than external reporting for public relations purposes, then they must be part of a comprehensive sustainability strategy that is driven through the organization. Having committed themselves to sustainability, many large companies and accounting researchers must now figure out how to use management accounting and control systems to implement the necessary changes. The development of social accounting may prove to be an excellent example of the importance of integration of governance, measurement, reporting, and systems and the critical importance of implementation and institutionalization in attempts to change organizational cultures, systems, and decisions. With reliance solely on external disclosures without internal integration, the social accounting of the 1970s was destined to fail. Likewise, without the institutionalization of governance, measurement, and reporting systems, current changes will not last. There is a significant amount of activity to develop various standards and improve indicators to identify, measure, monitor, and report social and environmental impacts to external stakeholders and to improve corporate accountability. This, however, is similar to the pattern of development in the 1970s, which did not lead to long-term success or the institutionalization of social accounting within industry or academia. As suggested earlier, an integration of the reporting to both internal and external stakeholders is required. Additionally, the linking of this reporting to a broader model of implementation that includes a broadened set of measures, improved corporate governance, and the uses of management systems to drive this through organizations is necessary (Epstein & Birchard, 1999). Academic researchers can provide the frameworks and tools necessary to ensure that the academic and managerial developments of social accounting have more longevity and substance than those in the past.

NOTES 1. Despite more than twenty-five years of development in the field, terminology still lacks standardization. Social audit, social accounting and accountability, social responsibility reporting, social and sustainability performance measurement, and sustainability reporting are all terms used to describe the measurement and reporting of an organization’s social, environmental, and economic impacts, as well as society’s impacts on that organization, including both positive and negative impacts. Corporate citizenship, social responsibility, accountability, stakeholder responsiveness, and sustainable development are all terms

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used to represent the ways in which corporations, internal and external stakeholders, and society interact. 2. In some cases the reports were descriptive and some quantitative. Measurements were sometimes in physical and other quantitative measures and some were monetized. 3. The study reviewed the internal and external documents of over 100 companies and conducted visits and interviews at 35. 4. For examples, see Lessem (1977) and Dierkes and Preston (1977).

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Dierkes, M., & Bauer, R. A. (1973). Corporate social accounting. New York: Praeger. Dierkes, M., & Preston, L. E. (1977). Corporate and social accounting for the physical environment – a critical review and implementation proposal. Accounting, Organizations and Society, 2(1), 3–22. Ditz, D., Ranganathan, J., & Banks, R. D. (1995). Green ledgers: Case studies in corporate environmental accounting. World Resources Institute. Doane, D. (2000). Corporate spin: The troubled teenage years of social reporting. London, UK: New Economics Foundation. Dunlap, R., & Catton, W. (1979). Environmental sociology. Annual Review of Sociology, 5, 243–273. Elkington, J. (1998). Cannibals with forks: The triple bottom line of the 21st century business. Gabriola Island, British Columbia: New Society Publishers. Epstein, M. J. (1996a). Accounting for product take-back. Management Accounting (August), 29–33. Epstein, M. J. (1996b). Measuring corporate environmental performance: Best practices for costing and managing an effective environmental strategy. Burr Ridge, IL: Irwin Professional Publishing. Epstein, M. J., & Birchard, B. (1999). Counting what counts: Turning corporate accountability to competitive advantage. Reading, MA: Perseus Books. Epstein, M. J., Epstein, J. B., & Weiss, E. J. (1977a). Introduction to social accounting. California: Western Consulting Group. Epstein, M. J., Flamholtz, E., & McDonough, J. J. (1976). Corporate social accounting in the United States of America: State of the art and future prospects. Accounting, Organizations and Society, 1(1), 23–42. Epstein, M. J., Flamholtz, E., & McDonough, J. J. (1977b). Corporate social performance: The measurement of product and service contributions. New York: National Association of Accountants. Epstein, M. J., & Freedman, M. (1994). Social disclosure and the individual investor. Accounting, Auditing, and Accountability Journal, 7(4). Epstein, M. J., Kumar, P., & Westbrook, R. A. (2000). The drivers of customer and corporate profitability: Modeling, measuring, and managing the causal relationships. Advances in Management Accounting, 9. Epstein, M. J., & Roy, M.-J. (1997). Integrating environmental impacts into capital investment decisions. Greener Management International: The Journal of Corporate Environmental Strategy and Practice (Spring). Epstein, M. J., & Roy, M.-J. (2001). Sustainability in action: Identifying and measuring the key performance drivers. Long Range Planning, 34. Epstein, M. J., & Wisner, P. S. (2001a). Linking management control systems to environmental performance: Evidence from Mexico. Working Paper. Houston, TX: Rice University. Epstein, M. J., & Wisner, P. S. (2001b). Using a balanced scorecard to implement sustainability. Environmental Quality Management (Winter). Epstein, M. J., & Young, S. D. (1999). Greening with EVA. Management Accounting (January), 45–49. Estes, R. W. (1973). Accounting and society. Wiley. Estes, R. W. (1976). Corporate social accounting. New York: Wiley-Interscience. Estes, R. W. (1996). Tyranny of the bottom line: Why corporations make good people do bad things. San Francisco: Berrett-Koehler Publishers. Freeman, A. M. (1993). The measurement of environmental and resource values: Theory and methods. Washington, DC: Resources for the Future. Freudenberg, W. (1986). Social impact assessment. Annual Review of Sociology, 12, 451–478.

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Gray, R. (2001). Thirty years of social accounting, reporting and auditing: What (if anything) have we learnt? Business Ethics: A European Review, 10(1), 9–15. Gray, R., Bebbington, J., & Walters, D. (1993). Accounting for the environment. R. H. Gray & The Certified Accountants Educational Projects. Gray, R., Owen, D., & Maunders, K. (1987). Corporate social reporting: Accounting and accountability. Prentice-Hall. Gr¨ojer, J. E., & Stark, A. (1977). Social accounting: A Swedish attempt. Accounting, Organizations and Society, 2(4), 349–386. Ilinitch, A. Y., Soderstrom, N. S., & Thomas, T. (1998). Measuring corporate environmental performance. Journal of Accounting and Public Policy, 17, 283–408. Kolk, A. (1999). Evaluating corporate environmental reporting. Business Strategy and the Environment, 8, 225–237. KPMG (1999). KPMG international survey of environmental reporting 1999. Netherlands. Lessem, R. (1977). Corporate social reporting in action – an evaluation of British, European and American practice. Accounting, Organizations and Society, 2(4), 279–294. Linowes, D. F. (1972). Strategies for survival. New York: Amacom. Linowes, D. F. (1974). The corporate conscience. New York: Hawthorn Books. Margolis, J. D., & Walsh, J. P. (2001). People and profits: The search for a link between a company’s social and financial performance. London: Lawrence Earlbaum. Mathews, M. (1997). Twenty-five years of social and environmental accounting research. Accounting, Auditing & Accountability Journal, 10(4), 481–531. Mishan, E. J. (1971). Cost benefit analysis. London: George Allen & Unwin Ltd. Neu, D., Warsame, H., & Pedwell, K. (1998). Managing public impressions: Environmental disclosures in annual reports. Accounting, Organizations and Society, 23(3), 265–282. Nikolai, L. A., Bazley, J. D., & Brummet, R. L. (1976). The measurement of corporate environmental activity. National Association of Accountants. Parker, L. D. (2000a). Green strategy costing: Early days. Australian Accounting Review, 10(1). Parker, L. D. (2000b). Environmental costing: A path to implementation. Australian Accounting Review, 10(3). Pearce, J., Raynard, P., & Zadek, S. (1998). Social auditing for small organizations: A workbook for trainers and practitioners. London: New Economics Foundation. Peters, G. (1999). Waltzing with the raptors: A practical roadmap to protecting your company’s reputation. Wiley. Post, J., & Epstein, M. J. (1977). Information systems for social reporting. Academy of Management Review (January). Pruzan, P. (1998). From control to values based management and accountability. Journal of Business Ethics, 17, 1379–1394. Purser, R., Park, C., & Montouri, A. (1995). Limits to anthropocentrism: Toward an ecocentric organization paradigm? Academy of Management Review, 20(4), 1053–1089. Rockness, J. (1985). An assessment of the relationship between U.S. corporate environmental performance and disclosure. Journal of Business Finance and Accounting (Autumn), 339–354. Schaltegger, S., Muller, K., & Hindrichsen, H. (1996). Corporate environmental accounting. Chichester, England: Wiley. Schnietz, K., & Epstein, M. J. (2003). The crisis value of a reputation for corporate social responsibility: Evidence from the 1999 Seattle WTO meeting. Working Paper. Houston, TX: Rice University. Seidler, L. J., & Seidler, L. L. (1975). Social accounting theory issues and cases. Los Angeles: Melville.

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Shrivastava, P. (1995). Ecocentric management for a risk society. Academy of Management Review, 20(1), 118–137. Simons, R. (1995). Levers of control: How managers use innovative control systems to drive strategic renewal. Boston: Harvard Business School Press. Social Venture Network (1999). Standards of corporate social responsibility. San Francisco: Social Venture Network. Society of Management Accountants of Canada (1995). Implementing corporate environmental strategies. Management Accounting Guidelines No. 37. Hamilton, Ont.: The Society of Management Accountants of Canada. Society of Management Accountants of Canada (1996). Tools and techniques of environmental accounting for business decisions. Management Accounting Guidelines No. 40. Hamilton, Ont.: The Society of Management Accountants of Canada. Society of Management Accountants of Canada (1998). Understanding and implementing ISO 14000. Management Accounting Guidelines No. 45. Hamilton, Ont.: The Society of Management Accountants of Canada. SustainAbility (2000). The global reporters. London, England: SustainAbility. Terleckyj, N. E. (1970, August). Measuring progress towards social goals: Some possibilities at national and local levels. Management Science, 16(12), 765–778. U.S. Department of H.E.W. (1970). Toward a social report. Ann Arbor: University of Michigan Press. Watts, P., & Holme, L. (1999). Meeting changing expectations: Corporate social responsibility. World Business Council for Sustainable Development. Wilson, I. (2000). The new rules of corporate conduct: Rewriting the social charter. Westport, CT: Quorum Books. Wisner, P., Epstein, M., & Bagozzi, R. (2002). Organizational antecedents and consequences of environmental performance. Working Paper. Houston, TX: Rice University. Wiseman, J. (1982). An evaluation of environmental disclosure made in corporate annual reports. Accounting Organizations and Society, 7(1), 53–63. Woodward, D. (1998, August). An Attempt at the classification of a quarter of a century of (non-critical) corporate social reporting. Accounting and Business Society, 6(1), 19–67. Zadek, S., & Chapman, J. (1998). Revealing the emperor’s clothes: How does social responsibility count? London: New Economics Foundation. Zadek, S., Pruzen, P., & Evans, R. (1997). Building corporate accountability: Emerging practices in social and ethical accounting, auditing and reporting. London: Earthscan Publications Limited.

LEGITIMACY AND THE INTERNET: AN EXAMINATION OF CORPORATE WEB PAGE ENVIRONMENTAL DISCLOSURES Dennis M. Patten and William Crampton ABSTRACT Internet usage has exploded over the past decade and the medium is now being suggested as a potentially powerful tool for disclosing environmental information and increasing corporate accountability. This study, grounded in legitimacy theory, argues that such a view may be overly optimistic. Results of an analysis of both annual report and corporate web page environmental disclosures for a sample of 62 U.S. firms do indicate that corporate web pages appear to be adding at least some additional, non-redundant environmental information beyond what is provided in the annual reports. However, the relative lack of negative environmental disclosure on the web pages, in conjunction with the finding that differences in the level of positive/neutral environmental disclosure are associated with legitimacy variables suggests that the focus of Internet disclosure may be more on corporate attempts at legitimation than on moving toward greater corporate accountability.

Advances in Environmental Accounting and Management Advances in Environmental Accounting and Management, Volume 2, 31–57 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-3598/doi:10.1016/S1479-3598(03)02002-8

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INTRODUCTION Internet usage has exploded over the past decade, and it appears that most major corporations have taken advantage of the medium by creating company web pages that provide information about their firms (see, e.g. Lymer, 1997; Wildstrom, 1997). Interestingly, the Internet is also being touted as a powerful tool for corporate environmental communications with stakeholders (Jones et al., 1998, 1999), and even as a medium for increasing corporate social and environmental accountability (SustainAbility/UNEP, 1999). This study suggests these views may be overly optimistic. Proponents of the legitimacy theory of disclosure (e.g. Deegan & Rankin, 1996; Hackston & Milne, 1996; Lindblom, 1994; Patten, 1991, 1992, 2000) argue that corporations use social and environmental disclosure as a tool for participating in, and responding to, the public policy process. In support of this theory, numerous studies (e.g. Adams et al., 1998; Deegan & Gordon, 1996; Hackston & Milne, 1996; Patten, 1991, 2002) have documented a significant relation between both firm size and industry classification and the level of social and environmental disclosure in financial reports. Further, other recent studies (Deegan & Rankin, 1996; Patten, 2000, 2002) provide evidence that corporations appear to use positive or neutral environmental disclosures1 in their financial reports as a means of offsetting or mitigating the impacts of negative environmental actions or disclosures. In general, the proponents of legitimacy theory interpret these findings as evidence that corporations use disclosure as a tool for seeking social legitimacy. This study argues that, unfortunately, corporations may see the Internet as just another tool for attempts at legitimation. Accordingly, the purpose of this study is to identify how firm-specific environmental disclosure on corporate web pages compares to disclosure in annual reports and whether the Internet is in fact being used to further environmental communication with stakeholders. In addition, the study seeks to identify whether web page environmental disclosure, like financial report environmental disclosure, appears to be a function of corporate attempts at legitimation. This study examines the extent of environmental disclosure, both in annual reports and on corporate web pages, for a sample of 62 U.S. firms (32 chemical industry companies and 30 electrical equipment companies). The web pages were examined in late 1998 and compared to the most recently available annual report for each company (1997 annual reports for 55 companies and 1998 annual reports for 7 companies). Content analysis using a coding scheme adapted from Wiseman (1982) was utilized to identify the extent of environmental information provided. Under this method, firms were awarded one point for each of up to 17 different areas of positive or neutral environmental disclosure included in each medium. In

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addition, one point was assigned for each of up to four different areas of negative environmental disclosure in each medium for each of the sample firms.2 The number of sentences devoted to environmental information in each medium was also calculated. Results of the analysis indicate significant differences in environmental disclosure across the two media examined. Sample companies, on average, included significantly more negative environmental information in their annual reports than on their web pages. This holds for both sentence counts and content analysis scores. In contrast, the sample firms exhibited significantly more sentences of positive/neutral environmental disclosure on their web pages than in their annual reports. Interestingly, there was not a corresponding difference in positive/neutral content analysis scores. The mean scores across media were nearly identical. Analysis of differences in disclosure for the specific content items across web pages and annual reports indicates that, in addition to the substantially higher annual report disclosure of negative environmental information, significant variation across a number of the positive/neutral disclosure items also exists. Significantly more companies provided disclosures in annual reports than on web pages for economic related environmental information and for discussion of environmental regulations and requirements. In contrast, there was significantly more web page disclosure of: (1) water discharge information; (2) natural resource conservation; and (3) environmental audit activities. Further, comparison across media within industry groups revealed additional variation. However, and importantly, a comparison of total disclosure scores (intersecting the annual report and web page disclosures) to annual report only scores indicates a statistically significant increase in environmental disclosure. This suggests that Internet disclosures are providing at least some additional, non-redundant environmental information beyond the traditional annual report disclosures. Multiple regression analysis was used to identify whether three legitimacy variables – firm size, industry classification, and the extent of negative environmental disclosure – were associated with the level of positive/neutral environmental disclosure in annual reports and on corporate web pages, respectively. Results for all models indicate that all three of the legitimacy variables were positively and significantly related to the extent of non-negative environmental disclosure. The relations hold across both annual report and web page disclosures. Further, when company specific acknowledgment of involvement in international environmental programs (e.g. ISO Standard 14001) was controlled for, the legitimacy variables continue to show significance. In general, the results of this analysis document that U.S. companies are using the Internet to disseminate environmental information. However, the comparative lack of negative environmental disclosure, in conjunction with the significant

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relation between the extent of positive/neutral disclosure and the legitimacy variables, suggests that the focus of Internet disclosure, in general, may be more on corporate attempts at legitimation than on moving toward greater corporate environmental accountability. The next section of this paper develops the justification for this study.

JUSTIFICATION FOR THE STUDY Over the past several decades a substantial body of investigation related to environmental disclosure in financial reports has been published.3 Among the consistent findings in this research is that corporate environmental disclosure tends to vary significantly across firms. This has been shown to hold for companies in the United States (see Gamble et al., 1995; Patten, 1992, 2002), the United Kingdom (see Gray et al., 1995), Australia (see Deegan & Gordon, 1996), New Zealand (see Hackston & Milne, 1996), Western Europe (see Adams et al., 1998), and the Asia-Pacific region (see Williams, 1999). A number of different theories have been espoused as explanations for the widespread variation in environmental (and other social) disclosure. Gray et al. (1995, p. 52) suggest that, of these, the socio-political theories (political economy theory, legitimacy theory, stakeholder theory) have resulted in the “most penetrating analyses” of corporate social disclosure. In general, these overlapping theories argue that social disclosure is a function of social and/or political pressure, and that firms facing greater social/political pressures will provide more extensive social disclosures. This study more specifically adopts the legitimacy framework. Proponents of legitimacy theory (e.g. Hackston & Milne, 1996; Lindblom, 1994; Patten, 1991, 1992, 2002) argue that the need for legitimacy is a systematic factor that influences the extent of corporate social information disclosure. According to Dowling and Pfeffer (1975, p. 123), “organizations are legitimate to the extent that their activities are congruent with the goals of the superordinate system.” And indeed, according to these authors (1975, p. 127), one of the things an organization can do to gain or maintain legitimacy is to “adapt its output, goals, and methods of operation to conform to prevailing definitions of legitimacy.” However, Dowling and Pfeffer (1975, p. 127) further note that organizations may also use communication to attempt to alter the definition of, or to project an image of, legitimacy. Patten (1991, 1992) adds to the legitimacy framework by more specifically arguing that, while economic legitimacy is monitored in the marketplace, social legitimacy is addressed through the public policy process. In support of this, Patten (1992, p. 472) cites Heard and Bolce (1981, p. 248) who note that “between 1965 and 1980 more than 100 pieces of legislation dealing with the social impact

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of business were enacted in the United States.” Companies, particularly those facing potentially larger impacts from public policy actions, therefore have an incentive to participate in the public policy process. Walden and Schwartz (1997, p. 127) argue that three inter-related non-market environments can impact the public policy process and lead to greater pressures against firms. The first of these, the cultural environment, is defined as consisting of the values and attitudes of the general population. Second, Walden and Schwartz identify the political environment as the source of new laws and regulations. Finally, these authors suggest the legal environment exists as the arena for implementation of regulations and requirements and the source of potential sanctions. Thus, according to Walden and Schwartz (1997), public policy pressure can be the result of dissatisfaction of the people (or subsets thereof), new or proposed political action, and/or differences in regulatory oversight. Accordingly, as summarized by Patten (1992, p. 472) “firms must adapt not only to the formal legal environment, but also to the public policy process from which the issues emerge.” Social disclosure, according to the tenets of legitimacy theory, is used by corporations as one means of participating in, and responding to, the public policy process. Lindblom (1994) (as cited by Gray et al., 1995, p. 54), for example, suggests that a company may use social disclosure to: (1) educate and inform its relevant publics about changes in the firm’s performance and activities; (2) seek to change the perceptions of the relevant publics; (3) manipulate perception by deflecting attention from the issue of concern by focusing on related (presumably more positive) issues; or (4) seek to change the external perceptions of its performance. There is at least some evidence that corporations appear to use environmental disclosure as a manipulative device to offset negative environmental performance or actions.4 To illustrate, Deegan and Rankin (1996) examined the environmental disclosures for a sample of 20 Australian companies that had been successfully prosecuted for environmental violations. They report that only two of the firms disclosed the existence of the offence, and more interestingly, that for all companies in the sample, the amount of positive environmental disclosure was significantly greater than the amount of negative disclosure. These results are consistent with the findings of Patten (2002), who finds that the extent of positive or neutral environmental disclosures for a sample of U.S. firms is systematically higher for firms with higher levels of size-adjusted toxic releases than for firms with lower releases. Both Deegan and Rankin (1996) and Patten (2002) argue that the environmental disclosures are being used as a tool to offset or mitigate the negative impact of actual environmental performance. Finally, another recent study (Patten, 2000) suggests that companies disclosing negative environmental information in their financial reports may attempt to offset

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or deflect attention from those disclosures by including other, positive or neutral environmental information as well. Patten (2000) identifies the change in the level of disclosure about Superfund-related remediation liabilities from the mid-1980s to the mid-1990s for a sample of 95 U.S. companies. He also identifies the change in the provision of positive/neutral environmental information over this period. Patten reports significant increases in the provision of both types of information. Further, the study also shows that firm-specific increases in negative disclosure were significantly correlated with firm-specific increases in the provision of positive/neutral environmental information, a finding the author interprets as evidence of attempts at legitimation by the affected companies. While the results presented above do suggest that corporations appear to use environmental disclosure as a legitimating device, it is important to note that, within the legitimacy framework, the use of disclosure is not purely reactionary. Because social legitimacy is addressed through the public policy process, it can be expected that private businesses “will initiate and participate in, as well as respond to the process of social decision making” (Preston & Post, 1975, p. 4). Social disclosure in this context “might be used to anticipate or avoid social pressure . . . [or] to boost the corporation’s public standing” (Parker, 1986, p. 76). Companies with greater potential impacts from the public policy process are assumed to have a greater incentive to participate in the process through disclosure. As such, variation in the extent of environmental disclosure across companies is argued to be a function of differences in the exposure of the companies to the public policy process.5 Previous studies (e.g. Adams et al., 1998; Cowen et al., 1987; Deegan & Gordon, 1996; Hackston & Milne, 1996; Patten, 2002) suggest that there are some systematic factors associated with greater potential public pressure relative to environmental concerns. Larger firms, presumably due to visibility issues, are subject to greater public and regulatory scrutiny than smaller companies. Similarly, companies in industries that have a larger potential impact on the environment are also deemed to be subject to greater pressures with respect to environmental concerns than firms from less environmentally sensitive industries. These previous studies also document a significant relation between both firm size and industry classification and the extent of environmental disclosure in corporate financial reports. In summary, legitimacy research suggests that corporations systematically use disclosure in financial reports as a legitimating communications device to participate in, and thus reduce their exposure to, the public policy process. This study attempts to extend this body of research by examining how a new and potentially powerful communications device, the Internet, is being used by corporations for environmental disclosure.

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The Internet and Environmental Disclosure As noted by Lymer (1997, p. 3), “the Internet is a global network of computers that share a common transmission language to enable the sharing of data and applications on a wide scale.” And although the medium was first developed in the late 1960s, the Internet did not gain widespread use until relatively recently. Indeed, its growth through the 1990s has been phenomenal. To illustrate, Lynch (1997, p. 53) notes that as recently as early 1993 there were only approximately 130 web sites in existence. According to The Internet Index,6 by April of 1998 that number had grown to an estimated 320 million. Given the exponential growth of the Internet, in conjunction with its ability to reach an audience of millions, it is perhaps not surprising that the medium is being suggested as a powerful tool for disseminating environmental information to interested stakeholders (see, e.g. Jones et al., 1998, 1999; or SustainAbility/UNEP, 1999). As noted by Jones et al. (1999, p. 77), “the Internet, with its lack of space restrictions, allows providers to make available a breadth and depth of information.” More optimistically, SustainAbility/UNEP (1999, p. 18), it its 1999 Engaging Stakeholders program report, suggests: The Internet will provide both new (increasingly ‘wireless’) channels for existing forms of corporate accountability and help evolve new forms of accountability and corporate governance. Imagine, for example, that a company’s stakeholders had access not only to online data on how it was performing against key sustainability-related targets, but also to instantaneous benchmark results, showing how it measures up against its competitors – and where areas of risk might be.

Unfortunately, the history of financial report environmental disclosure suggests that corporations may see the Internet not as the powerful tool for stakeholder accountability as envisioned by SustainAbility/UNEP, but rather as another device for legitimacy-related communication. Indeed, initial surveys of web-based environmental disclosure, while admittedly quite limited in scope, do not suggest that the Internet is, as yet, a substantial medium for increased corporate accountability. To illustrate, Jones et al.’s (1999) examination of 275 corporations that had previously published hard copy environmental reports (the sample was drawn from 21 countries across 21 different industries) found that “a total of 41% of the companies provided little or no environmental information on their website” (1999, p. 77). Similarly, SustainAbility/UNEP (1999, p. 10) report that only 83 of the 150 major international corporations examined for their survey included an environmental report on the company web site. Further, both Jones et al. (1999) and SustainAbility/UNEP (1999) suggest that even for those companies providing environmental information on their web pages the extent of disclosure varied substantially.

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Unfortunately, neither of the above-noted surveys provides any detailed data on the specific types of environmental information, by company, disclosed on the web pages examined, and neither makes any comparison to concurrent levels of company-specific environmental disclosure in financial reports. Indeed, to date, there appear to be no academic studies that address these issues.7 Accordingly, the first purpose of this study is to more specifically identify how firm specific environmental disclosure on corporate web pages compares to disclosure in annual reports and whether the Internet is in fact being used to further environmental communication with stakeholders. Second, the study also seeks to identify whether web page environmental disclosure, like financial report environmental disclosure, appears to be a function of corporate attempts at legitimation.

RESEARCH METHOD Sample In order to be included in the sample for this study, firms had to: (1) be listed as either a chemical industry firm or an electrical equipment industry company in the 1997 Fortune listing of the 500 largest U.S. firms; (2) provide a 1997 or 1998 annual report for review; and (3) have an accessible corporate web page on the Internet. The chemical and electrical equipment industries were chosen for analysis because each had a relatively large number of companies (40 and 39, respectively). In addition, the chemical industry is one that is normally classified as being subject to greater environmental public pressures while the electrical equipment industry is not (see, e.g. Cowen et al., 1987; Patten, 1991, forthcoming).8 This allows for analysis of differences in disclosure due to environmental sensitivity (discussed below). Four of the 79 companies in the combined industry groupings were eliminated due to being taken over by another firm during 1998, being a wholly-owned subsidiary of another firm, or because the firm divested its industry segment during 1998. Each of the remaining 75 companies was contacted in the Fall of 1998 with a request for the firm’s most recent annual report. All but seven of the companies responded, but four sent 10-K reports instead of annual reports.9 Finally, two firms were eliminated due to an inability to access their corporate web pages.10 The resulting sample, therefore, consists of 62 companies with 32 from the chemical industry and 30 from the electrical equipment industry. Fifty-five of the firms provided 1997 annual reports and seven sent 1998 reports. Sample firm descriptive data are summarized in Table 1.

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Table 1. Sample Firm Data. Chemical Industry

Electrical Equipment Industry

Firms included on Fortune 500 listing Firms excluded due to Divestiture/take-over/wholly-owned sub No annual report received No web page access

40

39

2 5 1

2 6 1

Final sample

32

30

Mean 1997 revenues (in $millions) Median 1997 revenues (in $millions)

$4,885 $2,704

$7,364a $2,105

Note: A listing of the sample firms is available from the authors upon written request. a Difference in means is not significant (at p = 0.10, two-tailed).

Environmental Disclosure Measures In order to determine the extent of environmental disclosure included on the corporate web pages, each of the sample companies’ Internet sites was accessed during November of 1998 and analyzed for the provision of environmental information. More specifically, each of two independent reviewers accessed each corporate web page and identified all environment-related information disclosures. These were identified by examining all links included through two levels from the home page on each site.11 To the extent that links to deeper levels were indicated, these, too, were followed. All environment-related disclosures were then printed out for hard copy coding. All differences in disclosure across reviewers were discussed and reconciled. Two important exclusions to web page disclosures were made. First, because the study also separately examines annual report environmental disclosures, on-line copies of the report, where available, were not included in the web page analysis.12 Second, links to external press release disclosures were also not followed.13 Similar to the web page analysis, each of the sample company annual reports was examined for environmental disclosures by two independent reviewers. All disclosures were identified, and differences across reviewers were discussed and reconciled. Two different variables were used in this study to measure the extent of environmental disclosure in sample firms’ annual reports and web pages. First, content analysis based on a coding scheme adapted from Wiseman (1982) was used. Under this approach, the environmental disclosures identified through review of the annual reports and the web pages were analyzed, and companies were awarded

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a point for each of up to 21 different areas of environmental information provided (see Table 4 for listing of the disclosure areas).14 These were divided into negative disclosure (four items) and positive or neutral disclosure (17 items).15 Borrowing from Deegan and Rankin (1997, p. 581), negative disclosures are defined as “disclosures that present the company as operating to the detriment of the natural environment.” The disclosures related to remediation problems – acknowledgment of exposures, specific disclosure as a Potentially Responsible Party under Superfund statutes,16 and disclosures of accruals or expenses related to remediation activities – would all appear to indicate that the company is responsible for past negative environmental actions. Similarly, the disclosures indicating exposures due to other, non-remediation environmental problems also signals negative environmental actions. In contrast, positive disclosures are those that “present the company as operating in harmony with the environment” (Deegan & Rankin, 1997, p. 581). Mention of environmental awards won and discussion of environmental attributes of products, for example, can clearly be seen as presenting a positive environmental image. Finally, there are some environmental disclosures which, in and of themselves, are neither positive or negative in nature. For example, disclosures of capital expenditures for pollution abatement or control and disclosures of emissions data can only take on positive or negative qualities in relation to other comparative data.17 Separate content analysis scores, negative and positive/neutral, were determined for the annual report and web page disclosures.18 Classifications were made independently by the two reviewers and all differences across reviewers were discussed and reconciled. It should be noted that while the web page disclosures are totally voluntary, environmental litigation and remediation disclosures are mandatory in the annual reports to the extent that probable liabilities exist.19 Finally, in addition to the content analysis scores, the number of sentences devoted to environmental information in each medium, broken down across negative and positive/neutral classifications, was also used as a measure of disclosure extensiveness.20 The statistical significance of differences in the extent of environmental disclosure across media was determined through a t-test on the difference in mean scores. A chi-square test was used to determine statistically significant differences in the number of companies providing specific types of environmental information (based on the coding scheme) across media. Regression Analysis The second major focus of this study was to identify whether corporate web page environmental disclosures appear to be a function of corporate attempts at

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legitimation. Accordingly, multiple regression analysis was used to test whether differences in the extent of disclosure are associated with firm specific legitimacy variables. As noted above, numerous studies have documented a significant relation between both firm size and industry classification and the level of financial report environmental disclosure. As such, each of these factors was included in the present analysis. However, as noted by Patten (1991, p. 305), firm size and industry classification are potentially noisy proxies for legitimacy-based public policy pressure. Indeed, since size, and to a lesser extent industry, are also factors that positive accounting theorists have used to test the political cost hypothesis related to accounting method choice (for an overview, see Watts & Zimmerman, 1986, pp. 222–243),21 it is not clear that the findings related to relations with the level of environmental disclosure can unambiguously be attributed to legitimacy concerns.22 Accordingly, this analysis attempts to extend the legitimacy-based testing by including an additional legitimacy variable. As noted above, Patten (2000) documents a significant relation between the change in Superfund-related disclosures for a sample of U.S. firms and the concurrent change in their positive/neutral financial report environmental disclosures. Although the results presented in Patten (2000) relate only to changes in the level of environmental disclosure, they suggest that there may be a legitimacy-based relation between the level of negative and positive/neutral environmental information provided in reporting media. As such, it can be conjectured that companies with higher levels of negative environmental disclosures in a given medium would be expected to attempt to offset or mitigate these disclosures through the provision of more extensive positive or neutral environmental information. Further, because current U.S. reporting standards require certain disclosures on environmental contingencies to the extent they exist (see, e.g. Siegel & Surma, 1992; Zuber & Berry, 1992) while web page disclosures are entirely voluntary, examining for potential differences in the relation between negative and positive/neutral environmental disclosure across media would appear to provide an interesting extension of legitimacy-based research. As such, in addition to firm size and industry classification, the level of negative environmental disclosure in each reporting medium was also included as an explanatory variable. Ordinary least squares regression analysis was used in this study to examine for the legitimacy relations. The regression model is stated as: EDi = a 1 + B 1 Firm Sizei + B 2 Industryi + B 3 NegDisci

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where EDi = Firm Sizei = Industryi = NegDisci =

the positive/neutral environmental disclosure measure (either content analysis score or sentence count) for firm i. the natural log of firm i’s 1997 revenues (from the annual report). 1 if the firm is from the chemical industry and zero if it is from the electrical equipment industry. the negative disclosure measure (either content analysis score or sentence count) for firm i.

Separate regressions were run using: (1) annual report positive/neutral content analysis scores; (2) annual report positive/neutral sentence counts; (3) web page positive/neutral content analysis scores; and (4) web page positive/neutral sentence counts as the dependent variable.23 All three independent variables are expected to be positively related to the dependent variable.

RESULTS Comparisons Across Media Results of the analysis of the extent of disclosure are presented in Table 2. The table reports comparisons for the total sample, and separately by industry. Consistent with firms in previous studies of environmental disclosure, the sample companies in this examination exhibited a wide range of disclosure. This is true for both the annual reports and the web pages. The number of annual report sentences of negative environmental disclosure varied from zero to 56 with a mean of 15.37. The web page negative disclosure sentences ranged from zero to 44 with a mean of 1.42. This difference in the mean number of sentences is statistically significant (at p = 0.000, two-tailed). In contrast, the web pages, on average, had significantly more sentences of positive/neutral environmental disclosure than the annual reports. The mean positive/neutral environmental disclosure sentence count on the web pages was 70.90 (based on a range from zero to 430) in comparison to the annual report average sentence count of 9.63 (range of zero to 60). This difference is statistically significant at the p = 0.000 level, two-tailed. Similar to the results for the sentence counts, the content analysis scores for negative disclosures in the annual reports, on average, were higher than the mean content scores for negative environmental disclosure on the web pages. The mean annual report negative environmental disclosure content score was 1.82 in comparison to a mean of 0.35 for the web pages. This difference is statistically significant (at p = 0.000, two-tailed). Interestingly, however, while the sample

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Table 2. Mean Environmental Disclosures. Comparison of Mean Environmental Disclosure Sentence Counts and Content Analysis Scores in Sample Companies’ Annual Reports and Corporate Web Pages. t-Stata

Sig. Levelb

Annual Report

Web Page

Negative sentences Total sample Chemical Elect. equip.

15.37 25.13 4.97

1.42 0.75 2.13

6.166 7.913 1.387

0.000 0.000 0.171

Positive/neutral sentences Total sample Chemical Elect. equip.

9.63 15.59 3.27

70.90 83.56 57.37

−4.067 −3.286 −2.458

0.000 0.002 0.017

1.82 2.66 0.93

0.35 0.41 0.30

6.742 8.414 2.369

0.000 0.000 0.021

Positive/neutral content scores Total sample 3.63 Chemical 5.28 Elect. equip. 1.87

3.73 4.69 2.70

−0.135 0.598 −0.910

0.893 0.552 0.367

Negative content scores Total sample Chemical Elect. equip.

a The b All

t-stat is for the t-test on the difference in means. significance levels are two-tailed.

companies had a significantly higher number of sentences of positive/neutral environmental disclosure on their web pages in comparison to their annual reports, there is not a corresponding difference in content analysis scores. The average positive/neutral content analysis scores are nearly identical across media, with a mean score of 3.63 for the annual reports and 3.73 for the web pages. This difference is not statistically significant. With the exception that there was no significant difference in negative sentence counts across annual reports and web pages for the electrical equipment firms, the results by industry mirror the overall sample results. As noted in Table 3, there is a statistically significant (at p < 0.05, two-tailed) correlation between the annual reports and the web pages for both the sentence count and the content analysis scores for positive/neutral environmental disclosures. There is also a positive correlation between the annual report and web page negative disclosure measures. However, the correlation for the negative content analysis scores is significant at only the p = 0.099 level (two-tailed), while the correlation between the two negative disclosure sentence counts is not statistically significant. In general these results suggest that companies

44

Table 3. Pearson Product-Moment Correlations.

∗ Indicates

1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000

−0.040 0.621** 0.211 0.361** 0.166 0.119 0.438** 0.336** 0.283*

significance at 0.05 level, two-tailed. significance at 0.01 level, two-tailed.

∗∗ indicates

0.302* 0.054 0.741** 0.743** 0.689** 0.510** 0.740** 0.845**

0.440** 0.605** 0.145 0.314* 0.438** −0.001 0.435**

0.324** −0.117 0.641** 0.670** 0.609** 0.617**

0.245 0.494** 0.229 0.156 0.418**

0.458** 0.225 0.568** 0.786**

0.490** 0.459** 0.235

0.376** 0.112

0.512**

DENNIS M. PATTEN AND WILLIAM CRAMPTON

LogRev Industry AR neg. scores Web neg. scores AR neg. sent. Web neg. sent. AR pos/neu scores Web pos/neu/scores AR pos/neu sent. Web Pos/Neu sent.

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including higher (lower) levels of environmental disclosure in their annual reports also tend to include higher (lower) levels of environmental disclosure on their web pages.24 Table 4 reports the number of sample companies providing disclosures, by specific content area, in annual reports and on web pages, respectively. As noted in the table, there are a number of areas where disclosure across media varies. First, significantly more companies included disclosure of the three remediation-related negative items in their annual reports than on their web pages. The finding that these negative disclosure items are more prevalent in the annual reports is not surprising in that such disclosures are required there while they are completely voluntary for the web pages. There was also significantly higher annual report disclosure for all four of the economic disclosure areas, and for discussion of environmental regulations or requirements. It should be noted, however, that for these disclosure areas the difference across media is significant for only the chemical industry firms. Finally, while there is not a statistically significant difference for the overall sample, significantly more chemical firms disclosed information related to compliance status in their annual reports than on their web pages. In contrast to the above results, there were some disclosure areas for which significantly more companies made web page disclosures (relative to the annual reports). These include: (1) water discharge information; (2) discussion of natural resource conservation; and (3) discussion of environmental audit activities. However, while the water discharge disclosure difference holds across both the chemical and electrical equipment firms, the discussion of natural resource conservation disclosures are significantly different for only the electrical equipment company sample. Interestingly, while the overall sample difference for disclosures on environmental audit activities is significant, neither within industry difference is statistically significant. Finally, significantly more electrical equipment companies provided disclosures about recycling and about air emissions on their web pages than in their annual reports. The results presented in Table 4 suggest that there are indeed differences in the type of environmental information companies are choosing to disclose on their web pages relative to their annual reports. In order to examine whether the web page disclosures are leading to an overall increase in available environmental information, therefore, total disclosure content scores (the intersection of disclosure areas included in annual reports with disclosure areas included on the web pages) for each company were compared with annual report disclosure scores only. As presented in Table 5, the mean total disclosure score for the sample firms is 7.68 in comparison to the mean annual report score of 5.45. This difference is significant at the 0.018 level, two-tailed. Further, comparison of the positive/neutral disclosures only shows a total mean content score of 5.73 in

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DENNIS M. PATTEN AND WILLIAM CRAMPTON

Table 4. Number of Sample Companies Making Disclosure by Area and Media. Positive/neutral disclosures Economic Current or past capital expenditures for pollution abatement or control Current or past operating costs for pollution abatement or control Projection of future expenditures for pollution abatement or control Projection of future operating costs for pollution abatement or control Pollution abatement Air emission information is provided Water discharge information is provided Solid waste disposal information is provided Pollution control or abatement facilities or processes are discussed Compliance status is mentioned or discussed Other disclosures Discussion or mention of environmental regulations or requirements Statement of environmental policies or company concern for the environment Conservation of natural resources discussed Mention or discussion of environmental awards Recycling information provided Disclosure of an office or department for environmental control Discussion of environmental attributes of products Discussion of environmental audit activities Negative environmental disclosures Discussion of exposures due to past or present remediation problems Specific disclosure that the company has been named as a potentially responsible party Disclosure of monetary accruals and/or expenses incurred for remediation Discussion of exposures due to other, non-remediation-related environmental problems

␹2

AR

Web

25

9

10.373∗∗ (C−0.05)

19

6

8.467∗∗ (C−0.01)

16

0

18.370# (C−0.001)

10

0

10.877# (C−0.01)

10 3 3 11

19 14 9 18

3.645 (EE−0.05) 8.247∗∗ (C−0.05, EE−0.05) 3.321 2.204

23

14

3.120 (C−0.05)

25

12

6.509∗∗ (C−0.05)

31

38

1.600

5 10 3 6

13 18 9 10

4.158∗ (EE−0.05) 2.951 3.321 (EE−0.05) 1.148

19 8

24 17

0.889 4.058∗

39

7

35.388# (C−0.001, EE−0.05)

33

6

27.268# (C−0.001)

32

4

30.687# (C−0.001, EE−0.001)

9

5

1.288

Note: Chi-square tests for the significance in the difference of the number of firms making individual category disclosures in annual reports as opposed to web pages. Significance at the 0.05 level (two-tailed) is designated with an ∗ , significance at the 0.01 level (two-tailed) is designated with an ∗∗ , and significance at the 0.001 level (two-tailed) is designated with an # . Where there is a statistically significant difference in the number of firms making disclosures within industry groupings, the industry (C = chemical, EE = electrical equipment) and significance level are noted in parentheses.

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Table 5. Comparison of Total Disclosure Content Scores to Annual Report Only Scores. Annual Report Content Scores

t-Stata

Sig. Levelb

Negative and positive/neutral disclosure Total sample 7.68 Chemical 10.16 Elect. equip. 4.80

5.45 7.94 2.80

2.407 1.907 1.871

0.018 0.061 0.066

Positive/neutral disclosure only Total sample 5.73 Chemical 7.63 Elect. equip. 3.70

3.63 5.28 1.83

2.804 2.300 2.136

0.006 0.025 0.037

Total Disclosure Content Scores

Note: Total disclosure scores represent the intersection of the annual report disclosure areas with the web page disclosure areas. a The t-stat is for the t-test on the difference in means. b All significance levels are two-tailed.

comparison to the annual report only score of 3.63. This difference is significant at the p = 0.006 level, two-tailed. Results, by industry, also presented in Table 5, again mirror the total sample results, although the significance levels are not quite as high. Thus, it appears that web page disclosures are providing at least some new, non-redundant environmental information (relative to the annual report disclosures).

Legitimacy Tests The second purpose of this study was to identify whether differences in web page environmental disclosure are associated with legitimacy variables. The study also extends existing research by examining whether, in addition to firm size and industry classification, the presence of higher levels of negative environmental information is associated with the provision of higher levels of positive/neutral environmental disclosure, and whether these relations differ across media. Pearson product-moment correlations are presented in Table 3. With the exception that industry classification is not significantly correlated with web page measures of environmental disclosure, univariate relations between each of the independent variables and its dependent counterpart are statistically significant. It also must be noted that there is a statistically significant correlation between firm size and three of the four measures of negative environmental disclosure.

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Table 6. Regression Results for Tests of the Relation Between the Legitimacy Variables and the Annual Report Non-Negative Environmental Disclosure Measures. Variable

Parameter Estimate

t-Stat

Significance of t-Stat

Panel A – Annual report positive/neutral content scores as dependent variable Constant −27.998 −3.602 Firm size 3.055 3.688 Industry 2.017 2.433 NegDisc 0.870 2.776 Adj. r2 = 0.510

F-stat = 22.205

Significance of F-stat = 0.0000

Panel B – Annual report positive/neutral sentence count as dependent variable Constant −79.708 −2.355 Firm size 8.565 2.393 Industry 6.295 1.782 NegDisc 0.310 2.758 Adj. r2 = 0.410

F-stat = 15.155

0.001 0.001 0.009 0.004

0.022 0.010 0.040 0.004

Significance of F-stat = 0.000

Note: The regression model is stated as: EDi = a 1 + B 1 Firm Sizei + B 2 Industryi + B 3 NegDisci where EDi is the environmental disclosure variable as noted in each panel for firm i, Firm Sizei is the natural log of 1997 revenues for firm i, Industryi is a one/zero classification variable where 1 indicates firms from the chemical industry, and NegDisci is the negative disclosure measure for company i. The sample size is 62 for all regressions. Significance levels are one-tailed for the Firm Size, Industry, and NegDisc variables.

However, tests recommended by Kmenta (1971, pp. 389–390) suggest that multicollinearity is not a problem. The results of the regression analysis for the annual report disclosures are presented in Table 6. Panel A reports the results using content analysis scores, while Panel B reports the results using sentence counts. Each of the regression models, based on the model F-statistic, is highly significant (p = 0.000, two-tailed) and, in each case, the amount of variation in the dependent variable explained is quite high. The adjusted R2 measures are 0.510 and 0.410 for the content analysis and sentence count models, respectively. As hypothesized, all three of the public policy pressure variables – firm size, industry classification, and level of negative disclosure – are positively associated with the level of positive/neutral environmental disclosure in the annual reports. All three measures are statistically significant (at p < 0.05 or better, one-tailed) in each model. The results of the regression analysis examining web page content analysis scores (Panel A) and sentence counts (Panel B) are presented in Table 7. Similar

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Table 7. Regression Results for Tests of the Relation Between the Legitimacy Variables and the Corporate Web Page Non-Negative Environmental Disclosure Measures. Variable

Parameter Estimate

t-Stat

Significance of t-Stat

Panel A – Web page positive/neutral content scores as dependent variable Constant −24.495 −2.413 Firm size 2.783 2.596 Industry 1.819 2.296 NegDisc 2.447 5.469 Adj. r2 = 0.514

F-stat = 22.547

Significance of F-stat = 0.000

Panel B – Web page positive/neutral sentence count as dependent variable Constant −1010.1 −4.144 Firm size 109.8 4.277 Industry 44.7 2.171 NegDisc 10.8 6.004 Adj. r2 = 0.533

F-stat = 24.178

0.019 0.006 0.013 0.000

0.000 0.000 0.017 0.000

Significance of F-stat = 0.000

Note: The regression model is stated as: EDi = a 1 + B 1 Firm Sizei + B 2 Industryi + B 3 NegDisci where EDi is the environmental disclosure variable as noted in each panel for firm i, Firm Sizei is the natural log of 1997 revenues for firm i, Industryi is a one/zero classification variable where 1 indicates firms from the chemical industry, and NegDisci is the negative disclosure measure for company i. The sample size is 62 for all regressions. Significance levels are one-tailed for the Firm Size, Industry, and NegDisc variables.

to the results for the annual report disclosures both models are highly significant and both models have high adjusted R2 values (0.514 for the content analysis score model and 0.533 for the sentence count model). Also consistent with the results of the annual report analysis, all three legitimacy variables are positively associated with the level of positive/neutral environmental disclosure and all are statistically significant (at p < 0.02 or better, one-tailed). Overall the results indicate that, in general, and across both media, larger firms tend to provide more positive/neutral environmental disclosure than smaller firms, companies in the environmentally sensitive chemical industry tend to disclose more positive or neutral environmental information than firms in the less environmentally sensitive electrical equipment industry, and firms with higher levels of negative environmental disclosure in a given medium tend to provide higher levels of positive/neutral environmental disclosure in that medium than firms with lower levels of negative disclosure. These results are consistent with

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DENNIS M. PATTEN AND WILLIAM CRAMPTON

legitimacy theory arguments that companies use environmental disclosure as a means of attempting to reduce public policy pressures.

Further Analysis The finding that the level of non-negative environmental disclosure is related to the public policy pressure variables is consistent with legitimacy theory arguments. However, it is possible that the higher disclosure levels are due to differences in company responses to calls for greater environmental disclosure by corporations world-wide. For example, the International Standards Organization’s ISO 14001 Standard, the Global Reporting Initiative, the Public Environmental Reporting Initiative, and the Coalition for Environmentally Responsible Economies, are all examples of programs developed largely in the 1990s that encourage greater corporate environmental disclosure. Companies involved in these programs might be expected to exhibit higher levels of environmental disclosure.25 A review of the annual reports and corporate web pages indicated that nine of the 62 sample firms acknowledged involvement in at least one of the above-listed programs. To assure that the results reported above are not being driven by this involvement two additional tests were conducted. First, all regressions were re-run including a one/zero indicator variable (ISO), where a one identified the nine companies Table 8. Regression Results Controlling for Sample Company Involvement in International Environmental Programs. Variable

Annual Reports Sentences

Content Scores

Web Pages Sentences

Content Scores

Panel A – Significance levels from regression models including a one/zero indicator variable to designate companies with acknowledgment of involvement in international environmental programs (ISO). Sample size = 62 Firm size 0.040 0.002 0.001 0.029 Industry 0.033 0.009 0.023 0.012 NegDisc 0.007 0.005 0.000 0.000 ISO 0.061 0.135 0.076 0.007 Panel B – Significance levels from regression models excluding companies with acknowledgment of involvement in international programs. Sample size = 53 Firm size 0.094 0.008 0.021 0.042 Industry 0.053 0.067 0.152 0.019 NegDisc 0.023 0.009 0.000 0.000 Note: Significance levels are one-tailed.

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with acknowledgment of involvement in the environmental programs. Second, the regressions were re-run deleting these nine firms from the sample. The results of the regression analyses controlling for involvement in the international environmental programs are summarized in Table 8 (Panel A). The ISO variable is positively related to all four disclosure measures and is statistically significant (at the p < 0.10 level or better, one-tailed) for all but the annual report content analysis score model. Importantly, all three of the legitimacy variables retain their significance (at p < 0.05 or better, one-tailed) in all four models. Similarly, the results of the regressions where the ISO companies are excluded, summarized in Table 8, Panel B, also continue to show support for the legitimacy theory arguments. With the exception that the industry classification variable is not statistically significant in the web page sentence count model, all of the legitimacy variables continue to be significantly related (at p < 0.10 or better, one-tailed) to the level of positive/neutral environmental disclosure for all of the models. In general therefore, the results of these further analyses suggest that while involvement in the international environmental programs does appear to influence the level of environmental disclosure, the legitimacy variables continue to be significant explanators of differences in the extent of disclosure.26

DISCUSSION The first major objective of this analysis was to identify how environmental disclosure on corporate web pages compared to similar disclosure in annual reports. The finding that the sample companies, on average, devoted significantly more space to environmental issues on their web pages than in their annual reports is certainly not surprising in that the cost of additional space on web pages is substantially lower than the cost of additional space in annual reports. However, the concurrent finding that the increased space does not correspond to similar increases in the content of disclosure is interesting. Further, the significantly lower level of negative environmental information on the web pages suggests that the emphasis of the web page disclosure is more public relations than full environmental disclosure. Of course, it is possible that company management assumes stakeholders interested in litigation and remediation disclosures will seek them out in the annual reports given current U.S. reporting standards on environmental contingencies.27 However, it must be noted that there were numerous instances where companies chose to include more positive aspects of environmental disclosure in both their annual reports and their web pages. More detailed analysis of this issue would appear to be warranted. The second major goal of the current study was to identify whether web page environmental disclosure, like financial report environmental disclosure,

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DENNIS M. PATTEN AND WILLIAM CRAMPTON

appears to be a function of corporate attempts at legitimation. Further, the study extended legitimacy-based research by examining whether the extent of negative environmental disclosure, in addition to firm size and industry classification, is associated with the level of positive/neutral environmental disclosure on corporate web pages as well as in annual reports. Results of multiple regression analysis indicate that all three of the legitimacy variables are significantly related to the level of positive/neutral environmental disclosure in both media. The results were also shown to hold when acknowledgment of company involvement in international environmental programs such as ISO Standard 14001 was controlled for. Accordingly, the results provide further evidence that corporate environmental disclosure appears to be influenced by legitimacy concerns. In general the results of this analysis suggest that, while corporate web page disclosure is adding to the level of environmental information beyond that available in annual reports, the emphasis appears to be more on legitimating the corporation than on adding to accountability. Of course, this is a potential problem that even SustainAbility/UNEP (1999) recognized. As noted in their own report (1999, p. 18), “unfortunately, there is a great temptation to put a public relations spin on information, whether published in a printed [environmental report] or on the website.” It must be noted, of course, that this study, like all empirical investigations, is subject to certain limitations. This examination is limited to an analysis of disclosures of firms from only two industries. The extent to which the results are generalizable, therefore, cannot be determined. Further, this analysis examines the disclosures for only U.S. companies. Previous surveys of web page environmental disclosure (e.g. Jones et al., 1999; SustainAbility/UNEP, 1999) document that the Internet is being used as a medium of corporate disclosure by a wide sample of international companies. Accordingly, a more detailed examination of the variation in the medium’s use for environmental information presentation across countries, and whether legitimacy-based arguments for the variation hold in other settings, would appear to be an interesting extension. Finally, this study looks at web page environmental disclosure at a single point in time. Given the flexibility for change on the Internet, analyses of differences in corporate web page disclosure over a period of time (and particularly in times of changing public pressures) could well prove interesting.

NOTES 1. In general, positive disclosures are defined as statements that portray the company as acting in harmony with the environment, negative disclosures are statements that indicate

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negative environmental impacts, and neutral disclosures are statements that can only take on positive or negative qualities in relation to other comparative data. These definitions are discussed in more detail later in the paper. 2. The specific items of negative and non-negative environmental disclosure are identified in Table 4. 3. For an overview of this literature, see Gray et al. (1995) or Mathews (1997). 4. Three firm-specific anecdotal examples are provided by Savage et al. (2000, pp. 79–81). 5. The interpretation of legitimacy theory as a purely reactive explanator for social disclosure appears to be a contributing factor to attempted rebuttals of the theory. To illustrate, Guthrie and Parker (1989, p. 344) specifically identify their interpretation of legitimacy theory’s explanation for social disclosure as “reacting to the environment where they are employed to legitimize corporate actions” (emphasis added). As such, when the authors suggest (1989, p. 350), for example, that the existence of human resource disclosures in Broken Hill Proprietary’s annual reports in the late 1960s and early 1970s, a period without company labor dispute, is evidence against legitimacy theory, they appear to be failing to take into account Parker’s own acknowledgment that social disclosure might be used to anticipate social pressures. 6. “The Internet Index” is an on-line source of statistical information related to the Internet. It is accessible at http://www.openmarket.com/intindex/98–05.htm. 7. Both Flynn and Gowthorpe (1997) and Ashbaugh et al. (1999), in their studies of financial reporting on the Internet, do identify that some companies also make environmental disclosures on their web pages. However, neither study provides any detail on the types of environmental information provided. 8. It should be noted that while the electronic equipment industry is not usually identified as an environmentally sensitive industry, that does not mean its companies do not have any environmental exposures. These firms, to the extent that they have manufacturing facilities, for example, are subject to reporting requirements under the Environmental Protection Agency’s Toxic Releases Inventory program. Further, as noted in the results presented later, a number of these companies report exposures related to remediation-related problems. 9. The 10-K report is an annual financial report that must be filed with the Securities and Exchange Commission. Because 10-K report environmental disclosure requirements differ from annual report environmental disclosure requirements (see, e.g. Freedman & Wasley, 1990; Zuber & Berry, 1992), the 10-K reports were not considered to be comparable to annual reports for the purposes of this study. As such, these firms were not included in the study. 10. One company required password verification to access its web page. The second firm’s web site continued to crash during review (numerous attempts were made to access this site over a four week period). 11. This is consistent with the approach taken by Lymer (1997). To further assure that no relevant information was missed, a complete web site analysis (tracing all links to their deepest levels) was conducted for 12 of the sample firms (ranging across both industries and a variety of firm sizes). No additional environmental disclosure was discovered. It is always possible, of course, that such disclosure did exist for the other sample firms. 12. The focus of this analysis was on the environmental information companies choose to highlight on their web pages. And while many of the firms did have on-line links to

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their annual reports, there were no instances of companies linking to the annual report for additional environmental information. 13. It is important to note that only links to external press releases were excluded. Press releases of the sample companies, themselves, were examined for environmental disclosure. 14. Sentences were used as the basis for coding for this study. That is, each of the independent reviewers read each sentence as a separate statement, and, if it was deemed to provide information related to one of the 21 categories of disclosure a point was awarded for that area. Where a single sentence contained information that properly disclosed information about more than one area of disclosure, a point was awarded for each category. Following complete coding by each of the reviewers, all differences were identified, discussed, and reconciled. Each of the independent reviewers had considerable prior experience with environmental content coding. 15. It must be noted that assigning positive, negative or neutral classifications to disclosures inherently requires an underlying value system. The assignations used in this study assume that relevant publics, on average, prefer companies to minimize their negative impacts on the environment. To the extent that these underlying assumptions are not valid (e.g. if investors, on average, prefer companies to pollute and pay fines instead of making efforts to meet regulations), the findings are subject to other interpretations. It must be noted, however, that classifying environmental disclosures as positive, negative and/or neutral is consistent with previous research in this area (see, e.g. Deegan & Gordon, 1996; Deegan & Rankin, 1996; Patten, 2000). 16. For an overview of the Superfund program and its relation to accounting standards see Barth and McNichols (1994). 17. It may not be intuitively obvious that neutral disclosures can serve a legitimating function. But, as noted by Lindblom (1994), for example, aside from projecting a positive image, disclosures might be used as a means of deflecting attention away from other, more negative aspects of environmental performance. It is also possible that companies tend to include neutral disclosures only when they believe the information is likely to add to the positive image of the firm. This would appear to be a testable hypothesis, but it is beyond the scope of the current paper. 18. As noted in the results section of this paper, a total disclosure score was also calculated for each company. For the total disclosure score, companies were awarded a point for each area of disclosure included either in the annual report or on the web page. Thus, it represents an intersection of the annual report and web page disclosures. 19. For a more detailed discussion of required U.S. reporting standards relative to environmental liabilities see Siegel and Surma (1992) or Zuber and Berry (1992). 20. Hackston and Milne (1996) tested for differences across alternative measurement scales and report that measurement error between various quantitative techniques is likely to be quite negligible. A potential drawback to using sentences, however, is that pictures, to the extent they are used as environmental disclosure statements, are not captured by the analysis. 21. Bewley and Li (2000) also offer size and industry classification as explanatory variables from a voluntary disclosure theory perspective. 22. It should be noted that the industry relation is not well developed under the political cost hypothesis of positive accounting theory. Watts and Zimmerman (1989, p. 239) suggest only that “besides the firm’s size, its industry also affects its political vulnerability.” But other than noting (1989, p. 239) that “firm size proxies for industry because firms within

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an industry have similar sizes,” no explanation for an expected relation to political costs is offered. In contrast, legitimacy theorists argue an industry impact on public policy pressure due to the negative social effects of the processes of the companies within certain industries. As there is no statistical difference in the mean size of the companies in the two industries examined in this study (see Table 1), the results reported here would appear to more clearly support legitimacy theory explanations. There also appear to be problems with Bewley and Li’s (2000) justification for an industry impact under voluntary disclosure theory. They note (p. 207), for example, “given that corporate pollution propensity differs across industries and is public knowledge, uninformed stakeholders’ expectations about corporate environmental exposure should reflect the difference.” Bewley and Li (2000, p. 207) then argue “firms in a more polluting industry need to disclose more in order to avoid adverse actions by uninformed stakeholders against the worst polluters in the industry.” This suggests that differences in disclosure are driven by performance and that only the better performers in high polluting industries have an advantage to higher disclosure. If true, there should be a significant positive relation between performance and disclosure. A number of previous studies (e.g. Fekrat et al., 1996; Freedman & Wasley, 1990; Ingram & Frazier, 1980; Wiseman, 1982) document that no such relation exists. This appears to seriously weaken Bewley and Li’s (2000) argument. 23. The NegDisc variable used in each model was the measure corresponding to the positive/neutral measure being examined. That is, for example, in the model examining annual report positive/neutral sentence counts, the NegDisc variable used was the annual report negative disclosure sentence counts. 24. It is worth noting that the correlation between the sentence count and content analysis score measures within medium was quite high (see Table 3). 25. Of course involvement in programs such as ISO Standard 14001 could well be interpreted as a corporate attempt at seeking legitimacy through its actions. 26. Tests were also conducted using proxies for firm environmental performance (as it relates to pollution propensity). Data for these proxies was culled from the Toxics Release Inventory database for 1997 release data. First, sample companies included in the top 1000 ranking based on total releases were designated using a one/zero indicator variable. This is similar to the pollution propensity proxy used by Bewley and Li (2000, p. 208). Second, a more specific measure of individual company performance, company total releases divided by company revenues (see, Patten, 2000, pp. 114–115) was also tested. Results, not presented here but available from the authors, indicated that neither of the proxies were significantly related to the level of disclosure in any models. Further, all three legitimacy variables maintained statistical significance (at p = 0.05 or better, one-tailed) in all additional tests. 27. This could be particularly true for those companies including on-line links to their annual reports. However, it is worth noting that six of the 8 firms including either environmental litigation or investigation disclosures on their web pages also had links to their annual reports (which also included these disclosures).

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Lindblom, C. K. (1994). The implications of organizational legitimacy for corporate social performance and disclosure. Presented at the Critical Perspectives on Accounting Conference, New York. Lymer, A. (1997). The use of the Internet for corporate reporting – a discussion of the issues and survey of current usage in the UK. Presented at First Financial Reporting and Business Communication Conference, Cardiff, Wales. Lynch, C. (1997). Searching the Internet. Scientific American, 276(March), 52–56. Mathews, M. R. (1997). Twenty-five years of social and environmental accounting research. Accounting, Auditing and Accountability Journal, 10(4), 481–531. Parker, L. (1986). Polemical themes in social accounting: A scenario for standard setting. Advances in Public Interest Accounting, 1, 67–93. Patten, D. M. (1991). Exposure, legitimacy and social disclosure. Journal of Accounting and Public Policy, 10(Winter), 297–308. Patten, D. M. (1992). Intra-industry environmental disclosures in response to the Alaskan oil spill: A note on legitimacy theory. Accounting, Organizations and Society, 15(5), 471–475. Patten, D. M. (2000). Changing Superfund disclosure and its relation to the provision of other environmental information. Advances in Environmental Accounting and Management, 1, 101–121. Patten, D. M. (2002). The relation between environmental performance and environmental disclosure: A research note. Accounting, Organizations and Society, 27(November), 763–773. Preston, L. E., & Post, J. E. (1975). Private management and public policy. Englewood Cliffs, NJ: Prentice-Hall. Savage, A., Cataldo, A. J., & Rowlands, J. (2000). A multi-case investigation of environmental legitimation in annual reports. Advances in Environmental Accounting and Management, 1, 45–81. Siegel, A., & Surma, J. P. (1992). Accounting for environmental compliance: Crossroad of GAAP, engineering, and government. New York: Price Waterhouse. SustainAbility/UNEP (1999). The internet reporting report. London: Beacon Press. Walden, W. D., & Schwartz, B. N. (1997). Environmental disclosures and public policy pressures. Journal of Accounting and Public Policy, 16(Summer), 125–154. Watts, R. L., & Zimmerman, J. L. (1986). Positive accounting theory. Englewood Cliffs, NJ: PrenticeHall. Wildstrom, S. H. (1997). Surfing for annual reports. Business Week, 3522(April 14), 22. Williams, S. M. (1999). Voluntary environmental and social accounting disclosure practices in the AsiaPacific region: An international empirical test of political economy theory. The International Journal of Accounting, 34(2), 209–238. Wiseman, J. (1982). An evaluation of environmental disclosures made in corporate annual reports. Accounting, Organizations and Society, 7(1), 53–63. Zuber, G., & Berry, C. (1992). Assessing environmental risk. Journal of Accountancy, 173(March), 43–48.

POLLUTION DISCLOSURES BY ELECTRIC UTILITIES: AN EVALUATION AT THE START OF THE FIRST PHASE OF 1990 CLEAN AIR ACT Martin Freedman, Bikki Jaggi and A. J. Stagliano ABSTRACT This study examines whether the 38 electric utility firms owning the 110 plants targeted by the 1990 Clean Air Act (CAA) made adequate pollution disclosures to inform the stakeholders whether they met the pollution emission requirements of the Act by the start of its first phase. First, it evaluates pollution emissions of the targeted plans at the start of the first phase of the Act, i.e. 1995. Then, it evaluates whether pollution disclosures of these firms improved leading up to the first phase of the Act. This evaluation is done by comparing pollution disclosures for the start of the first phase, i.e. 1995, with the year the CAA was enacted, i.e. 1990. Pollution emission data are obtained from the Department of Energy and from the Environmental Protection Agency (EPA), and pollution disclosure data for 1989, 1990 and 1995 are obtained from the annual reports and 10Ks. A specifically designed content analysis technique is used to categorize pollution disclosures. The pollution emissions results indicate that 1995 emissions are significantly lower than 1990 emissions. On an individual plant basis, the results, however, indicated that some plants reduced emissions while others used

Advances in Environmental Accounting and Management Advances in Environmental Accounting and Management, Volume 2, 59–100 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-3598/doi:10.1016/S1479-3598(03)02003-X

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the permit system. The pollution disclosures results indicate that the 1995 pollution disclosure are comparatively lower than 1990 disclosures. The reason for high disclosures for 1990 could have been to protect the firms against potential legal cases if the requirements were not met. Once the fears of legal actions subsided, pollution disclosures were probably reduced. Lack of consistency and adequacy in pollution disclosures, however, make it difficult for stakeholders to properly evaluate their future risks.

INTRODUCTION Title IV of the 1990 Clean Air Act (CAA) targeted coal-fired electric utility plants for abatement of sulfur dioxide and nitrogen oxide emissions. Phase 1 of the Act specifically named 110 plants that were required to reduce their sulfur dioxide emissions by December 31, 1995 (U.S. EPA, 1990). Most of these plants are owned by large publicly held corporations. The CAA also introduced an allowance system that enabled the companies to meet the emission requirements by holding emission permits that could be traded among the affected companies. The allowance system thus provided an alternative to the companies to meet the CAA emission requirements without having to adjust their plant configuration or generating process. The weakness of the allowance system was that the managers might have been encouraged to use the permit system instead of reducing pollution emission. The use of the permit system, however, is not a permanent solution to the pollution emission problem. Instead it is only a temporary solution, and the stakeholders have a right to know whether the CAA emission requirements are being met on a permanent basis by reducing the emission levels or on a temporary basis using permits. The paper examines whether the firms owning the targeted 110 electricity generating plants in the 1990 CAA made comprehensive disclosures on their pollution performance by the start of the first phase of CAA. Because pollution disclosures are influenced by pollution emissions it would be of interest to the stakeholders to know whether the CAA affected electric utility companies met the first phase-end emission requirements. The study evaluates pollution disclosure improvement of electric utilities by comparing their pollution disclosures for the start of the first phase of CAA, i.e. 1995, with their disclosures for the year the law was enacted, i.e. 1990. It further examines whether pollution disclosures are associated with the firms’ pollution strategies. It can be argued that more pollution disclosures are likely to be associated with more pollution efforts. The managers would like to highlight their pollution efforts and signal information to investors that they, as good citizens, are doing their best to reduce pollution emissions. Additionally, another strategy could be that more pollution disclosures are made when there are

Pollution Disclosures by Electric Utilities

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high pollution emission levels. In the case of high pollution emissions, managers would like to provide explanations for emissions and also detail some future plans to deal with the problem. The study’s results show that the CAA’s pollution emission standards on an overall basis were met by the start of the first phase of CAA. But on an individual plant basis, there were differences in pollution emissions among different plants. It, however, needs to be recognized that some firms might have taken advantage of the permit system to meet the CAA emission requirements instead of reducing pollution emissions. With regard to pollution disclosures, the results show that there was no significant difference in the 1995 pollution disclosures compared to 1990 disclosures. The results also show that pollution disclosures were significantly influenced by the level of pollution emissions and the efforts needed to meet the required CAA pollution emission level. The firms with higher pollution efforts and with higher pollution emissions were associated with higher pollution disclosures. The overall finding of no significant difference between the time of the enactment of CAA and the start of its first phase suggests that voluntary pollution disclosures did not improve over time. Instead, it appears that pollution information was disclosed by managers whenever they believed that it would be in the firm’s best interest. Consequently, the stakeholders’ pollution information needs have been ignored and the stakeholders are not being kept fully informed about the firm’s pollution-related activities. This finding has policy implication about the need for mandatory pollution disclosures to ensure full and comprehensive disclosures that enable the stakeholders in making informed judgments. The remainder of the paper is organized as follows: In Part II, we discuss important provisions of the 1990 Clean Air Act and evaluate pollution emissions by the end of the first phase of the CAA. Hypotheses and research methodology are discussed in Part III. The results are presented in Part IV and conclusion is contained in Part V.

CLEAN AIR ACT OF 1990 AND POLLUTION EMISSIONS BY THE END OF ITS FIRST PHASE Provisions of Clean Air Act 1990 for Electric Utilities Acid rain is a significant consequential outcome of the sulfur dioxide and nitrogen oxide emissions that are the by-products of electric generation through coal-fire plants. Canada and the northeastern states of the U.S. cited many mid-western U.S. electric utilities for creating the acid rain problem. In 1988, Richard Ayres, who was the chair of the National Clean Air Coalition, also blamed the Reagan

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administration for opposing an acid rain bill, and for supporting the utility and coal interests in opposing such a bill (Shabecoff, 1989). With a change in administration and Senate majority leadership, the environment for passage of the Clean Air Bill improved and the Clean Air Act was passed in November 1990. Title IV of the Act was a direct response to the acid rain problem. It required 110 coal-fired electric power plants to reduce their sulfur dioxide emissions to 2.5 pounds/million British Thermal Units (MMBTU) (U.S. EPA, 1990) by 1995. Additionally, it required all U.S. power plants to reduce their sulfur dioxide emissions to 1.2 pounds/MMBTU (US EPA, 1990) by year 2000. Emissions of nitrogen oxides were also targeted for reduction, and 1996, 1997 and 2000 were set as significant dates for such reductions. The focus of this paper is, however, is on comprehensive pollution disclosures. Based on technology that existed at the time the Clean Air Bill was being debated in 1989, the electric power plants could reduce their sulfur dioxide emissions by choosing an approach from among several options. The most costly and yet the most effective method was to utilize the stack scrubbers. In this process, the fluid gas stream is washed with a continuous spray of a chemical (usually lime) (Smock, 1990). In 1990, at the time of the passage of the Clean Air Act, the estimated cost of using scrubbers was about $170/kilowatt of the generating capacity. A moderate size coal-powered generating station of 20 megawatts required nearly $3.5 million for scrubbers. A less expensive alternative was the utilization of low-sulfur coal. Prior to 1990, it was politically difficult for power plants located in the mid-western states to purchase low-sulfur coal from outside when the states in which they were located were mining high sulfur coal (e.g. see Freedman & Jaggi, 1993). Switching to a cleaner fuel (e.g. natural gas) was still another alternative. But natural gas was much more expensive than coal. Some electric utility companies tried to find other alternative fuels to generate electricity, and with the help of grants from the U.S. Government, they attempted to develop clean coal technology that consisted of changing coal into other fuels and/or mixing it with other fuels (Burr, 1991).

Permit System as an Alternative The 1990 Clean Air Act provided another option to these plants to avoid being penalized for high pollution emissions. The Act introduced a permit system that enabled firms to meet sulfur dioxide emission standards without reducing emissions. Each firm was given permits that allowed it to emit a certain amount of sulfur dioxide. If a firm’s pollution emissions were lower than the allowable limits of the permits, the firm was allowed to trade the emission permits in the open market.

Pollution Disclosures by Electric Utilities

63

Firms with pollution emissions higher than those allowed by their own pollution permits could buy the permits from other firms and thus meet the emission standards. The apparent purpose of allowing permits to be traded in the open market was to encourage firms to reduce pollution emissions so that the overall pollution emissions would be lower. This market-based method of reducing emissions was considered to be a major advance over the traditional method of command and control. Kahn (1995) felt that the system of letting the market set prices for pollution permits and allowing firms to choose their own way to reduce emissions would lead to successful results. The effectiveness of this system can be evaluated after year 2000 when the impact of this Act is fully realized. This can be done by comparing the results of the permit system with the command and control system that is used for nitrogen oxide abatement.

The CAA Pollution Emission Requirements by the End of its First Phase The sulfur dioxide pollution emission limits for 110 power plants named in the Act were set at a level that was 80% of an average level based on their annual sulfur dioxide emissions over the 1985–1987 period. Thus, firms were given pollution permits for 80% level of pollution at each of their targeted plants. If a plant exceeded the annual emission limit starting with 1995 until year 2000, it needed additional permits to meet the limit and additional permits could be purchased in the open market. If a plant violated the law by emitting sulfur dioxide above the limit without any permit, it faced a fine of $2000 per excess ton (U.S. EPA, 1990). The cost of reducing sulfur dioxide emissions was expected to be significant for many firms that owned the 110 targeted power plants. However, being a regulated industry (it was still totally regulated in 1990), the firms could pass the abatement costs on to customers, and shareholders would not have to bear such costs. The ability to pass the costs on to consumers would, however, depend upon approval from regulatory bodies, and this would be influenced by the firm’s capability to convince the regulatory body (usually a public service commission) that recovery of such costs was necessary for the firm’s financial health. The recovery of costs would, however, be possible only with a lag, because firms would have to apply for such recovery and regulatory bodies would evaluate this request before making a decisions and this would take time. The approval lag therefore meant that firms would incur cost in one period and recovery would happen in future periods. Because some pollution abatement costs could be enormous, the lag could have a significant negative financial impact on the firm’s financial performance in the year the costs are incurred.

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MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

Table 1. Sulfur Dioxide Emissions by Plants for 1990 and 1995. Company (Plant)

Allegheny Power Albright Armstrong Ft. Martin (DQE part-owner) Harrison Hatsfield’s Ferry Total

1990 Emissions lbs/MMBTU

Tons

1.29 2.75 2.68

9,528 30,927 82,393

4.42 3.25

Allowances Tons

1995 Emissions Tons

lbs/MMBTU

12,000 29,840 82,790

11,444 21,907 74,369

2.57 2.61 2.68

282,302 159,242

136,270 115,420

9,944 164,841∗

0.14 3.4

3.48

564,392

376,320

282,505

1.81

American Electric Power Beckjord (Cinergy part-owner) Breed Cardinal Conesville Gavin Kammer Kyger Creek Mitchell Muskingham River Picway Tanners Creek

4.0

90,529

31,970

25,826

1.64

4.63 4.64 5.68 6.72 6.03 2.06 6.96 4.84 4.58

143,838 98,821 365,307 46,839 243,023 59,316 140,891 14,817 70,430

Off line 72,590 63,370 156,640 17,390 93,200 89,490 54,380 4,930 24,820

105,307∗ 90,818∗ 23,478 122,193∗ 92,806 61,623 102,908∗ 4,722 29,318∗

2.87 4.17 0.30 5.64 2.32 1.49 7.10 5.27 2.56

Total

5.31

1,273,811

611,780

658,999∗

2.38

Atlantic City Electric BL England

4.13

30,715

20,780

21,719∗

2.3

Baltimore Gas & Electric Connemaugh (PPL and others part-owners) Crane

3.2

174,692

126,240

78,093

1.25

3.0

28,625

19,560

12,162

1.20

Total

3.17

203,317

145,800

90,255

1.25

Centerior Ashtabula Avon Lake Eastlake (DQE part-owner)

5.78 3.33 4.51

33,101 58,894 14,006

16,740 42,130 7,800

18,183∗ 21,920 8,635∗

6.60 1.35 4.09

Total

3.99

101,001

66,670

48,738

3.79

CIPSCO Coffeen

6.30

71,423

35,670

31,228

1.63

Pollution Disclosures by Electric Utilities

65

Table 1. (Continued ) Company (Plant)

1990 Emissions

Allowances Tons

1995 Emissions

lbs/MMBTU

Tons

4.90 4.31

7,692 14,628

5,910 13,890

6,950∗ 19,610

4.63 3.67

Total

5.75

93,743

55,470

57,788∗

2.22

Cinergy Beckjord Cayuga Gallagher Gibson Miami Fort Wabash River

3.97 4.09 3.88 3.96 3.66

(see American Electric Power) 114,305 67,500 91,169∗ 45,267 27,950 51,629∗ 129,824 81,410 99,980∗ 84,798 50,650 25,994 58,167 26,560 33,891∗

2.88 2.95 2.25 1.53 2.54

Total

3.91

432,361

254,070

302,663∗

2.44

CMS Power JH Campbell

1.20

22,214

42,340

13,170

2.05

Commonwealth Edison Kincaid

6.19

166,399

65,390

11,170

0.78

2.44

40,221

39,170

42,882

2.44

3.23

83,422

107,320

61,829

1.25

Total

2.93

123,643

146,490

104,711

1.56

Empire District Electric Co. Asbury

3.80

27,075

16,190

8,057

1.16

General Public Utilities Portland Shawville

2.68 2.96

24,773 55,780

16,170 48,930

22,143∗ 58,400∗∗

3.0 2.92

Total

2.87

80,553

65,100

80,543∗

2.94

IES Industries Burlington George Neal Prarie Creek

4.74 0.65 4.10

17,975 1,755 12,177

10,710 1,290 8,180

9,020 2,522∗ 5,279

2.04 0.82 1.20

Total

3.39

31,907

20,180

Grand Tower Merodosia

DQE Cheswick Eastlake (see Centerior)a Fort Martin (see Allegheny Power) Sammis (Ohio Edison Part Owner)

Tons

16,821

lbs/MMBTU

1.25

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MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

Table 1. (Continued ) Company (Plant)

1990 Emissions lbs/MMBTU

Tons

ICG/Nova Baldwin Hennepin Vermillion

5.35 4.76 0

224,614 26,794 0

Total

3.32

IPALCO Elmer Stout HT. Pritchard Petersberg Total Interstate Power Co. Milton L. Kapp

Allowances Tons

1995 Emissions Tons

lbs/MMBTU

128,980 18,410 8,880

266,005∗ 27,926∗ 1,724

5.31 5.03 1.23

251,408

156,270

295,655∗

4.48

2.67 3.01 2.41 2.49

31,888 10,489 114,417 156,794

32,360 5,770 48,810 86,840

38,857∗ 5,932∗ 89,102 133,891∗

2.52 2.06 1.68 1.88

3.51

19,151

13,800

7,450

1.30

Kansas City Power & Light Montrose Kentucky Utilities EW Brown Ghent Green River

0.76

8,594

25,680

7,834

0.51

3.09 4.49 3.81

53,691 68,403 17,424

44,120 28,410 7,820

27,706 20,213 10,448∗

1.97 1.11 4.22

Total

3.75

139,518

80,350

58,367

1.54

Lilco Northport Pt. Jefferson

1.00 1.08

36,250 10,117

70,400 22,500

10,927 6,276

0.39 1.11

Total

1.02

46,367

93,200

17,203

0.51

Mid-American Energy Riverside

4.70

8,235

3,990

1,828

0.83

NYSEG Milliken Greenridge

2.98 3.24

32,398 12,129

23,580 7,540

9,376 9,824∗

0.81 2.7

Total

3.05

44,527

31,120

19,200

1.27

Niagara Mohawk Dunkirk

3.28

43,777

26,660

34,620∗

3.07

1.53

39,144

32,190

36,129∗

2.38

4.96 3.54

37,246 45,571

15,630 23,310

6,246 12,257

0.36 0.87

Northeast Utilities Merrimack NIPSCO Bailly Michigan city

Pollution Disclosures by Electric Utilities

67

Table 1. (Continued ) Company (Plant)

1990 Emissions lbs/MMBTU

Tons

Total

4.06

82,817

Northern States Power High Bridge

0.50

Ohio Edison Burger Edgewater Niles Sammis (see DQE) Total

Allowances Tons

1995 Emissions Tons

lbs/MMBTU

38,940

18,503

0.59

3,260

4,270

3,040

0.39

4.80 3.09 4.67

72,500 8,762 29,309

29,360 5,050 16,040

41,650∗ 10 15,134

4.6 0.01 2.6

4.57

110,571

50,450

56,794

3.53

Pennsylvania Power & Light Brunner Island Connemaugh (see Baltimore Gas & Electric Martins Creek) Sunbury

3.0 2.96

124,875 24,980

113,680 25,480

97,396 10,762

2.27 2.18

2.92

22,728

20,210

19,358

2.38

Total

2.98

172,583

159,370

127,518

2.28

Potomac Electric Power Co. Chalk Point Morgantown

2.80 2.55

60,636 83,191

46,240 73,740

41,086 66,555

2.14 2.05

Total

2.65

143,827

119,980

107,641

2.08

2.51 4.50 3.3 2.46 3.24 4.36 3.80 13.73

248,858 77,365 68,155 61,126 54,639 218,220 84,903 361,379

254,580 50,880 59,840 64,550 40,510 136,200 54,610 69,810

160,651 28,030 23,170 21,695 19,586 53,800 56,619∗ 20,269

1.62 1.40 1.26 1.52 1.30 1.35 3.3 1.29

Total

4.24

1,174,645

730,980

383,820

1.60

SIGCO Cully Warrick

4.73 4.78

42,823 35,201

21,260 26,980

2,549 37,682∗

0.21 2.98

Total

4.75

78,024

48,240

40,231

1.61

TECO Big Bend

4.24

143,310

82,250

90,448∗

1.48

Southern Co. Bowen Crist Gaston Hammond Jack McDonough Wansley Watson Yates

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MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

Table 1. (Continued ) Company (Plant)

1990 Emissions lbs/MMBTU

Tons

Union Electric Labidie Sioux

4.22 3.69

243,465 82,452

Total

4.08

Utilicorp Sibley

5.2

Allowances Tons

1995 Emissions Tons

lbs/MMBTU

154,070 46,260

128,804 47,856∗

1.79 2.56

325,917

200,330

176,600

1.94

45,310

15,580

12,214

0.87

Virginia Electric & Power (Dominion Resources) MT Storm 2.74 139,203

121,730

97,793

1.71

Wisconsin Energy No. & So. Oak Creek

2.48

143,440

53,635

26,668

0.91

WPL Holdings Dewey Edgewater

1.27 2.20

6,295 46,530

12,690 24,750

4,127 18,482

0.56 0.70

Total

2.03

52,825

37,440

22,709

0.67

Wisconsin PSC Pullian

3.2

10,865

7,510

2,087

0.45

Associated Electric Coop New Madrid Thomas Hill

5.0 3.0

164,683 63,729

60,720 29,640

16,753 16,970

0.44 0.42

Total

4.4

228,412

90,360

33,723

0.43

Big River Energy Corp Coleman

4.40

68,819

36,430

52,272∗

3.28

Dairyland Power Genoa

4.08

28,536

6,010

15,304∗

1.64

East Kentucky Coop Cooper H. L. Spurlock

2.39 2.61

18,138 25,872

22,770 22,780

18,389 38,735

2.08 1.15

Total

2.52

44,010

45,550

57,124∗

1.45

Electric Energy Inc. Joppa Steam

3.2

119,071

69,030

27,947

0.62

Hoosier Energy Frank Ratts

5.2

36,765

16,810

20,641∗

2.36

Non-Public Reporting Entities

Pollution Disclosures by Electric Utilities

69

Table 1. (Continued ) Company (Plant)

1990 Emissions

Allowances Tons

lbs/MMBTU

Tons

Indiana-Kentucky Elec. Clifty Creek

5.69

268,818

120,190

Kansas City Municipal Quindaro

3.45

6,116

Owensboro, KY Municipal Elmer Smith

5.26

Springfield, MO Municipal James River

1995 Emissions Tons

lbs/MMBTU

91,495

1.90

4,220

63

0.24

49,123

20,930

7,854

0.56

3.07

6,566

4,850

3,764

0.62

Tennessee Valley Auth. Allen Colbert Cumberland Gallatin Johnsonville Paradise Shawnee

3.32 2.53 4.50 4.38 3.43 4.44 6.2

57,797 74,089 295,572 137,382 84,465 112,232 11,005

47,760 96,870 181,540 76,460 80,670 59,170 10,170

48,274∗ 76,908 25,829 99,796∗ 114,677∗ 155,612∗ 2,953

2.09 2.04 0.21 3.24 3.0 4.92 0.55

Total

4.09

772,542

552,610

524,049

a Needed

to use more allowances to meet the standard.

Pollution Emissions by the Start of the First Phase of the CAA A comparative analysis of pollution emission was conducted to evaluate whether the 110 targeted plants met the pollution requirements. The results indicated that on an overall basis all electric utility met the requirement either by reducing pollution or through the use of permits. Data on sulfur dioxide emissions for each plant for 1990 and 1995 and on the allowances granted by the CAA on each plant are provided in Table 1. Out of 107 plants, 39 plants utilized excess allowances to meet the 1995 standard. Considering that 17 of these plants had sulfur dioxide emissions that were less than the standard in 1990, only 90 plants had to institute a new strategy to reduce emissions by 1995. In essence, 43% of the plants (39 out of 90) chose the strategy of utilizing excess allowances. On a company-wide basis, 10 of the 38 publicly reporting companies had total sulfur dioxide emissions greater than the allowances they were granted. Thus, these firms had to acquire extra allowances from the market prior to the end of 1995. Five of the small energy coops or municipalities also had to acquire

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MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

allowances. It is assumed that these companies chose this strategy because it was the cheapest alternative. Overall, as a consequence of the strategy chosen by management of these utilities, many firms either reallocated the allowances or purchased them on the open market. Sulfur dioxide emissions decreased for 91 plants over the five-year period. In terms of gross emissions, sulfur dioxide emissions decreased from 8.7 million tons in 1990 to 4.2 million tons in 1995. This is a 51% reduction. The comparison of differences in emissions by individual plant for the five-year period shows that the differences are statistically significant (p < 0.001). Emissions per MMBTU also decreased dramatically. In 1990 the average sulfur dioxide emission was 3.67 lbs/MMBTU and by 1995 it had decreased to 1.76 lbs/MMBTU. Since one of the phase 1’s goals has been to achieve a level of 2.5 lbs/MMBTU by 1995, the results show that on an average basis this goal has been achieved. However, on an individual plant basis the goal is not achieved. Thirty of the 107 plants had emissions greater than the 2.5 lbs/MMBTU standard in 1995.

HYPOTHESES AND RESEARCH METHODOLOGY Rationale for Pollution Disclosures Why should managers be motivated to provide detailed pollution disclosures to the stakeholders? This question has been extensively examined in the literature. Patten (1991) argues that the managers’ motivation to disclose pollution on a voluntary basis is to legitimize corporate interests. At another place, he also explains that public pressures could be the motivating factor for such disclosures (1992). Guthrie and Parker (1990) have argued that voluntary disclosures might be made to further the ideological position of managers, and these can be considered as political statements. Ullmann (1985), who summarized a number of studies that attempted to find economic justifications for pollution disclosures, however, is of the opinion that there is no single rationale that has general applicability. Instead, each firm may have specific reasons for voluntarily disclosing environmental or pollution information. An explanation from the utilitarian or distributive perspective may explain disclosure of pollution information from a broader perspective and that may have a more general applicability. The utilitarian approach suggests that voluntary disclosures are generally considered when their benefits outweigh their costs (Mill, 1970). On the other hand, the distributive justice perspective (Rawls, 1971) suggests that voluntary disclosures would be made if they could mitigate

Pollution Disclosures by Electric Utilities

71

negative consequences arising out of pollution emissions. Because of ambiguity for identification of costs and benefits of pollution disclosures, the support for the utilitarian approach is weak. The distributive justice perspective may provide a better rationale for disclosure of pollution information. It can be argued that managers could use pollution disclosures as warning signals to mitigate the risk involved in future consequences of the firm’s pollution activities, which may involve future pollution expenditures, fines for violating certain pollution rules and regulations, etc. If comprehensive disclosures are made by managers, they could shift the responsibility to the stakeholders to properly evaluate the firm’s future performance in the context of disclosed information. By providing the appropriate information, stakeholders could fairly assess the firm’s pollution performance and use that information to make informed decisions. Prior studies have emphasized pollution disclosures from the investors’ and creditors’ perspective (see, for example, Freedman & Jaggi, 1986; Ingram, 1978; Wiseman, 1982). These studies were guided by the FASB’s emphasis on investors’ and creditors’ information needs on the assumption that environmental degradation’s impact will be reflected in the firm’s economic performance. This approach, however, ignores the information needs of other stakeholders who also have a direct interest in the firm’s performance. These stakeholders are employees, suppliers, creditors, and the community. Gray, Owen and Maunders (1991) have argued that the firm should be accountable to all stakeholders, including society at large. Clarkson (1991) also argues that disclosures should meet the information needs of all stakeholders. The impact of pollution emissions and pollution expenditure is likely to be felt on the employees’ compensation as well as on their working environment, which will affect their quality of life. If there are any changes in the purchase of fuel for generating electricity, it will have an impact on suppliers. For example, if plants switch from moderate or high sulfur coal to low sulfur coal or there is change in the mix of fuels between coal and natural gas, there may result in shifting from one supplier to another. The change in fuel may also affect the rate charged to the customers. Thus, control of pollution emissions may directly impact the consumers, i.e. the rate-payers. Though accounting standards do not emphasize the society’s information needs, pollution information needs are supported by a general tradition in the U.S.A. that the society has a “right to know.” There are also “community-right-to-know” laws, which require that the populace shall be kept informed. One of these laws relates to environmental pollution, i.e. Toxics Release Inventory (TRI)(a subset of the Superfund Act of 1986). According to this section of the law, every firm releasing certain emissions into the environment has an obligation to provide information to the EPA and to the local community. The TRI consists of a list of emissions and amounts of chemicals that firms are emitting

72

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

into the environment over a period of time (quarterly, annually). When these lists become available, local media generally make this information available to the community. Though sulfur dioxide and nitrogen oxide emissions are not a part of TRI, the society should be interested to know about these emissions. The existing accounting regulation on disclosure of pollution information (FAS No. 5) requires reporting of all potential material liabilities in the financial statements. Additionally, the SEC (SEC Releases Nos. 33–6130 and 34–16224) requires that material current and future capital expenditures for environmental control be disclosed. There is, however, no regulation that requires firms to disclose the level and amount of current and future emissions, how the plants plan to meet the CAA requirements, and what would be the economic consequences of pollution emissions for the firm. This information is disclosed on a voluntary basis. It may be disclosed in the annual financial reports and in a special environmental report. Thus, the voluntary disclosure of information on pollution emissions will supplement the mandated disclosures to provide a better picture on the firm’s current and future environmental performance. It, however, needs to be pointed out that earlier studies (e.g. Freedman & Jaggi, 1982; Ingram & Frazier, 1980; Rockness, 1985) concluded that voluntary environmental disclosures may not fully reflect the firm’s actual pollution performance. This is so because the firms have selectively been disclosing the “good news” and withholding the “bad.” In the case of regulated electric utility industry, it is possible that voluntary environmental disclosures might have been used to support future rate-hike requests or to assuage shareholders’ fears of catastrophic negative financial effects from abatement activities.

RESEARCH DESIGN In this section, we first describe the hypotheses for the study and then elaborate on the procedures used for sample selection and data collection. This is followed by a discussion of the tests used to evaluate the hypotheses.

Hypotheses 1995 vs. 1990 Pollution Disclosures Naming of 110 plants in the Clean Air Act alerted the stakeholders that these plants were experiencing pollution problems. Highlighting the problems of the plants might have caused concern to investors about pollution-related activities of firms owning these plants and about the impact of these activities on the firms’ financial

Pollution Disclosures by Electric Utilities

73

performance. The management could have alleviated or reduced stakeholders’ uncertainty by disclosing detailed information on pollution emissions in 1995 at the start of the first phase of CAA. The 1995 disclosures may include information on the CAA emission levels and how these levels are being achieved, i.e. by reducing actual abatement activity or by purchasing emission allowances. If the emission levels were reduced through pollution abatement activities, then disclosure of information on capital and differential operating expenditures would be useful to investors for evaluating the impact of such expenditures on the firm’s financial performance. If allowances were purchased in the marketplace, then the firm should have disclosed the amount and cost of the allowances purchased. Furthermore, disclosures should include information on capital expenditures planned for future pollution-related activities to reduce emissions to the required/desired level. These pollution disclosures also should provide information on the impact of abatement activities on the firm’s economic performance. It can be argued that the firms undertaking necessary measures to meet the CAA emission requirements might have little motivation to disclose detailed pollution information because they might believe that stakeholders’ concerns were resolved by complying with the emission requirements. They should, however, realize that in the absence of detailed pollution information, it would be difficult for the stakeholders to determine whether and how the emissions requirements were met. Thus, firms’ failure to report detailed pollution information would not appear to be in the best interest of either stakeholders or management. Based on this discussion, we expect the 1995 pollution disclosures of the targeted plants to be much higher than their 1990 pollution disclosures. We use 1990 pollution disclosures as a base-line or benchmark to evaluate 1995 disclosures. A temporal comparative evaluation of the first phase’s first year with the year that CAA became law is considered appropriate because 1995 pollution disclosures are based on 1995 pollution performance in relation to 1990 pollution performance. The following hypothesis is used for this comparison: H1. The level of 1995 pollution disclosures is significantly higher than 1990 pollution level. Rejection of the above hypothesis will indicate that the firms are not making adequate pollution disclosures on voluntary basis. 1990 Pollution Level Effect on 1995 Pollution Disclosures When the Clean Air Bill was being debated during 1989 and 1990, the 110 targeted plants each had different levels of SO2 emission as compared to the limitation that would be imposed. Therefore, the reduction (if any) required to achieve the

74

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

mandated level varied from plant to plant and company to company. Since the goal of CAA Phase 1 compliance was to achieve a global level of sulfur dioxide emissions of 2.5 lbs/MMBTU, those companies that owned plants emitting more than this standard had to make a greater effort to achieve the standard. If the emission levels of all targeted plants were the same, the effort needed to achieve the desired level of sulfur dioxide emissions in 1995 would be nearly the same. Because of differences in the 1990 emission levels of the targeted plants and the existence of a fixed standard, firms required varying levels of effort to achieve the 1995 mandated level. Since stakeholders would be concerned with the amount of effort – which translates into costs to be incurred by each firm – we expect that companies with higher pollution levels would disclose more detailed pollution information. This expectation is tested by the following hypothesis: H2. The 1995 pollution disclosures are negatively associated with the 1990 emission levels of the firm’s CAA-targeted plants. Effect of the Number of Targeted Plants on 1995 Pollution Disclosures Managers’ motivation to disclose detailed pollution information also could depend on the number of targeted plants owned by the firm. Some firms owned only one targeted plant, while others had a number of such plants. If the number of affected plants is small, the CAA impact on the firm’s pollution disclosures should be insignificant because overall economic performance of the firm would not be impacted in an important way. On the other hand, if multiple targeted plants were owned by a particular firm, pollution emissions abatement could have a significant impact on the firm’s financial performance. Therefore, we expect that stakeholders would be more concerned with firms that owned a larger number of targeted plants. We expect the managers of such firms to be sensitive to this heightened stakeholder information need. Therefore, we hypothesize that they would disclose more detailed pollution information compared to firms with a smaller number of targeted plants. This expectation can be tested with the following hypothesis: H3. There is positive association between 1995 pollution disclosures and the number of CAA targeted plants owned by a firm. The Allowance Effect on 1995 Pollution Disclosures In 1995, CAA-impacted firms were given saleable pollution permits for each of their targeted plants. These allowances were indistinguishable and could be aggregated by the firm. If actual pollution emissions of a firm were higher than its total allowances, the firm was required either to reduce emissions by the amount of the difference between allowances and actual emissions or buy permits from other utilities to cover its “excess” emissions. Fines were imposed for failing to comply

Pollution Disclosures by Electric Utilities

75

in some fashion. If actual emissions were lower than the allowances, the firm could sell the excess allowances in the open market. This process was repeated each year during the first phase of CAA implementation (i.e. 1995 through the year 2000). At the outset in 1990, the firms were aware of the amount of shortfall in allowances that they had to make up by 1995 in order to avoid penalty. We expect the firms’ pollution efforts to depend upon the actual pollution emissions compared to allowances given under CAA. If actual emissions were higher than allowances, we call this state “over the allowances” in the discussion below. If actual emissions were lower than allowances, we denote them “under the allowances.” In case a firm was “over the allowances,” it would need either to reduce emissions or cover the excess emissions with purchases of permits from other holders. If the firm was “under the allowances,” it could sell permits in the open market (in this case there would be no need for emission reduction). Because the firms “over the allowances” were required either to reduce emission levels through pollution-abatement activities or cover the excess emissions with purchase of permits, we expect these firms to disclose more detailed pollution information about their activities with regard to CAA compliance. This expectation is tested with the following hypothesis: H4. There is a positive association between pollution disclosures and a firm’s emission levels being “over the allowances.” In the circumstances that the above hypothesis is not supported, it would mean that managers of firms with emission levels “over the allowances” were not sensitive to pollution information needs of stakeholders and they simply ignored stakeholders’ differential information needs despite the requirement of higher pollution control efforts by their targeted plants.

Sample Composition and Data Collection The Clean Air Act targeted 110 coal-fired electric power plants for reduction of sulfur dioxide beginning in 1995. We analyze the whole population of impacted companies. Of the 110 plants, 12 are owned by municipalities (two of these went off-line by 1995) or the Tennessee Valley Authority, an agency of the U.S. government, and nine are part of separate, small energy cooperatives. Of the remaining 89 plants, one plant was shut down before the 1995 deadline. The final sample consists of 88 plants owned by 38 public firms. Therefore, every CAA-impacted investor-owned company is part of the analysis conducted for this research. Most of the 38 firms operate east of the Mississippi River; generally the targeted plants are located in the southern or mid-western U.S. The firms vary quite a bit in size. The largest is the $20 billion Southern Company, owner of 78 power plants

76

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

capable of generating 30,000 megawatts of electricity; 72 of its power stations are coal-fired. The smallest company is Empire District Electric Company with five generating plants, two of which are coal-fired. Its assets amount to less than $575 million, and it has a generating capacity of about 750 megawatts. The number of targeted plants owned by any firm ranges from one to ten. American Electric Power owns ten targeted plants, and 15 firms owned a single affected plant. Beyond those extremes, then, most firms owned two or three CAA-targeted plants. The section of Table 1 that contains the public reporting companies and their plants constitute the population used in the study.

Emission Data and CAA Emission Requirement Electric power plants above a certain size are required to file Form EIA-767 annually with the Department of Energy (DOE). Prior to 1994, DOE calculated emissions data for various pollutants from data provided by plant owners. The 1990 pollution emissions levels we used were calculated from these raw data. The emission allowances allowed by the Clean Air Act also are based on this raw data since they are derived from years 1985, 1986, and 1987. The 1990 Act required all power plants to install a continuous emission monitoring system (CEMS) in each smokestack before 1995. This system is used to measure actual pollution emissions from the stack. We obtained the 1995 pollution emission data generated by this system from the EPA. This data set also provides emissions figures that were calculated by DOE for prior years. Sulfur dioxide emissions data for 1995 were available for all 88 plants covered in this study. The CAA specified an upper limit (in tons) of sulfur dioxide emissions that each of the named plants had to meet by 1995. Companies were given from the start of enactment until the end of 1995 to develop and implement an appropriate response to the legislative mandate. In 1995, the plant owners were allotted pollution permits that essentially allowed them to emit SO2 up to 80% of a plant’s 1985–1987 average yearly emissions. If emissions from a particular plant were less than its allowances, the firm could apply the unused or “surplus” ones to other plants, bank them for use in a future year, or sell them in the open market. There is an expectation that firms will act rationally to implement the least-cost solution in complying with the Clean Air Act. Of course, there are a number of unknown factors that firms had to contend with, not the least of which was the changing demand for electric power generation as deregulation of the industry unfolded over the decade of the 1990s. The two major sources of both pollution data and information on the economic impacts of the Clean Air Act are company annual reports and Form 10-K

Pollution Disclosures by Electric Utilities

77

filings with the Securities and Exchange Commission. Other possible sources of information include articles in the media, environmental reports by the companies, and governmental reports. Annual reports and 10Ks for all 38 companies were obtained for the years 1989, 1990, and 1995. (We also requested environmental reports from each firm but did not receive a single one of them!) A number of firms changed their name and some merged in the years 1989 to 1995. Iowa Power became part of IES Industries; Public Service Company of Indiana merged with Cinergy (formerly called Cincinnati Gas & Electric). No media story was found on any firm that could provide additional information on the impact of the CAA or the firms’ pollution performance that had not already been captured through the two main data sources.

Disclosure Index To facilitate a comparative analysis of disclosures concerning the Clean Air Act, a pollution disclosure index was developed by using the content analysis technique. This type of index has been applied in previous accounting research studies (see, for example, Wiseman, 1982). Disclosure categories discussed in prior studies provided the basis for development of the index used here. Two main issues deserve special attention in the specification of the index. First: What items should be included in the index? Second: What should be the weighting scheme for items included in the index? On the basis of the index items used in prior studies, relevant items were selected for the current research to ensure creating a metric that signaled that detailed information concerning the CAA requirements had been made available to stakeholders. The information disclosed should enable stakeholders to assess whether the CAA requirements were met and what the cost for pollution-related expenditures was (so that the impact on the firm’s economic performance could be judged). The following items are considered important from the stakeholders’ right-toknow perspective. They are deemed to be decision-relevant in the context of any one type of stakeholder’s interests: (1) Future-oriented information so that investors/creditors can adjust their expectations on whether the company would meet the CAA requirements. This involves disclosure of information about future expenditures for reducing SO2 emissions and the method the firm expected to use to meet the 1995 standard. Information on costs of present and future allowances also should be disclosed; (2) Information to enable employees to assess their current job situation and learn of whether the firm’s activities would impact future employment

78

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

opportunities. In addition to financial information and future-oriented information, employees would be interested to know about emissions levels; (3) Information that would enable suppliers to assess their future prospects of selling fuel to the affected plants. This would mean that the firm disclosed information regarding how they intended to meet the Act’s requirements; (4) Information on the prospects for future rate hikes, which would be of interest to customers and shareholders. This means that firms would disclose information on the expected cost to reduce sulfur dioxide emissions and how these costs would be covered; (5) Information about the impact on air quality of the firm’s CAA compliance plan. Communities in general would be interested in this information. Based on the requirements of the Clean Air Act, stakeholders’ needs, and the community’s right to know, disclosures were categorized as follows: (1) (2) (3) (4) (5) (6)

Whether the Clean Air Act (or Bill) was mentioned; Whether the impacted plants were specified; The firm’s plan to meet Phase 1 requirements; Estimated (or actual) costs to deal with Phase 1 compliance; Impact on ratepayers; and Amount of sulfur dioxide emissions.

So far as the weighting scheme is concerned, the simplest method would be to use equal weights for all the disclosure items listed above. The main justification for using equal weights is that it is difficult to defend differential weighting as being an unbiased estimator. However, it is clear from the nature of this listing of disclosure items that some have greater information content than others. For example, quantitative information has an advantage over purely qualitative disclosures when it comes to use in financial decision models. Thus, there is a compelling argument for use of a differential weighting scheme. The following weighting scheme was devised to capture the above items: Item Mention of the Clear Air Act Affected plants named Phase 1 plans described Compliance costs stated Incidence of cost described Rate impact detailed Emissions data provided Maximum score

Weight 1 2 2 3 2 2 3 15

Pollution Disclosures by Electric Utilities

79

We also computed this index using an equal weighting scheme to compare pollution disclosures over the five-year period. With the equal weighting scheme, one point was assigned to each of the seven items.

Models Used to Test the Hypotheses First, we evaluate whether 1995 disclosures differ from 1990 disclosures by conducting a t-test. This test does not consider the impact of other variables on pollution disclosures for the two periods. We consider the impact of other variables on pollution disclosures during two different periods by conducting a regression test on the pooled data for 1990 and 1995. A dummy variable for the time period is used to evaluate the effect of different periods on pollution disclosures. The following regression model is used: POLit = ␣0 + ␤1 D YEARit + ␤2 PLEVELit + ␤3 PLANTSit + ␤4 DIF EMISSIONit + ␤5 PL CAPACITY + ␤6 SIZEit + ␤7 D SCRUBBERit + ␧it

(1)

where, POLit = pollution index of firm i in period t; D YEARit = 1 when t is 1995 for firm i, otherwise 0; PLEVELit = level of pollution emissions in lbs/MMBTU for firm i in period t; PLANTSit = number of targeted plants owned by the ith firm in period t; DIF EMISSIONit = difference between firm i’s actual emissions and its CAA allowances in year t; PL CAPACITY = ratio of targeted plant capacity to the owner’s total generating capacity; SIZEit = firm i size in year t, measured as the log of total assets; and D SCRUBBERit = 1 if scrubbers were used by firm i in year t, otherwise 0. ␣0 = intercept; ␤1 . . . ␤7 = regression coefficients for respective variables; and ␧it = stochastic disturbance term.We also conduct regression tests separately for 1990 and 1995. The following model is used to examine the association of the variables on change in pollution disclosures with three test variables (DPLEVEL, PLANTS, and DDIF EMISSION) and three control variables (PL CAPACITY, SIZE, and D SCRUBBER): DPOLi = ␣0 + ␤1 DPLEVELi + ␤2 PLANTSi + ␤3 DDIF EMISSIONi + ␤4 PL CAPACITYi + ␤5 SIZEit + ␤6 D SCRUBBERi + ␧it (2) where, DPOLi = change in pollution index of firm i in 1995 from 1990; DPLEVELi = change in pollution emissions in terms of lbs/MMBTU of firm i in 1995 from 1990; and DDIF EMISSIONi = change in the difference between

80

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

actual emissions and allowances granted by CAA in 1995 from 1990. Other variables have been defined above.

RESULTS AND DISCUSSION Descriptive Statistics Table 2 provides information on different types of disclosures made in 1989, 1990, and 1995 by each of the firms owning the 88 targeted plants. An evaluation of disclosures indicates that in 1989, before the CAA was developed, two (DQE and Iowa Power) out of 38 firms failed to mention the Clean Air Bill. Fourteen firms outlined how they planned to reduce sulfur dioxide emissions. Coincidently, compliance costs were estimated by 14 companies. Five firms reported that compliance cost would be “substantial” or “significant.” Three companies mentioned that compliance cost would be minimal. Finally, eight firms estimated the effect on ratepayers. These disclosures were made when the CAA had not yet been enacted; none of the disclosures was required to be made. This level of voluntary environmental disclosure about a potential law is surprising. It is possible that the firms were motivated to provide information to justify their case for future rate increases or to somehow “derail” passage of the bill. Another observation is that the firms provided pollution information in many different ways. Some firms named all the plants that might be involved and explained various methods that could be used to meet potentially heightened SO2 emissions standards, others simply reported about the on-going Congressional debate.

Results on Comparative Analyses of 1995 and 1990 Pollution Disclosures A comparative evaluation of 1995 and 1990 disclosures (Table 2) indicates that 21 firms provided quantitative disclosure in the later year compared to 27 in the earlier one, and 14 of the 1990 disclosers estimated the effect on ratepayers. Weighted and unweighted disclosure indices were computed for all firms for 1990 and 1995. These are provided in Table 3 below. The mean scores of both indices for 1990 and 1995 indicate that disclosures declined overall in 1995 from 1990. The mean weighted disclosure index decreased from 7.1 in 1990 to 5.8 in 1995. The unweighted index had been 3.6 in 1990 and declined to 3.0 in 1995; this is nearly the same percentage change as in the weighted index. The t-tests indicate that the differences in disclosures for the two years are statistically significant at the 0.037 level for weighted scores

Company

Allegheny Power

American Electric Power

Atlantic City Electric

Baltimore Gas & Elec.

Centerior

CIPSCO

Year

Mention

# Eff.

# Named

Phase I

Cost

Payer

2 SCR SCR, LSC SCR, Allow

$1.5–2B $2B $555M

Cust.

Substant. $200–800M (Gavin) $480M

Cust.

Yes Yes Yes

5 5 5

2 1 1

89 90

Yes Yes

10 10

0 10

SCR, LSC

95

Yes

10

10

SCR, LSC

89 90 95

Yes Yes Yes

1 1 1

0 1+ 1+

SCR

89 90

Yes Yes

2 2

0 2

SCR

95

Yes

2

0

SCR, LSC

$600M Not Mat. (Connemaugh $17M) $174M

89 90

Yes Yes

3 3

0 0

SCR, LSC

$900M–1.2B $400–700M

95

Yes

3

0

LSC, Allow

$50M

89

Yes

3

1

CC

$120–200M

90

Yes

3

2

LSC

$20–50M

Emiss

Gavin – allow 25% SO2

Substant. Cust.

5%

Cust. Cust.

9–15% 7–8%

10–14% Cust.

1–2%

100 kg/ton Red. of SO2 needed 70% SO2 reduct.

81

89 90 95

Rate

Pollution Disclosures by Electric Utilities

Table 2. 1990 Title IV Clean Air Act Disclosure – Phase I.

82

Table 2. (Continued ) Company

Cinergy

Commonwealth Edison

DQE

Empire District Elec.

General Public Utilities

Mention

# Eff.

# Named

Phase I

Cost

95

Yes

3

2

LSC

$76M

89

Yes

2

0

SCR, LSC

$1B (By 2000) $100M (90–94)

90 95

Yes Yes

2 2

0 0

SCR, LSC LSC, Allow

89 90 95

Yes Yes Yes

1 1 1

0 0 0

LSC

89 90 95

Yes Yes Yes

1 1 1

1 1 1

89 90 95

No Yes Yes

4 4 4

0 4 0

89 90 95

Yes Yes Yes

1 1 1

1 1 1

89 90

Yes Yes

2+ 2+

0 0

95

Yes

2+

2+

SCR, Allow LSC CC

Payer

Rate

Emiss

<12–16%

<12–16% $34M Can’t det. Minimal $25M

Cust.

Can’t det. $450M

$50M

LSC Allow

SCR, LSC

$1B $675M (574M after 1995) $234M

Cust.

200M by 2001

SCR red.

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

CMS Energy

Year

SO2 95% at Connemaugh

IE Industries

89 90

Yes Yes

1 1

0 1

LSC LSC

IES Ind. (Merged Iowa Power and Iowa Southern)

95

Yes

3

0

Allow, LSC

Iowa Power

89 90 95

No Yes [See IES above]

1 1

0 0

LSC

89 90

Yes Yes

2 2

0 2

Illinova

95

Yes

2

2

IPALCO

89 90 95

Yes Yes Yes

3 3 3

0 0 0

89 90 95

Yes Yes Yes

1 1 1

0 1 1

LSC LSC LSC

Cust. Cust.

Iowa-Ill. Gas & Elec.

89 90

Yes Yes

1 1

0 1

Gas, LSC

Cust.

Midamerican Energy

95

Yes

1

0

Illinois Power

Interstate Power

Pollution Disclosures by Electric Utilities

Allow Not Sig. $6M ($1M Capital)

Cust. Cust.

SCR, LSC SCR, LSC

$150–300M $40M

Ins. Cust. U.S., Il. 17M Cust.

Closed plant Allow

$24M

0–15% Henn = 50% SO2 , 60% NOX

<5%

$200–250M

83

Company

Year

Mention

# Eff.

# Named

84

Table 2.

(Continued ) Phase I

Cost

89 90 95

Yes Yes Yes

1 1 1

0 0 0

CC

Kentucky Utilities

89 90 95

Yes Yes Yes

3 3 3

0 1 3

SCR, LSC SCR, LSC SCR, LSC

$130M $145M

Long Island Lighting

89 90 95

Yes Yes Yes

2 2 2

0 0 0

Use oil

Not. det. No effect $4.9M

New York State Elec. & Gas

89

Yes

2

0

90 95

Yes Yes

2 2

0 1

SCR, Allow

89 90 95

Yes Yes Yes

1 1 1

0 1 1

LSC LSC Compliance

89 90

Yes Yes

1 1

0 0

Niagara Mohawk

Northeast Utilities

Rate

Emiss

Not Mat. $16.6M $5.24M Cust. Cust.

Signif.

Cust.

$250–350M $115M

Cust.

$300M

Cust.

8% 7%

SO2 red. 160–140 3–4% SO2 red. 138kg/ton in 1989, 70kg/ton in 2000

$32M (’94) $5M (’95) None

500kg/ton SO2 red. Req. by 1995

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

Kansas City Power & Light

Payer

95

Yes

1+

1+

89

Yes

2

2

CC

90

Yes

2

2

SCR, LSC

95

Yes

2

2

LSC

89 90 95

Yes Yes No

1 1 1

0 0 0

In comply

Ohio Edison

89 90 95

Yes Yes Yes

4 4 4

0 0 0

SCR, LSC CC In comply

PA Power & Light

89 90

Yes Yes

4 4

0 0

LSC, Allow LSC, CC

95

Yes

4

0

In comply

89 90 95

Yes Yes Yes

2+ 2+ 2+

0 0 2+

89 90

Yes Yes

4 4

0 1

Northern States Power

PEPCO

Public Service of Indiana

95

[See Cinergy above]

Southern Company

89 90

Yes Yes

8 8

0 0

0% <3%

90% SO2 & NOX red. Bailey = 90% SO2 red.

Can’t Det.

Can’t Det.

Cust.

New equip, LSC New equip, LSC

$190M $36.2M

SCR, LSC SCR, LSC

$300M Signif. $1.7B (overall)

SCR, LSC LSC

70% SO2 red.

$3B $400M

Cust. 3%

3%

Can’t det.

Cust.

50% SO2 red. by 2000

31% Red. in SO2 needed

8% 1%

85

Acquired by Cinergy

$41M U.S. = $49M Cust = $14M Cust. = $14M

Pollution Disclosures by Electric Utilities

NIPSCO

86

Table 2. Company

Year

Mention

# Eff.

# Named

(Continued ) Phase I

Cost

Payer

Rate

Yes

8

1

LSC

$320M

89 90

Yes Yes

2 2

2 2

SCR

$180M $130M

Cust.

10–15%

95

Yes

2

2

SCR

$103M

Cust.

1–2.3%

89 90 95

Yes Yes Yes

1 1 1

0 0 0

LSC LSC, Allow

Minimal Insig. Insig.

89

Yes

2

0

90 95

Yes Yes

2 2

0 0

LSC, Allow

May be substant. Net = 0 $300M

Utilicorp

89 90 95

Yes Yes Yes

1 1 1

1 1 0

LSC LSC In comply

Virginia Elec. & Power

89

Yes

1

0

90

Yes

1

1

LSC, Allow

(Dominion Resources)

95

Yes

1

1

LSC, Allow

$141M

Wisconsin Energy

89 90

Yes Yes

2 2

0 0

LSC

$50M $25M

Tampa Elec. Teco

Union Electric

1%

$31M $40M May be signif. $470M $140M/yr

1%

1.5M/T SO2 red. by 2000

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

95 Southern Indiana Gas & Elec. (SIGCO)

Emiss

Wisconsin Public Service

Yes

2

2

89

Yes

2

0

90

Yes

2

0

95

Yes

2

0

89 90 95

Yes Yes Yes

1+ 1+ 1+

0 1+ 1+

LSC

$45.3M

New equip

$8–16M $7M ’93–’94 $8–16M $7M ’93–’94 Not sig.

Cust.

Pollution Disclosures by Electric Utilities

WPL Holding Company

95

In comply In comply LSC

Key: SCR = scrubbers; LSC = low sulfur coal; Allow = allowances; Cust. = customer; CC = clean coal technology; Not Mat. = not material; INS = insurance.

87

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Table 3.

Comparison of Disclosure Scores 1990 and 1995.

Company

Disclosure Score Weighted

Allegheny Power American Elec. Power Atlantic City Electric Baltimore Gas & Elec. Centerior CIPSCO Cinergy CMS Energy Commonwealth Ed. DQE Empire District GPU IE/IES Iowa Power Illinova IPALCO Interstate Power Iowa-Ill/Mid-American Kansas City P&L Kentucky Util. Lilco NYSEG Niagara Mohawk Northeast Util. NIPSCO Northern States Pwr. Ohio Edison Penn. P&L PEPCO Southern Co. SIGCO TECO Union Electric Utilcorp Virginia Power Wisconsin Energy Wisconsin P&L Wisconsin Pub Serv. Mean Score

Unweighted

1990

1995

1990

1995

6.4 8 8 8 11 12.2 6 5 8 8 3 8 10 3 10 7 7 7 6 11.6 3 9 5 4 8 3 3 8 6 9 13 5 4 8 8 6 8 5

8.4 10 5 6 6 7.2 6 4 5 1 5 9 3 3 8 1 5 1 4 10 6 7 8 9 5 0 3 3 8 9.25 13 5 6 3 8 8 3 5

3.2 4 4 4 5 5.6 3 3 4 4 2 4 5 2 5 3 4 4 3 5.3 2 4 3 2 4 2 2 4 3 4 6 3 2 4 4 3 4 3

4.2 5 3 3 3 3.6 3 2 3 1 3 5 2 2 4 1 3 1 2 5 3 2.5 4 4 3 0 2 2 4 4.125 6 3 3 2 4 4 2 3

7.1

5.8

3.6

3.0

Pollution Disclosures by Electric Utilities

89

and at 0.01 for the unweighted ones. We conclude from these results that 1995 disclosure levels were not better than those in 1990. Pollution disclosures over different periods may be affected by several factors, such as the level of pollution, the amount that plant emissions needed to be reduced, and the number of targeted plants owned by the firm. To gain a better understanding of pollution disclosures in 1995 compared to 1990, it is important that disclosures be considered in conjunction with other factors. We conducted an OLS regression estimation (Eq. (1)) by using a dummy variable for 1990 and 1995. The disclosure index is the dependent variable, with control variables relevant to disclosure included in the equation. The regression outcome is presented in Panel A of Table 4. The results indicate that the coefficient for dummy variable YEAR is negative. Although the sign of the coefficient is in the correct direction to provide support for the conclusion drawn from the t-tests, this difference is not statistically significant. On the basis of these results, we cannot reject the null hypothesis, even though the t-test results support such a rejection. The coefficient of the PLEVEL variable is positive and statistically significant, suggesting that the level of actual emissions influences the disclosure decision.

Impact of Firm-Specific Factors on Pollution Disclosures To evaluate the impact of firm-specific factors on pollution disclosures in 1990 and 1995, we conducted separate OLS regressions for the two years using Eq. (2) (shown previously). The results for these tests are contained in Panels B and C of Table 4. For both years the coefficients for the PLEVEL variable are positive and statistically significant. This suggests a positive association between pollution disclosures and pollution levels measured in terms of lbs./MMBTU emitted. Coefficients for all the other variables are not statistically significant. To see if the change in pollution disclosures between 1990 and 1995 was influenced by firm-specific factors, we also conducted a regression analysis by using a “change in pollution disclosures” indicator as the dependent variable (this model is shown above as Eq. (3)). The results of this test are given in Table 5. As noted in this tableau, the change in pollution emissions (PLEVEL) continues to be a significantly important factor. The higher the pollution level, the higher the level of disclosure. The significant coefficient of the PLANTS variable indicates that there is a positive association between the number of targeted plants owned by a firm and its pollution disclosures. This was the expected observation. The variable of change in over/under emissions compared to allowances from 1990 to

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MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

Table 4.

Regression Results for Combined 1990 and 1995 and Separately for 1990 and 1995.

POLit = ␣0 + ␤1 D YEARit + ␤2 PLEVELit + ␤3 PLANTSit + ␤4 DIF EMISSIONit + ␤5 PL CAPACITY + ␤6 SIZEit + ␤7 D SCRUBBERit + ␧it

Variable

Coefficient

Panel A 1990 and 1995 combined Intercept 10.13377 Year −0.186403 Plevel 0.810299 Plants 0.31251 Dif Emission −2.89E−06 Capacity 0.017239 Size −0.296973 Scrubber 0.872175 Regression statistics R2 Adj R2 F 3.710856

0.282421 0.206315 Significance F 0.00192**

Panel B 1990 Intercept Plevel Plants Dif Emission Capacity Size Scrubber

14.68174 0.62731 0.318251 −2.29E−06 0.299628 0.486725 1.255159

Regression statistics R2 Adj R2 F 2.224033

0.307866 0.169439 Significance F 0.0680*

Panel C 1995 Intercept PLevel Plants Dif Emission Capacity

12.91177 1.393168 0.160302 −1.2E−05 −0.356963

Std. Error

t-Stat

Probability

8.487838 0.762251 0.28842 0.233028 1.98E−06 1.661743 0.384264 0.722864

1.193916 −0.244543 2.809441 1.341086 −1.457503 0.010374 −0.772837 1.206555

0.23678 0.80756 0.0065** 0.18449 0.14971 0.99175 0.44237 0.23191

11.4034 0.340503 0.419505 2.88E−06 2.199278 0.506282 1.026258

1.287489 1.842305 0.758634 −0.793426 0.136239 −0.96137 1.223044

0.20776 0.0753* 0.45399 0.43376 0.89254 0.34405 0.23083

14.94982 0.687896 0.35059 9.08E−06 2.760713

0.863674 2.02526 0.457236 −1.318827 −0.129301

0.39462 0.0518** 0.65079 0.19721 0.89798

Pollution Disclosures by Electric Utilities

Table 4. Variable

Coefficient

Size Scrubber Regression statistics R2 Adj R2 F 1.43782 ∗ Significant

−0.457038 0.680467

91

(Continued ) Std. Error

t-Stat

Probability

0.690133 1.126429

−0.662245 0.604092

0.51286 G0.55032

0.22334 0.068001 Significance F 0.233244

at the 0.10 level. at the 0.05 level.

∗∗ Significant

1995 has a significantly positive coefficient. This is indicative that a greater change in the difference between actual emissions and allowances is positively associated with greater pollution disclosures. A greater level of disclosure may be needed to explain the nature of higher emissions and how the firm planned to reach CAA compliance. Table 5.

Regression Results for the Change in Disclosures 1990–1995.

POLi = ␣0 + ␤1 PLEVELi + ␤2 PLANTSi + ␤3 90 − 95CHG EMISSIONi + ␤4 PL CAPACITYi + ␤5 SIZEit + ␤6 D SCRUBBERi + ␧it

Variable

Coefficient −10.84514661 −0.966359554 1.407955112 2.19E−05 −0.800876014 0.492052529 −0.322205435

Intercept PLEVEL Plants ChgEmm Capacity Size Scrubber Regression statistics R2 Adj R2 F 2.164765453 ∗ Significant

0.343198316 0.184659978 Significance F 0.0678*

at the 0.1 level. at the 0.05 level.

∗∗ Significant

Std. Error

t Stat

15.959 0.40163 0.58085 7.00E−06 2.800257 0.718747 1.13378

−0.679557273 −2.406089531 2.423921408 3.135144 −0.286000916 0.684597384 −0.284185691

Probability 0.50217 0.022** 0.022** 0.0039** 0.77691 0.49903 0.77828

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These results support H1, H2, and H3 that pollution disclosures are positively associated with the level of pollution emissions, number of targeted plants by a firm, and over/under emissions compared to allowances.

Additional Analyses of Pollution Disclosures Based on Different Pollution Levels It seems that the pollution level and the amount of effort needed to meet the CAA requirements played an important role in disclosure. In order to obtain additional insight into the impact of pollution levels and clean-up efforts on pollution disclosures, we compared pollution disclosures of firms at different levels of emissions. We categorized the 38 firms into three groups based on the amount of cleanup needed when the law was passed in 1990. These groups are: (1) firms in compliance with CAA at the time of enactment having no reduction in emissions required; (2) firms required to reduce emissions by the greatest amount; (3) firms required to reduce their emissions, but by the least amount. Pollution disclosures for each group are provided in Table 6. Firms that were in compliance with CAA in 1990 are shown in Panel A of Table 6. Presumably because these firms did not need any additional emission reduction, their pollution disclosures were almost the same in 1995 and 1990. Most of these firms recognized as early as 1989 that the first phase of the Clean Air Act would not have a significant impact on them, their ratepayers, or shareholders. Except for Long Island Lighting, these companies reported estimated or actual costs of complying with the CAA requirement. The main cost for these firms was the mandated installation of a continuous emission monitoring system and not for further abatement of emissions. By 1995, five of these firms also met the year 2000 SO2 standard of 1.2lbs./MMBTU. Only CMS Energy did not meet the standard in 1995, although, interestingly, it did meet it in 1990. Finally, none of these companies disclosed their actual sulfur dioxide emissions. Their disclosure index numbers are presented in Panel B of Table 6. The mean score of the disclosure indices (weighted and unweighted) shows that, on average, these firms made fewer disclosures in 1995 compared to 1990. The firms whose plants had to reduce sulfur dioxide by the greatest aggregate amount are included in Table 7. In general, these firms elected to reduce emissions with the use of scrubbers and they realized early on that abatement costs might be substantial. Of the seven companies with the widest gap between actual 1990 emissions and the 1995 standard, six estimated a cost that would turn out to be greater

Pollution Disclosures by Electric Utilities

Table 6.

93

Disclosures Made by Companies of Plants in Compliance in 1990.

Panel A: Disclosure Categories Company and Plant

Quantitative Disclosures 1989

1990

1995

CMS Energy JH Campbell

Cannot determine

No effect

$25M

Kansas City P&L Montrose

Not material

$16.6M

$5.24M

Cannot determine

Not significant

Just cost of CEMS

Cannot determine

In compliance

No disclosure

$50M

$25M

$45M

$8–12M

$8–16M

Insignificant

Long Island Lighting Port Jefferson Northport Northern States Power High Bridge Wisconsin Energy North Oak Creek South Oak Creek WPL Holdings Nelson Dewey Panel B: Disclosure Index

Disclosure Index for Companies of Plants in Compliance in 1990 Weighted

Unweighted

1990

1995

1990

1995

CMS Energy Kansas City P&L Long Island Lighting Northern States Power Wisconsin Energy WPL Holdings

5 6 3 3 6 8

4 4 6 0 8 3

3 3 2 2 3 3

2 2 3 0 4 2

Average

5.2

4.2

3.2

2.2

than the total expenditures finally incurred. American Electric Power provides an illustrative example of why this might have occurred. This company planned to put a scrubber on its Gavin plant stacks, estimated the cost, and implemented the strategy. The firm then used the excess allowances from the re-fitted Gavin plant to cover its excess emissions at other plants, thereby reducing the overall cost below that previously estimated. The other five companies either did not use a scrubber (as they previously had intimated they would) or seriously overestimated the cost

94

Table 7.

Pollution Disclosures of Companies that in 1990 Needed to Abate the Most SO2 .

Panel A: Disclosures Company

No. of Total Allowances Plants Abatement Needed Needed in 1995

Method of Abatement

Differences in Cost Disc 89–95

Actual Method

89, 90

95 $480M $420M $555M $300M then 0 (90) No disc $34M $24M No disc No disc Insig. $174M

American Elec. Power Southern Co. Allegheny Power Union Electric

9.5 8 4.5 2

662,031 443,665 188,072 125,587

217,994 2,009 49,421 1,596

SCR, LSC SCR, LSC 2 SCR No disc

SCR, LSC, Allow LSC SCR, Allow LSC, Allow

($200–800M) $3B $2B Substantial(89)

Commonwealth Edison Cinnergy Illinova IPALCO Penn Power & Light TECO Baltimore Gas & Elec.

1 5 3 3 3.5 1 1.5

101,009 98,291 95,138 69,954 62,665 61,060 57,517

0 72,689 183,361 47,051 0 8,198 0

SCR, Allow SCR, LSC SCR, LSC No disc LSC, Allow LSC SCR

LSC LSC, Allow Closed plant Allow No disc In Compliance Allow SCR, LSC

NIPSCO Kentucky Utilities Centerior

2 3 2.5

43,877 41,744 39,331

0 0 2,278

CC, SCR, LSC SCR, LSC SCR, LSC

LSC SCR. LSC LSC, Allow

CIPSCO $20–50M (90) Ohio Edison Sigco Utilicorp

3 3.5 2 1

38,273 36,223 29,784 29,730

6,760 12,296 10,702 0

CC, LSC SCR, LSC SCR LSC

LSC In compliance SCR In compliance

$450M $1B $150–250M $2M–250M No disc Insig. $600M (89) not material (90) $14M $130M $100M-1.2B (89) $400–700M (90) $120–200M (89) No disc $130–180M $31–40M

No disc $145M $50M $76M No disc $103M No disc

MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

Proposed

Company American Electric Power Southern Company Allegheny Power Union Electric Commonwealth Edison Cinergy Illinova Ipalco Penn. Power & Light TECO Balt G&E NIPSCO Kentucky Utilities Centerior CIPSCO Ohio Edison Sigco Utilicorp Mean

Weighted 1990 8 9 6.4 4 8 6 10 7 8 5 8 8 11.6 11 12.2 3 13 8 8.1

1995 10 9.25 8.4 6 5 6 8 1 3 5 6 5 10 6 7.2 3 13 3 6.4

Unweighted 1990 4 4 3.2 2 4 3 5 3 4 3 4 4 5.3 5 5.6 2 6 4 3.9

1995 5 4.125 4.2 3 3 3 4 1 2 3 3 3 5 3 3.6 2 6 2 3.3

Pollution Disclosures by Electric Utilities

Panel B: Disclosure Index

Note: Total tons of SO2 over standard of plants exceeding the standard in 1995.

95

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MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

of implementing this control technique. An evaluation of Table 7 information, together with Table 2 data, suggests that these firms expected ratepayers to cover the cost of their abatement strategies. Since the estimated increase in rates is a function of the expected abatement cost, these firms also overestimated the expenditures that would have to be borne by ratepayers. The disclosure index scores of these firms shown in Table 7 indicate that companies in this category made the most extensive disclosures. The disclosure scores are greater than the averages reported for the total sample. A comparison of individual firms’ scores with an average score across all firms (see Table 3) shows that weighted as well as unweighted scores for both years are greater than the averages of the full sample. Firms that had to reduce SO2 emissions by the least amount are shown in Table 8. As to quantitative reporting, their disclosures were much less than high-abatement firms. None of them disclosed in 1990 any plans to utilize a scrubber. However, based on the reports of NYSEG, General Public Utilities, Niagara Mohawk, and Virginia Electric and Power in 1989 or 1990, it is evident that they intended to retro-fit plant stacks with scrubbers. Also interesting is the fact that some of the firms had to reduce emissions by a relatively small amount, yet chose not to abate to the CAA standard. Atlantic City Electric, for example, built a scrubber for the BL England plant, but it must not have been fully operational in 1995. General Public Utilities essentially continued to operate as it did in pre-CAA periods, making use of allowances instead of incurring any costs to actually reduce emissions at its plants. Disclosure scores for this group are presented in Panel B of Table 8. An evaluation of these scores shows that they are close to the averages for the whole sample. They also indicate that firms with 1995 emissions at nearly the same level as in 1990 disclosed more pollution information in the later year than in the earlier one.

Interpretation of Results This analysis of disclosures made by publicly owned electric utilities of the targeted plants provides some evidence as to how their reporting was influenced by the CAA emission requirements. The results show that disclosure extensiveness seems to be a function of the firm’s need to reduce emissions. The companies covered by this study – every one that was impacted by the Clean Air Act’s first phase – generally made more extensive disclosures in 1990 than they did in 1995. In 1990, these firms were trying to assess the impact of CAA on their performance and were formulating a strategy to meet the CAA requirements. Many of them reported a worst-case scenario in 1990 (e.g. installing

Pollution Disclosures of Remaining Companies that in 1990 Needed to Abate SO2 (Least to Most).

Panel A: Disclosures Company

Wisconsin PSC Mid-American Energy Northeast Utility Interstate Power Atlantic City Elec. Empire District Elec. IES Industries NYSEG General Pubic Util. Niagara Mohawk Virginia Elec. Power DQE Potomac Electric

No. of Plants 1 1 1 1 1 1 3 2 2 1 1 2.5 2

Total Abatement Needed

Allowances Needed in 1995

Proposed

Method of Abatement Actual Method

89, 90

Differences in Cost Disc 89–95 95

3,355 4,245 6,954 5,351 9,935 10,8850 11,727 13,407 15,453 17,117 17,473 23,158 23,847

0 0 3939 0 939 LSC 1,232 LSC 2,284 15,443 7,920 0 835 0

In compliance Gas, LSC No disc LSC No disc Allow LSC, Allow No disc No disc LSC LSC, Allow CC New equipment LSC

In compliance No disc No disc LSC SCR No disc $6M SCR SCR, LSC, Allow In compliance LSC, Allow No disc New equipment LSC

No disc No disc None No disc Substantial No disc No disc $250–350M $675–1B $300M $470M $50M $190M

No disc No disc $41M No disc No disc

$115M $234M $37M $140M No disc $36.2M

Pollution Disclosures by Electric Utilities

Table 8.

Panel B: Disclosure Index Company Wisconsin PSC Mid-American Energy Northeast Utility Interstate Power Atlantic City Electric Empire Dist. IES Ind. NYSEG GPU Niagara Mohawk VA Elect Power Potomac Elec.

Unweighted

1995 3 1 9 7 5 5 3 7 9 8 8 8

1990 3 4 2 4 4 2 5 4 4 3 4 3

1995 2 1 4 3 3 3 2 2.5 5 4 4 4

7.0

6.0

3.5

3.2

97

Average

Weighted 1990 8 7 4 7 8 3 10 9 8 5 8 6

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MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO

stack scrubbers and incurring high abatement costs) when, in hindsight, there were few new scrubbers installed and the costs were not nearly as great as had been anticipated. A possible motivation (beyond simple “conservatism”) was that they were setting the stage for future rate hikes no matter what set of expenditure outcomes actually occurred. In a sense, the firms were warning stakeholders and public utility commissions about the potential consequences of the Clean Air Act. By 1995, with the costs already incurred (except for acquiring more allowances), there was no further need to disclose differentially greater amounts of information. Although firms that needed to reduce emissions by similar amounts tended to provide the same level of disclosure, there still was much reporting variation. With this differential disclosure, stakeholders may have found it difficult to compare the impact of the CAA across companies in the industry. In general, investors and creditors probably would have been wary (even though companies stated that ratepayers would bear the costs) due to the substantial expenditures that many firms claimed would be made. Differential pollution disclosures also might send confusing signals to employees. The heavy costs that initially were estimated to be needed to meet the emission requirements might have created fear of plant generation cutbacks or closing. Plant closings, reduction of output at some facilities, and changing fuel at others, surely would have impacted employees. If financial statements (or any public documents) were the main source of information about the potential impact of this law, employees might well have felt insecure regarding their job situation. Since ratepayers were expected to bear the costs of CAA-required abatement, initial cost estimates also created uncertainty. When firms resolved their abatement problems using low-sulfur coal, most of these fears subsided. The inadequacy of disclosure in 1995, however, created additional uncertainties for all stakeholders. Firms would be better advised to keep stakeholders adequately informed about pollution emissions and meeting the requirements for CAA Phase 2.

CONCLUSION The first phase implementation of Title IV of the Clean Air Act of 1990 appears to have achieved its goal concerning reduction of sulfur dioxide emissions. Overall, those electric utility plants targeted in this phase did reduce average emissions below the 2.5lbs/MMBTU standard. Although a total SO2 emissions reduction has been achieved, at the individual plant level success has been somewhat mixed. Thirty of the 90 plants whose emission level was greater than 2.5lbs/MMBTU in 1990 were still emitting above that level in 1995. And despite the fact that extensive use of the allowance system has been made by the targeted plant owners, 51% of

Pollution Disclosures by Electric Utilities

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the emissions reduction was achieved by using other techniques, mainly through substitution of low-sulfur coal – an alternative that existed before the legislative mandate of 1990. With regard to disclosure, the findings in this study indicate that reporting on a voluntary basis has not been a particularly adequate response to stakeholders’ information needs. The findings suggest that some firm-specific pollution-related factors played a role in management’s pollution disclosure strategy. A positive association was detected between pollution disclosures and the level of effort needed to meet the emission standard, the number of plants that a firm was required to clean up to meet the CAA mandate, and the differences between actual pollution and allowances granted to the firm under CAA. Unlike the conclusions reached in nearly all previous studies in this area, our results can be interpreted to suggest that there is an association between the firm’s pollution control strategy and its disclosure strategy. More evidence is needed before we can generalize this finding to other industries and different scenarios. Still, these results come from a large and robust study. They indicate a shift in management policy regarding disclosure such that we can foresee a future in which it is likely that disclosure efforts will be associated more closely with the efforts needed to control environmental degradation. Yet, if there is no additional evidence to support pollution disclosures on a voluntary basis, especially reporting commensurate with the efforts needed to control pollutions, the imposition of mandatory disclosures requires evaluation. Adequate pollution disclosures should be provided so that stakeholders are able to make proper assessments of the firm’s pollution performance in light of the efforts needed to reach the desirable level of pollution performance. Mandating performance without mandating disclosure might not be the most useful public policy posture when it comes to matters of environmental protection.

REFERENCES Burr, M. (1991). Teaming up on clean coal. Independent Energy (February), 33. Clarkson, M. (1991). The moral dimension of corporate social responsibility. In: R. Coughlin (Ed.), Morality, Rationality & Efficiency (pp. 185–196). MC Sharpe. Freedman, M., & Jaggi, B. (1982). Pollution disclosures, pollution performance and economic performance. OMEGA (2nd Quarter), 167–176. Freedman, M., & Jaggi, B. (1986). An analysis of the impact of corporate pollution performance included in annual financial statements on investors’ decisions. Advances in Public Interest Accounting, 1, 193–212. Freedman, M., & Jaggi, B. (1993). Air and water pollution regulation: Accomplishments and economic consequences. Westport, CT: Quorum.

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Gray, R., Owen, D. L., & Maunders, K. (1991). Accountability, corporate social reporting and the external social audits. Advances in Public Interest Accounting, 4, 1–21. Guthrie, J., & Parker, L. (1990). Corporate social disclosure practice: A comparative international analysis. Advances in Public Interest Accounting, 3, 159–175. Ingram, R. (1978). An investigation of the information content (certain) social responsibility disclosure. Journal of Accounting Research (Autumn), 270–285. Ingram, R., & Frazier, K. (1980). Environmental performance and corporate disclosure. Journal of Accounting Research (Autumn), 614–622. Kahn, J. (1995). The economic approach to environmental and natural resources. Ft. Worth, TX: Dryden Press. Mill, J. S. (1970). Principles of political economy. London: Pelican Books. Patten, D. (1991). Exposure, legitimacy and social disclosure. Journal of Accounting and Public Policy, 10, 297–308. Patten, D. (1992). Intra-industry environmental disclosures in response to the Alaskan oil spill: A note on legitimacy theory. Accounting, Organizations and Society, 17, 471–475. Rawls, J. (1971). A theory of justice. Cambridge, MA: Belknap Press. Rockness, J. (1985). An assessment of the relationship between U.S. corporate environmental performance and disclosure. Journal of Business Finance and Accounting (Autumn), 334–354. Shabecoff, P. (1989). Bush is talking, congress is shifting an emergence of political wills on acid rain. New York Times (February 19), 5. Smock, R. (1990). Acid rain bills point to well-scrubbers retrofits. Power Engineering (July), 34. Ullmann, A. (1985). Data in search of a theory. Academy of Management Review (July), 540–547. U.S.E.P.A. (1990). The clean air act amendments of 1990: Summary materials. Washington, DC: Government Printing Office. Wiseman, J. (1982). An evaluation of environmental disclosures made in corporate annual reports. Accounting, Organizations and Society, 7(1), 53–63.

FINANCIAL ANALYSTS’ VIEWS OF THE VALUE OF ENVIRONMENTAL INFORMATION Herbert G. Hunt III and D. Jacque Grinnell ABSTRACT One question of interest to several different groups is whether capital markets value environmental information and, if so, to what extent this information is incorporated into security valuation models. This paper addresses these questions by reporting on a survey of financial analysts and other influential members of the financial community with respect to their knowledge of various types of environmental information and their use of this information in security analysis. The results, while exploratory in nature, indicate a surprising lack of knowledge among the respondents concerning various organizations and reporting initiatives that are well known in environmental circles. A pervasive theme running through the results suggests that while most analysts do not explicitly incorporate environmental variables into their evaluation models, for those that do, their focus is on downside risk rather than upside potential. The results suggest that the reluctance to make widespread use of environmental information is due, at least partly, to concern with the reliability of the available information. This suggests that more work needs to be done to communicate relevant and reliable environmental performance information to the investment community.

Advances in Environmental Accounting and Management Advances in Environmental Accounting and Management, Volume 2, 101–120 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-3598/doi:10.1016/S1479-3598(03)02004-1

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HERBERT G. HUNT III AND D. JACQUE GRINNELL

INTRODUCTION Some environmentalists, academics, business consultants, and corporate managers claim that following environmentally-friendly or environmentally-sustainable practices is good, not only for the soul, but also for the “bottom line.” Alternatively, others claim “eco-efficiency does not pay and that a few big companies are driving up environmental standards to squeeze out less well capitalized competitors” (Schmidheiny & Zorraquin, 1998, p. 67). The detractors also argue that, regardless of what proponents say, most of what gets done in the environmental field is simply driven by regulations, or threat of regulations. Whether or not following environmentally-friendly practices leads to enhanced economic performance is, ultimately, an empirical question. Existing studies present evidence and arguments on both sides of the debate as to the economic merits of eco-efficiency. For example, some researchers have reported positive correlations between environmental performance, variously defined, and measures of firm profitability (e.g. Hart & Ahuja, 1996; Russo & Fouts, 1997; Toms, 1999) and shareholder value (e.g. Blumberg et al., 1998; Cohen et al., 1995; Dowell et al., 2000; Feldman et al., 1997; Yamashita et al., 1999). Alternatively, others have suggested that few companies realize any economic payback from their environmental investments (e.g. Walley & Whitehead, 1994). At this point, it remains unclear to many observers whether environmental performance and financial performance are positively related in any systematic way and, if so, whether a cause and effect relationship can be gleaned from the evidence (Garrity et al., 2002). However, a report by the Environmental Capital Markets Committee of the National Advisory Council for Environmental Policy and Technology states that “(a) significant body of research shows a moderate positive correlation between a firm’s environmental performance and its financial performance – regardless of the variables used to represent each kind of performance, the technique used to analyze the relationship, or the date of the study” (2000, p. 1). Despite this evidence of a positive relationship between environmental and financial performance, the Committee goes on to observe that the “capital markets have been slow to incorporate environmental information into mainstream investment decision-making” (2000, p. 1). Furthermore, The environment is currently seen by analysts and fund managers as a legal (compliance) or emotional/ethical issue; it is not perceived to be a decisive factor of quality management; its financial impact is deemed to be immaterial; the information provided by the corporate sector lacks credibility; and there is insufficient demand side market pressure within the financial community itself to integrate this issue into regular investment analysis (Suranyi, 1999, p. v).

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As suggested by the above, the reason for the reluctance of the capital markets to fully incorporate environmental information into security valuation models may be that influential market participants such as financial analysts view environmental information as either irrelevant, or as too unreliable. Indeed, “The vast majority of investment managers . . . view most environmental concerns . . . as utterly irrelevant to their jobs. Such issues, unless defined by the law or given a number in the accounts, are for them simply out of play” (Schmidheiny & Zorraquin, 1998, p. 79). Currently, little evidence is available regarding the views of financial analysts, as representatives of the investment community, regarding matters such as the existence of an environmental-financial performance link, the importance and use of environmental performance variables for valuing securities, their sources of environmental information, and the adequacy of firm-level public reporting and disclosures related to environmental matters. Most of the available evidence is based on limited-scope surveys using small sample sizes and, in one case, included only London-based analysts. The current study is designed to examine the financial community’s use of environmental information by analyzing financial analysts’ views of the value and use of such information in their work. Specifically, we present the results of an exploratory survey of a large sample of U.S.-based financial analysts regarding their views on the issues discussed above and provide preliminary insights in this area. The survey results reveal that respondents: (1) are relatively unfamiliar with well-known environmental organizations and initiatives associated with environmental issues as they relate to the corporate world; (2) do not feel that an aggressive environmental stance will lead to a higher stock price but agree that an aggressive approach to environmental protection leads to reduced investment risk and lower cost of capital; (3) generally do not incorporate measures of environmental performance into their valuation models due, at least in part, to the lack of reliable measures of environmental performance; (4) agreed somewhat that financial analysts should use environmental indicators when valuing securities and that there currently is a gap between what should be done in this regard, and what is actually done in practice;1 and (5) do not routinely ask corporate managers about the contributions of their environmental programs to their firms’ cash flows. The results also indicate that on some of the issues examined in this survey, differences exist among sub-groups of the respondents when they are partitioned based on years of experience and based on whether they consider themselves as “generalists” or “specialists.” The remainder of the paper proceeds as follows. The next section briefly examines previous work done in this area followed by a description of the survey used in the current study. We then present an analysis and discussion of the results. The final section provides a summary and concluding comments.

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PREVIOUS STUDIES As pointed out above, limited evidence exists concerning financial analysts’ knowledge and use of environmental information. Much of what does exist is based on three limited-scope surveys performed in the mid to late 1990s. One of these surveys is described in a working paper by Gentry and Fernandez (1996) produced by the United Nations Development Programme (Committee on Industrial Environmental Performance Metrics, 1999). The survey included between 16 and 20 questions directed towards selected Fortune 500 chief financial officers and financial analysts concerning their use of environmental information in assessing companies’ relative strengths. The researchers found that while a small percentage of respondents make use of environmental performance data, the majority pay little attention to it in their work. For example, both analysts and CFOs ranked environmental spending as least important among 10 quantitative factors potentially useful in analyzing a company. Similarly, they ranked corporate environmental policy last among six qualitative factors.2 When asked to rank the significance of various factors hindering the incorporation of environmental information into company analyses, the respondents ranked as most significant inadequate sources of useful data, lack of quantifiable data, unreliability of available environmental data and lack of tools for quantifying environmental data. In a survey sponsored by Extel Financial and a group called Business in the Environment, researchers solicited the opinions of 85 top London analysts covering 28 different business sectors (Schmidheiny & Zorraquin, 1998). Among other things, this survey found that the respondents generally didn’t concern themselves with environmental issues “because they did not perceive them as relevant in assessing companies” (Schmidheiny & Zorraquin, 1998, p. 93). Almost half of the analysts said they never used any source of environmental information, half said they distrust company figures on environmental initiatives, and less than 20% considered companies’ environmental policies as important. On the other hand, the analysts predicted that environmental issues would become more important in their work in the future. Schmidheiny and Zorraquin (1998) concluded that the survey findings can best be summed up with the thought that “when environmental issues have a quantifiable financial impact (or a price), then analysts consider them important, and impacts are taken into account, despite poor data” (p. 93). Some collateral evidence of the value and use of environmental information is provided by Soyka and Feldman (1998). Those authors report the results of a limited survey of mutual fund managers regarding the equity and debt valuation implications of environmental factors. The authors found some support for investors’ willingness to pay a “premium” for the equity and debt of companies that

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invest in environmental health and safety improvements that create incremental value for the firm. That finding is somewhat at odds with those of the two earlier surveys mentioned above. For example, Gentry and Fernandez (1996) reported that only 17% of analysts and 25% of CFOs felt that investors would pay a premium for a firm with an exceptional environmental program whereas 70% of analysts and 75% of CFOs indicated that investors would apply a discount in valuing companies with poor environmental performance. The focus on the downside of environmental issues is also evident in the survey of British analysts in which 69% of respondents mentioned concern with environmental liability costs while fewer than 20% stated that a firm’s environmental policies are important in their work.

METHODS AND PROCEDURES As a first step in the development of the survey instrument used in the current study, a 15-item questionnaire was mailed to 30 non-service sector equity analysts in the Northeast U.S. in the spring of 1999. Included in this pilot study were questions concerning the analysts’ use of environmental performance information and non-quantitative data and whether they had observed a link between environmental performance and stock price. We also solicited their opinions on the availability and reliability of firm environmental performance data and whether such data should be used in valuing equity securities. Nine of the analysts returned completed questionnaires and their responses and comments were used to develop the 24-item survey instrument used in the current study. Given our objective of obtaining the views of a significant number of influential members of the investment community, we requested permission to survey the members of three large professional analysts groups: (1) the Association for Investment Management and Research (AIMR); (2) the New York Society of Security Analysts (NYSSA); and (3) the Boston Security Analysts Society (BSAS). The NYSSA granted us permission to survey its members and provided us with a list containing their names and addresses.3 The NYSSA mailing list was parsed based on self-reported titles in order to identify individuals whom we believed were in a position to knowledgeably comment on the issues raised in the questionnaire. To this end, we focused primarily on persons who identified themselves as equity analysts, credit analysts, fixed income analysts, directors of research, and mutual fund or portfolio managers. A cover letter explaining the purpose of the study and the questionnaire were sent to 3,996 individuals. We received a total of 323 responses, of which 315 were usable, yielding an effective response rate of 7.9%. Due to budget constraints, no

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Table 1. Characteristics of Analysts Sampled. Number

%

98 21 20 5 6 98 36 31

31.11 6.67 6.35 1.59 1.90 31.11 11.43 9.84

315

100.00

56 63 77 116 3

17.78 20.00 24.44 36.83 00.95

315

100.00

Title/responsibilities Equity analyst Credit analyst Fixed income analyst Mergers & acquisitions analyst Director of research Mutual fund or portfolio manager Multiple titles/responsibilities Other Total Years of experience as investment specialist 1–5 years 6–10 years 10–20 years More than 20 years No response Total

follow-up reminder was sent to people who did not respond to the initial mailing.4 Some demographics of the respondents are presented in Table 1. In addition to the information shown in Table 1, 148 of the respondents (47.0%) described themselves as “generalists” while 135 (47.9%) indicated that they followed one or more specific industries.

SUMMARY AND INTERPRETATION OF RESULTS Aggregate Analyses In addition to three questions related to information about the respondent, the survey instrument included 24 items that address a variety of issues related primarily to firms’ environmental performance and their public disclosure of environmental information. The first of these asked the respondents to indicate whether or not they were familiar with each of six organizations or initiatives that are well known in environmental circles for their association with environmental issues as they relate to individual firms. The results are summarized in Table 2. As the table shows, the analysts indicated a surprising lack of familiarity with these organizations

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Table 2. Analysts’ Familiarity with Selected Organizations and Initiatives Associated with Environmental Issues. Name of Organization or Initiative

Investor Responsibility Research Center (IRRC) International Organization for Standardization (ISO) Coalition for Environmentally Responsible Economies (CERES) Council on Economic Priorities (CEP) Public Environmental Reporting Initiative (PERI) Global Reporting Initiative (GRI)

Respondents Indicating Familiarity Number

% Total (315)

65 88 42 35 9 26

20.63 27.94 13.33 11.11 2.86 8.25

and initiatives. This evidence provides one indication that environmental performance is not currently a major issue in the minds of the investment community at large. A majority of the remaining items in the survey instrument required the analyst to respond to a variety of statements on a seven-point scale ranging from strongly disagree (1) to strongly agree (7), with 4 indicating a neutral position. One subset of four items related to the analyst’s perception about the linkage between firm environmental performance and either economic performance or risk. The means, standard deviations and 2-tailed significance levels for these statements are displayed in Table 3.5 On balance, the analysts slightly disagree that good environmental performance, beyond the threshold level needed to comply with the law, will positively affect the firm’s stock price. On the other hand, the respondents agree somewhat that good environmental performance reduces risk and lowers the firm’s cost of capital and that greater availability of reliable information about firm environmental performance will lessen the perceived risk of investment in firms with good environmental performance or aggressive environmental strategies. Overall, the results reported in Table 3 suggest that analysts tend to focus on downside risk as opposed to upside potential when it comes to environmental matters. This observation is based on the fact that the respondents disagreed with the statement dealing with upside potential, but tended to agree with the three statements relating to financial risk. This finding is consistent with analysts’ focus on downside risk reported in earlier studies and discussed in the previous section. Another subset of seven items related to analysts’ use of environmental performance measures in security valuation. These statements, along with a summary of the responses are presented in Table 4. The results indicate that respondents weakly agree that they should use environmental performance indicators and that

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Table 3. Analysts’ Beliefs about the Existence of a Linkage Between Firm Environmental Performance and Economic Performance. Statement

(1) If a firm has good environmental performance (i.e. acts aggressively in terms of having a pollution prevention strategy that goes beyond governmental compliance), it will have a higher stock price (compared to a firm that simply complies with the law) (2) An investment in a company known for its aggressive approach to environmental protection is a less risky investment than that of a company that is not (3) Environmentally responsible companies create additional value through being less risky business entities with a lower cost of capital (4) If the amount of reliable information pertaining to environmental performance becomes more readily available to the capital markets, it will result in a lower perceived risk of investment in firms with good environmental performance or proactive environmental strategies

Number of Responses

Meana (Std. Dev.)

Significanceb

314

3.72 (1.46)

0.001

313

4.36 (1.68)

0.000

313

4.48 (1.57)

0.000

313

4.61 (1.56)

0.000

response based on a seven point scale with 1 = strongly disagree and 7 = strongly agree. levels are based on a 2-tailed dependent sample t-test that the mean response was equal to 4 (i.e. neutral). a Mean

b Significance

there is a gap between what should be done and what is actually done in practice in this regard. The mean response of 5.29 to statement 3 indicates that respondents who believe there is a gap also believe that the gap is due to difficulty in obtaining reliable environmental performance information. The mean response to statement 4 indicating that the analysts do not incorporate measures of environmental performance into their own valuation models despite agreeing that they “should” do so (statement 1), provides further evidence of this gap. Although the mean response to statement 5 is consistent with the findings of Gentry and Fernandez (1996) discussed earlier, it is not significant at conventional levels. The responses to the last two statements in Table 4 suggest that, while the analysts do not routinely ask corporate managers about the effect of environmental programs on cash flows, they think that corporate managers who believe their environmental initiatives create value will voluntarily communicate that view. A follow-up question asked the respondents to identify, from a given list of variables, those that they consider in evaluating a firm’s environmental

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Table 4. Analysts’ Use of Environmental Performance Measures. Statement

(1) Financial analysts should use environmental performance indicators when valuing securities (2) There is a gap between what should be done and what is actually done in practice with regard to the use of environmental performance indicators in valuation models (3) If you believe there is a gap, it is due to difficulty in obtaining reliable information (4) I incorporate measures of environmental performance in my valuation model used to assess firms (5) If you do not incorporate environmental information in your assessment, it is because of the lack of, or difficulty in obtaining, reliable measures of environmental performance (6) As part of my normal interaction with corporate managers, I routinely ask them about the contribution of their environmental programs to the firms’ cash flow (7) Corporate managers who believe that their firms’ environmental activities create value tend to communicate this view even if I fail to ask them about such activities

No. of Responses

Meana (Std. Dev.)

Significanceb

314

4.17 (1.60)

0.067

290

4.20 (1.56)

0.030

129

5.29 (1.25)

0.000

315

2.97 (1.70)

0.000

268

4.16 (1.74)

0.142

306

2.93 (1.61)

0.000

308

4.72 (1.45)

0.000

response based on a seven point scale with 1 = strongly disagree and 7 = strongly agree. levels are based on a 2-tailed dependent sample t-test that the mean response was equal to 4 (i.e. neutral). a Mean

b Significance

performance. The results are presented in Table 5. The most widely used measure is “environmental liabilities” (considered by approximately 74% of the respondents to this question). The next most used variables are size (61%) and number (53%) of fines and penalties associated with environmental violations. The results reported in Table 5 again suggest that, when analysts do consider environmental variables in their evaluations, their focus is mainly on downside risk rather than upside potential, a point made above with respect to the results reported in Table 3. This downside orientation by analysts has also been observed by other researchers as noted in the last section. For example, in the study of London analysts, “Environmental issues were perceived mainly in terms of liabilities: 69% (of surveyed analysts) mentioned the financial consequences of incurring environmental liability costs, with cleanup costs featuring high among concerns”

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Table 5. Variables Considered by Analysts in Evaluating Environmental Performance. Variable Considered

Environmental liabilities Size of fines and penalties Number of fines and penalties Expenditures for pollution prevention Number of superfund sites Comprehensiveness of company’s environmental program Emissions Waste reduction programs Other

Number of Respondents Indicating Use

As Percent of Respondents to This Question (257)

As Percent of Respondents to Survey (315)

190 158 137 96 90 88

73.93 61.15 53.31 37.35 35.02 34.24

60.32 50.16 43.49 30.48 28.57 27.94

80 66 24

31.13 25.68 9.34

25.40 20.95 7.62

(Schmidheiny & Zorraquin, 1998, p. 92). Interestingly, the 69% figure in the London study closely matches the 74% figure reported in Table 5 for the current study. In a significant paper examining the link between environmental performance and shareholder value, Blumberg et al. (1998, p. 9) state, “Financial markets have hitherto generally recognized only negative environmental performance.” The EPA study by the Environmental Capital Markets Committee (2000) referred to earlier also cited a similar focus on downside risk among analysts. Specifically, “The traditional perception of equity investment analysts is that if environmental strategies matter at all in a firm’s financial performance, they do so in terms of liabilities and risks” (p. 5). Thus, the results presented in Tables 3 and 5, in conjunction with earlier studies, suggest that analysts tend to focus on environmental compliance as the important issue rather than whether or not a firm is pursuing a proactive environmental strategy. We also asked the respondents to identify, again from a given list, the sources they use to obtain environmental information. The results are shown in Table 6. Annual reports to shareholders and SEC reports were the most often cited sources (by nearly 87% of the analysts who responded to the question). This heavy reliance on annual and SEC reports as sources of environmental information is consistent with the emphasis placed on environmental liabilities as a variable to be considered in evaluating environmental performance (discussed above) since these reports are the primary source of such information. This finding also reinforces the observation made above that analysts appear to be focusing on downside risk, or primarily on information that clearly shows the financial

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Table 6. Environmental Information Sources used by Analysts. Type of Information Source

Annual reports & reports to the SEC Management interviews Proxy statements Third party reports (e.g. IRRC, CEP) EPA reports General media, financial press, industry publications Environmental progress reports Other

Number of Respondents Indicating Use of Source

As Percent of Respondents to This Question (260)

As Percent of Respondents to Survey (315)

226

86.92

71.75

160 77 67

61.54 29.62 25.77

50.79 24.44 21.27

47 36

18.08 13.85

14.92 11.43

34 13

13.08 5.00

10.79 4.13

implications of environmental matters. Management interviews were also often cited as an information source by a majority of the respondents (61.5%). Interestingly, while a recent report found that 35% of the Fortune Global 250 had published separate environmental progress reports (Kolk et al., 2001), only 13% of the analysts who responded to this question in our survey indicated they used such reports in their work. This result is somewhat surprising in light of international initiatives to encourage these types of reports (e.g. CERES guidelines and, most recently, the Global Reporting Initiative) and the increasing number of companies that are issuing such reports (e.g. see Bebbington & Gray, 2000). Their relatively low usage could stem from their lack of comparability due to the absence of standardized environmental reporting standards or from concerns with their credibility since they typically are not verified by independent third parties (Beets & Souther, 1999). Furthermore, issuers of separate environmental reports often identify groups other than shareholders as primary target audiences for such reports. One such audience identified by U.S. and European companies is the issuing firms’ own employees (Cairncross, 1995; Lober et al., 1997). To the extent that firms target environmental reports primarily to their employees, and view shareholders as secondary users, analysts are justified in their skepticism concerning the reliability and relevance of the reports. As Cairncross (1995, p. 207) points out, “If environmental reports are to be useful to shareholders, they need to give more information on the links between environmental policy and corporate performance.” A final subset of items in our survey addressed issues concerning public reporting and disclosures related to environmental matters. A summary of the results

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Table 7. Analysts’ Views on Public Reporting and Disclosures Related to Environmental Matters. Statement

(1) The accounting numbers in financial statements adequately reflect the financial implications of environmental performance, thereby making it unnecessary to consider environmental performance as a separate factor in valuing a firm (2) FASB and SEC liability recognition and disclosure requirements related to environmental matters are adequate (3) Firms are generally complying with FASB and SEC reporting requirements related to environmental matters (4) It is important for firms to endorse the CERES principles (5) There should be standardized reporting on environmental performance (such as that established by CERES or proposed by the GRI) (6) It is important for firms to have their environmental performance reports verified by independent third parties

No. of Responses

Meana (Std. Dev.)

Significanceb

301

2.87 (1.35)

0.000

298

3.77 (1.38)

0.004

297

4.65 (1.19)

0.000

278

4.03 (1.10)

0.624

292

4.50 (1.50)

0.000

300

4.63 (1.63)

0.000

response based on a seven point scale with 1 = strongly disagree and 7 = strongly agree. levels are based on a 2-tailed dependent sample t-test that the mean response was equal to 4 (i.e. neutral). a Mean

b Significance

related to this area of inquiry is presented in Table 7. The respondents disagree with the view that a company’s financial statements adequately reflect the financial implications of environmental performance, thereby making it unnecessary to consider environmental performance as a separate element in valuing a firm. They also disagree somewhat that FASB and SEC liability recognition and disclosure requirements related to environment matters are adequate. However, the respondents agree with the view that firms are generally complying with existing FASB and SEC reporting requirements related to environmental matters. These results are somewhat at odds with empirical studies suggesting that, when it comes to environmental matters, many firms are not in compliance with SEC reporting and disclosure rules (Repetto & Austin, 2000) and that others use differential disclosure policies depending on the composition of the financial statement users (Ely & Stanny, 1999). For example, Repetto and Austin (2000) analyzed the reporting and disclosure practices of firms in the pulp and

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paper industry and concluded that “Despite evidence that environmental issues can affect companies’ financial performance, review of companies’ financial statements reveals that disclosure of such material risks and uncertainties has been inadequate . . . (and that) . . . the SEC’s enforcement efforts in this area have been minimal” (pp. ix–x). Ely and Stanny (1999) examined how (quantitatively vs. qualitatively) and where (annual reports vs. 10K reports) firms disclosed information on the number of sites for which it had been named as a potentially responsible party (PRP). The authors found differences in reporting practices between types of shareholders and analyst following, leading them to conclude that equal access to potentially material financial information is not provided by firms named as PRPs and that the financial statement users determine the level of detail that firms disclose in their annual reports and 10Ks. Thus, while the analysts in our study appear to be aware that they may need to go beyond a firm’s financial statements to get a complete picture of the financial implications of environmental matters, they incorrectly assume that firms are currently complying with existing regulatory reporting and disclosure requirements. With respect to environmental performance reporting, the respondents are neutral about the importance of having firms endorse the CERES principles. There is some agreement that there should be standardized reporting on environmental performance and that it is important for firms to have their environmental performance reports verified by independent third parties. These results are consistent with those of the survey of London analysts that found that only one third of those respondents felt that current environmental disclosure and reporting levels are sufficient if environmental issues ever become a significant part of routine firm assessment and valuation. Similarly, 54% of the London analysts indicated that external verification of corporate environmental information would be useful (Schmidheiny & Zorraquin, 1998, p. 93).

Additional Analyses In addition to the aggregate results summarized above, we also examined potential differences among sub-groups of the respondents. Specifically, we analyzed mean response values for all survey items contained in Tables 3, 4 and 7 for analysts grouped by years of experience and industry following (i.e. “generalist” vs. following one or more specific industries). One-way ANOVA tests were performed on the sub-groups to test for statistical significance. With the survey respondents grouped by years of experience, there are statistically significant differences (at the 0.10 level) in mean responses for four of the survey statements. When the analysts are grouped as “generalists” or “specialists,” differences emerge with respect to

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Table 8. Group Mean Responses Based on Analysts’ Years of Experience as an Investment Specialist.a Statement Referenceb Table 3, Stmt. 1 Table 4, Stmt. 4 Table 4, Stmt. 6 Table 7, Stmt. 6

Groupc

Total Sample

I

II

III

IV

F-Value (Significance)d

3.72 (1.46) 2.97 (1.70) 2.93 (1.61) 4.63 (1.63)

3.73 (1.50) 2.64 (1.65) 2.75 (1.54) 5.02 (1.38)

3.40 (1.31) 2.78 (1.73) 2.56 (1.45) 4.98 (1.41)

3.60 (1.51) 2.78 (1.72) 2.73 (1.64) 4.59 (1.70)

3.95 (1.47) 3.32 (1.63) 3.34 (1.62) 4.33 (1.74)

2.154 (0.093) 2.985 (0.031) 4.254 (0.006) 3.294 (0.021)

a Mean responses based on a seven point scale with 1 = strongly disagree and 7 = strongly agree. Standard deviations are presented in parentheses. b Refer to indicated table to see survey statement. c Groups based on years of experience are as follows: I: 1–5 years (n = 56); II: 6–10 years (n = 63); III: 10–20 years (n = 77); IV: 20+ years (n = 116). d 2-tailed significance levels.

two survey statements. The results of these analyses of sub-groups are presented in Tables 8 and 9.6 As Table 8 reveals, there are some statistically significant, although not particularly large, differences among respondents partitioned by years of experience. Specifically, the groups differ in their strength of disagreement with three of the survey statements. These statements are as follows: (1) If a firm has good environmental performance . . . it will have a higher stock price . . . (Table 3, Stmt. 1); (2) I incorporate measures of environmental performance in my valuation model . . . (Table 4, Stmt. 4); and (3) As part of my normal interaction with corporate managers, I routinely ask them about the contribution of their environmental programs to the firms’ cash flow (Table 4, Stmt. 6). Interestingly, for all three statements, the Table 9. Mean Responses of Generalists vs. Industry Specialists.a Statement Referenceb

Table 7, Stmt. 3 Table 7, Stmt. 4

Total Sample

4.65 (1.19) 4.03 (1.10)

Group Generalists

Specialists

4.54 (1.17) 3.88 (1.22)

4.81 (1.21) 4.13 (0.992)

F-Value (Significance)c

3.544 (0.061) 3.044 (0.082)

a The results reported in this table include the 148 respondents who describe themselves as “generalists”

and the 135 respondents who follow one or more specific industries. Mean responses based on a seven point scale with 1 = strongly disagree and 7 = strongly agree. Standard deviations are presented in parentheses. b Refer to indicated table to see survey statement. c 2-tailed significance levels.

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most experienced analyst group had the highest mean indicating less disagreement with the statements than the less experienced groups. The opposite is true with respect to Statement 6 from Table 7 which asks respondents to indicate whether they agree that it’s important for firms to have their environmental reports verified by independent third parties. In this latter case, the least experienced analysts showed the strongest support for the verification of environmental reports while the most experienced analysts showed the weakest support. Table 9 presents the mean responses for analysts who identified themselves as “generalists” and those who identified themselves as “specialists” (i.e. follow one or more specific industries).7 The groups differed on only two of the survey statements and the differences are relatively small. With respect to whether firms are generally complying with FASB and SEC reporting requirements related to environmental matters (Table 7, Stmt. 3), the specialists showed a higher level of agreement than the generalists. The specialists also indicated weak agreement with the notion that it is important for firms to endorse the CERES principles (Table 7, Stmt. 4) whereas the generalists exhibited weak disagreement. Since we didn’t develop hypotheses about the group differences reported above, we can only speculate about why they exist. For example, the Table 8 results may suggest that as analysts become more experienced, they have had more opportunity to observe a positive relation between environmental performance and financial performance. Consequently, they may be more willing to move away from the heavily quantitative, objective type valuation models taught in U.S. business schools and more willing to consider non-traditional, and less quantitative, variables in their work. Further, the more experienced analysts may not see the need to have environmental reports independently verified, either because they trust the accuracy of the reports, because they have lost faith in the independent verification process, or simply because they don’t use the reports in their work (as suggested by the data presented in Table 6). The differences between the two groups in Table 9 are small, but suggest that analysts who specialize in particular industries may observe patterns of non-compliance within their respective industries that the generalists don’t observe. Also, endorsement of the CERES principles may be a much larger issue within certain industries, and if so, the respondents who specialize in those industries could be driving the results. The testing of these, and other, possibilities is left for future research studies.

Limitations There are two shortcomings in the design and execution of this study that should be noted and that may limit the extent to which the results reported here can be

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generalized. First, although we performed a limited pilot study before developing the final version of the survey questionnaire used in this study, we did not specifically incorporate design features into the survey instrument to enhance its reliability such as randomized response scales and randomized question order. However, we did compute correlation coefficients (not reported here) for all the scaled-response survey items and found that respondents appear to have been consistent in their responses on similar items. For example, Pearson correlation coefficients for the four items contained in Table 3 ranged from 0.432 to 0.746 and all were significant at the 0.001 level. Second, our response rate of 7.9% is quite low and this may call into question whether our results are representative of the population of analysts that received the survey. If we had demographic information on the population that could be compared to that of the respondents, a more definitive determination could be made as to whether our results are representative. Unfortunately, that information is not available (at least to the authors), and therefore, caution should be used in generalizing the findings reported here to other groups.

SUMMARY AND CONCLUDING COMMENTS There is currently a gap in our knowledge of the link, if any, between environmental performance and financial performance. While some environmentalists, academics and others maintain that there is a positive link between environmentallysustainable practices and various measures of financial performance, there is conflicting empirical evidence regarding this matter. One question central to this area of inquiry is the extent to which capital markets value environmental information and, more specifically, how it is incorporated into security valuation models. The main objective of the research reported in this paper is to shed some light on these issues by analyzing the use of environmental information by financial analysts, a group that has significant influence in the capital markets and is in a position to comment on the potential link between environmental and financial performance. This paper reports the results of an exploratory mail survey of investment specialists who are members of the New York Society of Security Analysts. Analysis of the 315 usable responses reveals several interesting insights. First, the respondents were relatively unfamiliar with six organizations and initiatives that are well known in environmental circles for their association with environmental issues as they relate to the corporate world. Second, when asked for their views concerning the potential linkage between environmental performance and economic performance, the respondents weakly disagreed with the idea that an

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aggressive approach to dealing with environmental issues leads to a higher stock price. However, they generally agreed that an aggressive approach to environmental protection leads to reduced investment risk and lower cost of capital. Third, when asked about their use of environmental performance measures in their own work, respondents indicated that they generally do not incorporate measures of environmental performance into their valuation models and that this is due, at least in part, to the lack of reliable measures of environmental performance. When asked more normative questions, the respondents indicated weak agreement that financial analysts should use environmental indicators when valuing securities and that there is a gap between what should be done in this regard, and what is actually done in practice. Those respondents who believe there is a gap between theory and practice agreed that the gap is due to the difficulty of obtaining reliable information. The respondents indicated that they do not routinely ask corporate managers about the contributions of their environmental programs to their firms’ cash flows and that it is incumbent on corporate managers to communicate to analysts the extent to which their firms’ environmental activities are value enhancing. In addition, the survey instrument included questions concerning the variables that analysts considered important in evaluating environmental performance and the sources that they use to obtain environmental information. We also elicited the analysts’ views regarding public reporting and disclosure issues related to environmental matters. On balance, subject to the limitations discussed earlier, the results of this study suggest that security analysts are, at most, lukewarm on the role that environmental information currently plays, or should play, in valuing debt and equity securities. In cases where analysts do indicate usage of environmental information, the focus tends to be on downside risk rather than upside potential. To a large extent, the reluctance to incorporate environmental variables into security valuation models appears to be related to at least two different issues. First, as pointed out earlier, a clear-cut and definitive link has not been established between environmental performance and financial performance. Future research aimed at empirically establishing such a link appears to be a necessary step toward the more widespread incorporation of environmental information into security valuation models. Second, the results of this study and earlier ones suggest that analysts have concerns with the reliability of the available environmental performance information and/or to difficulties in obtaining more reliable information. This suggests that much work remains to be done in communicating relevant and reliable environmental performance information to the investment community. Taken together, the results of our survey, the findings of previous research of the lack of comparability among companies in their environmental reporting (e.g.

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Lober et al., 1997) and the spotty compliance with existing regulatory standards (e.g. Repetto & Austin, 2000), point to the need for two additional developments in this area. First, as suggested by Blumberg et al. (1998), there is a need for a “financially relevant framework – in effect a generally accepted reporting language – for assessing companies’ environmental performance” (p. 9). This would not only enhance comparability among reporting firms, but it would provide guidance for those involved in preparing and disseminating the information to interested parties. Second, external verification of environmental information, even that included in stand-alone environmental reports, is essential to ensuring the credibility of the information (Beets & Souther, 1999). Verification would address some of the concerns voiced by the analysts in our survey and earlier studies as well as encourage the development of more reliable measures of environmental performance.

NOTES 1. Those respondents who believe there is a gap between theory and practice agreed that the gap is due to the difficulty of obtaining reliable environmental information. 2. The other nine quantitative factors, in descending order of importance, were as follows: sales, return on equity, margins, earnings growth, cash flow, potential for industry growth, potential to gain market share, employee turnover, and research and development. The other five qualitative factors, in descending order of importance, were quality of management, customer satisfaction, employee satisfaction, reputation in business community and reputation among general public (Committee on Industrial Environmental Performance Metrics, 1999, p. 40). 3. Our requests for mailing lists from AMIR and BSAS were denied. AIMR indicated that it did not want to run the risk of having its members “over surveyed,” thus potentially negatively impacting response rates to Association-sponsored surveys. BSAS was also concerned with having its membership over-surveyed and stated that it believed that the issue addressed in our survey instrument would not be of great interest to its members. These responses were an early indication that the role of environmental performance as a driver of financial performance might not be a burning issue among the general community of investment specialists. 4. Clearly, our failure to do a follow-up mailing to test for non-response bias is a limitation of this study and limits the generalizability of the results. 5. Statistical significance for all survey questions involving the 7-point scale was tested using a dependent sample t-test with the test value set equal to 4, the neutral position on the scale. Thus, the significance levels shown for each question indicate the probability of obtaining the reported mean value for the question if the respondents actually hold a neutral position on that question. 6. We have not included the results for survey items for which group means were not significantly different from one another. The authors would be glad to provide this information to any interested reader.

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7. Excluded from Exhibit 9 are those respondents who follow the banking, financial services and insurance industry (n = 16) and those respondents who didn’t indicate any particular industry following (n = 16).

ACKNOWLEDGMENTS An earlier version of this paper was presented at the Western Region American Accounting Association Meeting in San Diego, April 2002. The authors thank two anonymous reviewers of this journal for their thoughtful comments and suggestions. They are also grateful to Jim Sinkula and Dan Toy for helpful suggestions and to Adam Lewis and Jamie Caird for research assistance. This study benefited from a University of Vermont SUGR/FAME research grant.

REFERENCES Bebbington, J., & Gray, R. (2000). Accounts of sustainable development: The construction of meaning within environmental reporting. Unpublished Working Paper 00–18, University of Aberdeen. Beets, S. D., & Souther, C. C. (1999, June). Corporate environmental reports: The need for standards and an environmental assurance service. Accounting Horizons, 13(2), 129–145. Blumberg, J., Blum, G., & Korsvold, A. (1998). Environmental performance and shareholder value. Geneva: World Business Council for Sustainable Development. Cairncross, F. (1995). Green, Inc.: A guide to business and the environment. Washington, DC: Island Press. Cohen, M. A., Fenn, S. A., & Naimon, J. S. (1995). Environmental and financial performance: Are they related? Washington: Investor Responsibility Research Center. Committee on Industrial Environmental Performance Metrics, National Academy of Engineering, National Research Council (1999). Industrial environmental performance metrics: Challenges and opportunities. Washington: National Academy Press. Dowell, G., Hart, S., & Yeung, B. (2000). Do corporate global environmental standards create or destroy market value? Management Science, 46(8), 1059–1074. Ely, K., & Stanny, E. (1999). User sophistication and the specificity of disclosure as reflected in disclosure of a firm’s status as a potentially responsible party. Unpublished Working Paper, Emory University and Sonoma State University (April). Feldman, S. J., Soyka, P. A., & Ameer, P. (1997). Does improving a firm’s environmental management system and environmental performance result in a higher stock price? Journal of Investing (Winter), 87–97. Garrity, S., Grinnell, D. J., & Hunt, H. G., III (2002). The linkage between environmental and financial performance: A review of the literature. Unpublished Working Paper, University of Vermont and California State University, Long Beach (September). Gentry, B. S., & Fernandez, L. O. (1996). Valuing the environment: How Fortune 500 CFOs and analysts measure corporate performance. United Nations Development Programme (UNDP), Office of Development Series, Working Paper Series. New York: UNDP.

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Hart, S., & Ahuja, G. (1996). Does it pay to be green? An empirical examination of the relationship between emission reduction and firm performance. Business Strategy and the Environment, 30–37. Kolk, A., Walhain, S., & van de Wateringen, S. (2001). Environmental reporting by the Fortune 250: Exploring the influence of nationality and sector. Business Strategy and the Environment, 15–28. Lober, D. J., Bynum, D., Campbell, E., & Jacques, M. (1997). The 100 plus corporate environmental report study: A survey of an evolving environmental management tool. Business Strategy and the Environment, 57–73. National Advisory Council for Environmental Policy and Technology (2000). Green Dividends? The Relationship Between Firms’ Environmental Performance and Financial Performance. A Report by the Environmental Capital Markets Committee. Washington: U.S. Environmental Protection Agency (May). Repetto, R., & Austin, D. (2000). Coming clean: Corporate disclosure of financially significant environmental risks. Washington, DC: World Resources Institute. Russo, M. V., & Fouts, P. A. (1997). A resource-based perspective on corporate environmental performance and profitability. Academy of Management Journal, 40(3), 534–559. Schmidheiny, S., & Zorraquin, F. J. L. (1998). Financing change: The financial community, ecoefficiency, and sustainable development. Cambridge, MA: MIT Press. Soyka, P. A., & Feldman, S. F. (1998). Investor attitudes toward the value of corporate environmentalism: New survey findings. Environmental Quality Management (Autumn), 1–10. Suranyi, M. (1999). Blind to sustainability? Stock markets and the environment. London, UK: Forum for the Future (June). Toms, J. S. (1999). Enlightenment vs. self-interest: Financial performance differentials of “ethically” managed companies. Chartered Institute of Management Accountants Discussion Paper No. 4 (February). Walley, N., & Whitehead, B. (1994). It’s not easy being green. Harvard Business Review (May–June), 46–52. Yamashita, M., Sen, S., & Roberts, M. C. (1999). The rewards for environmental conscientiousness in the U.S. capital markets. Journal of Financial and Strategic Decisions, 12(1) (Spring), 73–82.

THE IMPACT OF CORPORATE SOCIAL RESPONSIBILITY ON THE INFORMATIVENESS OF EARNINGS AND ACCOUNTING CHOICES Ahmed Riahi-Belkaoui ABSTRACT The article hypothesizes that the level of corporate social responsibility affects both the informativeness of earnings and the magnitude of discretionary accounting accrual adjustments. The hypothesis exploits: (1) the positive relationship between corporate social responsibility and firms’ risk-return profiles; and (2) managers’ incentives in using discretionary accounting accrual adjustments. Results show that corporate social responsibility is positively associated with earnings’ explanatory power for returns and related to the magnitude of accounting accrual adjustments.

INTRODUCTION Since the late 1960s, accounting research has provided ample evidence on the significant effects of accounting earnings disclosures on firms’ security prices (Bernard, 1987, 1989; Collins et al., 1999; Lev, 1989). Earnings (returns) appear to affect equity prices (returns), even though the effect in some cases is small. With some exceptions, most of the accounting valuation models linking Advances in Environmental Accounting and Management Advances in Environmental Accounting and Management, Volume 2, 121–136 Copyright © 2004 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1479-3598/doi:10.1016/S1479-3598(03)02005-3

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earnings to prices did not constrain the informativeness of earnings.1 One constraint is the level of corporate social responsibility, as it may reinforce the informativeness of earnings, i.e. their ability to explain changes in stock returns. Accordingly, this study investigates the impact of the level of corporate social responsibility on both the informativeness of earnings and the accounting choices of managers. Corporate social responsibility is regarded as a powerful signal of the firm’s organizational effectiveness (Manne & Wallich, 1972; Riahi-Belkaoui, 1992). It constitutes an image of the corporation held by corporate audiences and at the same time influences the decisions made by the same corporate audiences (McGuire, 1963; Riahi-Belkaoui & Pavlik, 1991). This view of the influence of corporate social responsibility is used to formulate the first hypothesis. The first hypothesis predicts the informativeness of accounting earnings in explaining stock returns varies systematically with the level of corporate responsibility held by the firm, i.e. the higher the level of corporate responsibility held by corporate audiences, the higher the weight they will attach to the informativeness of earnings. Corporate audiences are also found to construct the social responsibility of firms by interpreting information signals about the firms’ various monitors in general, and the firms’ risk-return profiles in particular (Karpik & Belkaoui, 1989; RiahiBelkaoui, 1991; Ullmann, 1985). This reliance on accounting information in general and earnings in particular in the corporate audiences’ corporate responsibility building process is utilized to formulate the second hypothesis. The second major hypothesis postulates that managers’ accounting choices are systematically related to the level of corporate social responsibility in an attempt to influence corporate audiences’ assessment of the firm’s social involvement. Basically, an established level of corporate social responsibility acts as an implicit rather than explicit contractual restriction imposed on managers. If a high level of social responsibility is built on the basis of higher earnings, managers may be more aggressive in the determination of accounting accruals and the magnitude of discretionary accrual adjustments is predictably and positively related to the level of corporate social responsibility. The results of this study using U.S. firms shows that: (a) the level of corporate social responsibility is positively associated with the informativeness of accounting earnings; and (b) the magnitude of discretionary accounting accrual adjustments is significantly higher when the level of social responsibility is high. These results are robust in the presence of endogenous and exogenous determinants of accounting choices and earnings’ explanatory power for returns, including firm size, systematic risk, growth opportunities, and the variability and persistence of accounting earnings.

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SOCIAL RESPONSIBILITY, CONTRACTS AND ACCOUNTING The Impact of Social Responsibility on the Informativeness of Earnings Corporate social responsibility or social performance involves a continuum of social responsive activities that goes from profit-making only (Friedman, 1962); going beyond profit-making (Backman, 1975; Davis, 1960); going beyond economic/legal requirements (McGuire, 1963); voluntary activities (Manne & Wallich, 1972); economic, legal, and voluntary activities concentric, everwidening circles of influence (Committee for Economic Development, 1971); concern for the broader social system (Eelles & Walton, 1961); responsibility in a number of social problem areas (Hay, Gray & Gates, 1976); giving way to social responsiveness (Ackerman & Bauer, 1975; Riahi-Belkaoui, 1999a, b); and doing what society and the customer pay us for (Drucker, 1977). However, given that business receives its legitimation from society, social performance is best defined as the accomplishment or the perception of accomplishment of the desired ends of society in terms of moral, economic, legal, ethical, and discretionary expectations (Murray & Montanani, 1986). Social responsibility reputation is an asset, which can generate future rents (Riahi-Belkaoui, 1974, 1976, 1980). It is the outcome of a competitive process in which firms signal their key characteristics to constituents to maximize their social status (Forbrum & Shanley, 1990). It affects many operational and strategic decisions. Social responsibility rankings are an important measure of the firm’s organizational effectiveness, signaling to the publics about a firm’s profitability and social responsiveness (Karpik & Belkaoui, 1989). They crystallize the statuses of firms within an industrial social system. Favorable social responsibility rankings create favorable situations for firms, economically, socially and politically, with the creation of a better image, enhancing access to capital markets and attracting investors (Riahi-Belkaoui, 1976). These favorable views of social responsibility as held by corporate audiences and/or stakeholders may have an impact on the actions of the same audiences and/or stakeholders. Basically, social responsibility is a signal that influences the actions of the same firms’ corporate audiences and/or stakeholders and their perceptions of the relevance of earnings to the determination of stock returns (Karpik & Belkaoui, 1989). One likely result is the potential impact on the degree of informativeness of earnings which yields the first hypothesis: The informativeness of accounting earnings as an explanatory variable for returns is systematically related to corporate social responsibility.

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The Impact of Corporate Social Responsibility on the Behavior of Discretionary Accounting Accruals Social responsibility rankings represent the publics’ cumulative judgments of firms over time. Because firms compete for these rankings in a market characterized by incomplete information, corporate audiences are assumed to attend to market, accounting, institutional and strategy signals about firms in their reputational building (Karpik et al., 1989; Ullmann, 1985). Corporate audiences are found to build the social responsibility of firms by attending to information signals about the firm’s various monitors in general and the firm’s risk-return profile in particular (Karpik et al., 1989). Once a social responsibility ranking is established, it becomes an implicit rather than explicit contractual restriction imposed on both managers and corporate audiences. In the case of corporate audiences, they are more likely to search for information on the determinants of corporate social responsibility, given the informational asymmetry and ambiguity that characterize the interactions between managers and stakeholders. This is due to the fact that important signals broadcast to constituents are accounting and earnings based and are under managers’ controls. In the case of managers, the implicit requirement of maintaining a good social responsibility ranking, built on accounting data, leads to a more aggressive determination of accounting accruals. One likely result is the impact on the behavior of discretionary accounting accruals, which leads the second hypothesis: The magnitude of adjustments in managers’ accounting choices is systematically related to the level of social responsibility.

Other Considerations Affecting Accounting Choices Based on contracting theory and economic theories of the political process, that governs managers’ incentives in the selection and reporting of accounting numbers, other endogenous and exogenous determinants of accounting choices and earnings’ explanatory power for returns are also examined. They include six additional factors: firm size, systematic risk, leverage, growth opportunities, earnings variability, and earnings persistence (Warfield et al., 1995).

SAMPLE SELECTION AND DATA The social performance index was derived from the annual survey of corporate reputation by Fortune Magazine. The survey, covering thirty-three industry

The Impact of Corporate Social Responsibility

Table 1. Summary for the Variables Used for the First Hypothesis. Panel A: Descriptive Statistics Variable

Mean

Stock return (Ri,t ) Accounting earning (Ei,t /Pi,t −1 )

0.0952 0.0570 0.4082 0.5309 0.0881 0.0072 0.0087 0.1269 −0.0082

Earnings interacted with: a. Social responsibility (Ei,t × SRPi /Pi,t −1 ) b. Size (Ei,t × SIZEi /Pi,t −1 ) c. Growth opportunities (Ei,t × GROWTHi /Pi,t −1 ) d. Systematic risk (Ei,t × RISKi /Pi,t −1 ) e. Leverage (Ei,t × DEBTi /Pi,t −1 ) f. Earnings variability (Ei,t × VARi /Pi,t −1 ) g. Earnings persistence (Ei,t × PERSi /Pi,t −1 )

Standard Deviation

Median

First Quartile

Third Quartile

0.0552 0.0854

0.0897 0.0649

0.0602 0.0369

0.1286 0.0847

0.3641 0.6125 0.2349 0.0134 0.0119 0.099 0.1686

0.4116 0.5689 0.0508 0.0028 0.0072 0.1028 −0.0010

0.8212 0.3171 0.0331 0.0008 0.0023 0.0601 −0.0018

0.5621 0.7832 0.0774 0.0083 0.0139 0.1653 0.0005

E

REP

SIZE

GROWTH

RISK

DEBT

VAR

PERS

1.00

0.968 1.00

0.9633 0.8867 1.00

0.5320 0.0210 0.3670 1.00

0.2030 0.3823 0.3489 0.0690 1.00

0.4496 0.6123 0.5051 0.0067 0.1172 1.00

0.7328 0.7231 0.7586 0.3351 0.3417 0.1557 1.00

−0.4856 −0.4123 −0.4788 0.0103 0.0158 −0.0596 −0.2069 1.00

Panel B: Pearson Correlation Matrix (Using Variables from Panel A) Variable Accounting earnings (E) Social responsibility (SRP) Size (SIZE) Growth opportunities (GROWTH) Systematic risk (RISK) Leverage (DEBT) Earnings variability (VAR) Earnings persistence (PERS)

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Note: Stock returns (R) are measured for the 12 months period from nine months prior to the fiscal year-end through three months after the fiscal year-end, earnings (E) is the accounting earnings per share, Social Responsibility (SRP) is measured by the Fortune Magazine score, size (SIZE) is measured as the company’s market value of equity (in 000s), systematic risk (RISK) is measured by the market model beta, growth opportunities (GROWTH) are measured by the market to book ratio for common equity, leverage (DEBT) is measured by the ratio of total debt to total assets, earnings variability (VAR) is measured by the standard deviation of earnings for the 20 quarters 1994–1998, earnings persistence (PERS) is the first-order autocorrelation in earnings for the 20 quarters 1994–1998, and price (P) is the stock price at the beginning of the period. The sample size is 404 firm-year observations.

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Table 2. Summary Statistics for the Variables Used for the Second Hypothesis. Panel A: Descriptive Statistics Variable

Mean

Standard Deviation

Median

First Quartile

Third Quartile

0.0190 5.8123 8.782 0.090 0.1583 35.893 0.1673 −0.1618

0.0110 0.9120 0.9284 0.131 0.1428 52.129 0.0789 0.1316

0.0179 5.3121 8.6983 0.044 0.1384 2.460 0.1374 −0.015

0.0120 5.1021 8.1616 0.016 0.0541 1.5881 0.1164 −0.023

0.0092 6.5124 9.4140 0.124 0.2277 4.2165 0.1930 −0.0097

Variable

REP

SIZE

RISK

DEBT

GROWTH

VAR

PERS

Reputation (REP) Size (SIZE) Systematic risk (RISK) Leverage (DEBT) Growth opportunities (GROWTH) Earnings variability (VAR) Earnings persistence (PERS)

1.00

0.5030 1.00

0.4687 0.8083 1.00

−0.1290 −0.1312 −0.1341 1.00

0.0187 −0.0613 −0.0704 −0.2428 1.00

0.4650 0.3006 0.1606 −0.2193 −0.1521 1.00

0.1323 0.1590 0.0818 0.1183 −0.0651 0.0808 1.00

Absolute abnormal accrual (/AAC/) Social responsibility (SRP) Size (SIZE) Systematic risk (RISK) Leverage (DEBT) Growth opportunities (GROWTH) Earnings variability (VAR) Earnings persistence (PERS) Panel B: Pearson Correlation Matrix

AHMED RIAHI-BELKAOUI

Note: Abnormal accrual, AAC, is defined as the current-period accrual less the expected normal accrual, where the difference is standardized by the beginning period stock price. Absolute abnormal accrual, /AAC/, is measured as the absolute value of abnormal accruals (AAC). All other variables are as defined in Table 1.

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groupings, asked executives, directors and analysts in particular industries to rate companies in the following eight key attributes of reputation: (1) quality of management; (2) quality of products/services offered; (3) innovativeness; (4) value as a long term investment; (5) soundness of financial position; (6) ability to attract/develop/keep talented people; (7) responsibility to the community, environment; and (8) wise use of corporate assets. Ratings were on a scale of 0 (poor) to 10 (excellent). Social performance of each firm is measured by the score obtained in item 7 of the organizational effectiveness instrument, namely, responsibility to the community/environment. To be included in the sample a firm must meet the following selection criteria: (1) The firms must be included in Fortune Magazine’s reputation surveys from 1994 to 1998. (2) Annual earnings-per-share and dividends are available from Standard and Poor’s Compustat primary, secondary, tertiary and full coverage database. (3) Data necessary to compute stock returns (including dividends) are available from Computstat Price, Dividends and Earnings database. Both price per share and earnings per share were adjusted for stock splits and stock dividends. (4) Annual data necessary to compute discretionary accruals are available from Standard and Poor’s Compustat primary, secondary, tertiary and full coverage database. The complete sample consists of 404 firm-year observations. Descriptive statistics and correlation analysis of the data used in both hypotheses are shown in Tables 1 and 2.

INFORMATIVENESS OF EARNINGS CONDITIONAL ON SOCIAL RESPONSIBILITY Social Responsibility as a Determinant of Earnings’ Explanatory Power Table 3 presents the correlation between earnings and returns (column 3) and the earnings coefficients (column 4) for the different ranges of social responsibility (column 1). The correlation between returns and earnings is positive and significantly greater than zero for the total sample with a level of social responsibility ranging from 3.25 to 9.01, and for each of the other reputation ranges. These correlations range from a minimum of 0.288 for the 3.25–6.11 level of social responsibility to a high of 0.62 for the 7.38–9.01 level of social responsibility. In addition, the Pearson (Spearman) correlation between the level of social responsibility (column 1), and the correlation between earnings and returns

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Table 3. Relation Between Earnings and Returns Depending on the Level of Social Responsibility. Level of Social Responsibility 3.25–6.11 6.11–6.68 6.68–7.30 7.30–9.01 3.25–9.01

Number of Firm-Period Observations

Correlation Between Earnings and Returns

Earnings Coefficient

130 89 89 96 404

0.281 0.512 0.513 0.62 0.81

0.12 0.59 0.71 1.03 0.07

Note: Stock returns are measured for the twelve-month period extending from nine months prior to the fiscal year-end through three months after the fiscal year-end, earnings per share is scaled by the beginning-of-period stock price per share, and social responsibility is the Fortune Magazine score. The sample of annual earnings reports are drawn from the 5-year period corresponding to the 1994–1998 calendar years. All correlation (Pearson) between annual accounting earnings per share and stock returns, and the earnings coefficients from the regression of stock returns, and the earnings coefficients from the regression of stock returns on accounting earnings per share, are significant at the 0.01 level or better.

(column 3) for the four social responsibility levels equals 0.81 (0.79), which is significantly greater than zero at the 0.05 level. The evidence from this first test points to social responsibility as a determinant of the informativeness of earnings. The second test of the informativeness of earnings conditional on social responsibility levels examines the cross-sectional variation of the earnings coefficient conditional on social responsibility. The following pooled cross-sectional regression model, with a social responsibility interaction term is used:

 E i,t E i,t × SRPi R i,t = a 0 + a 1 + a2 + u i,t (1) P i,t−1 P i,t−1 where Ri,t is the stock return of firm i for annual period t, extending from nine months prior to fiscal year-end through three month after fiscal year-end, Ei,t is earnings-per-share, Pi,t −1 is the price-per-share at the end of period t−1, and SRPi is the level of social responsibility for the year. The relation between earnings and social responsibility is measured by a2 . It shows the extent to which the informativeness of earnings is affected by the level of social responsibility. The regression results in Table 4 indicate that the informativeness is affected by the level of social responsibility as both the regression coefficient (0.388) and the earnings-reputation coefficient (0.25) are both significantly greater than zero at the 0.0001 level. Given that the results in Table 3 imply non-linearity with the data, the same regression was run separately for each of the four categories of social responsibility levels in Table 3, thereby not imposing a constant residual assumption across

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Table 4. Regression in Stock Return on Both Earnings and Earnings-Social Responsibility Interaction.

 E i,t E i,t × SRPi + a2 + u i,t R i,t = a 0 + a 1 P i,t−1 P i,t−1 Parameter Estimates a0 0.042 (11.32)∗

a1

a2

0.388 (11.24)∗

0.329 (15.61)∗

Sample Size

Adjusted R2 (%)

F-value (Sig. Level)

346

27.29

151.53 (0.001)

Note: Stock returns (R) are measured for the twelve-month period extending from nine months prior to the fiscal year-end through three months after the fiscal year-end. Earnings (E) is the accounting earnings per share, social responsibility is equal to the Fortune Magazine score and price (P) is the stock price per share. Parameter estimates and t-statistics (in parentheses) are presented for the regression. An asterisk (∗ ) designates statistical significance at the 0.01 level. The sample is comprised of firm-year observations from the 1994–1998 calendar year.

social responsibility categories. The earnings coefficients from these regressions, reported in column 3 of Table 3, imply a monotonic increase in the regression coefficients. The increase of these coefficients from 0.12 for the 3.25–6.11 range of social responsibility to 1.09 for the 7.38–9.01 range of social responsibility verifies the results of hypothesis 1 in Table 4.

Social Responsibility and Other Determinants of Earnings’ Explanatory Power As stated earlier, additional considerations are recognized regarding both the informativeness of earnings and managerial incentives determining accounting choices. These considerations, in addition to reputation include firm size, systematic risk, leverage, growth opportunities, earnings variability, and earning persistence. Accordingly, the following pooled cross-sectional regression model is formulated:


 E i,t E i,t × SRPi E i,t × SIZEi R i,t = a 0 + a 1 + a2 + a3 P i,t−1 P i,t−1 P i,t−1


 E i,t ×GROWTHi E i,t ×RISKi E i,t ×DEBTi + a4 + a5 + a6 P i,t−1 P i,t−1 P i,t−1

 E i,t × VARi E i,t × PERSi,t + a7 + a8 + u i,t (2) P i,t−1 P i,t−1

130

Table 5. Regression of Returns on Earnings, Earnings-Social Responsibility Interaction, and Earnings Interaction with Other Determinants of Earnings Explanatory Power.



 E i,t E i,t × SRPi E i,t × SIZEi E i,t × GROWTHi R i,t = a 0 + a 1 + a2 + a3 + a4 P i,t−1 P i,t−1 P i,t−1 P i,t−1


 E i,t × RISKi E i,t × DEBTi E i,t × VARi + a5 + a6 + a7 + a 8 (E i,t × PERS) + u i,t P i,t−1 P i,t−1 P i,t−1 Parameter Estimates a0 0.018 (7.41)∗

a1

a2

a3

a4

a5

a6

a7

a8

0.139 (7.10) ∗

0.05 (5.16) ∗

0.181 (4.87) ∗

0.038 (4.26) ∗

−0.096 (−7.21) ∗

0.463 (18.0) ∗

−0.312 (−7.80) ∗

0.010 (6.25) ∗

Sample Size

Adjusted R2 (%)

F

404

36.28%

248.61∗

AHMED RIAHI-BELKAOUI

Note: Stock returns (R) are measured for the twelve-month period from nine months prior to the fiscal year-end through three months after the fiscal year-end, earnings (E) is the accounting earning per share, social responsibility (SRP) is the Fortune Magazine score, size (SIZE) is measured as the company’s natural logarithm of the market value of equity, systematic risk (RISK) is measured by the market model beta, growth opportunities (GROWTH) are measured by the market to book ratio for common equity, leverage (DEBT) is measured by the ratio total debt to total assets, earnings variability (VAR) is measured by the standard deviation of earnings, earnings persistence (PERS) is the first-order autocorrelation in earnings, and price (P) is the stock price at the beginning of the period. The sample size is comprised of firm-year observations drawn from the 1994–1998 calendar years.

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The new variables are defined as follows: SIZE is the natural logarithm of a firm’s market value of equity, GROWTH is measured as market value of equity scaled by book value, RISK is a firm’s systematic risk,2 DEBT is the firm’s ratio of total debt to total assets, VAR is the variability of earnings for the all the quarters of the period of analysis, PERS is persistence of earnings as measured by the first-order autocorrelation in earnings for the same period. The results, shown in Table 5, verify again the relation between social responsibility and earnings’ informativeness after the inclusion of these additional considerations. As expected the market reaction to earnings was negatively related to systematic risk (a5 (−0.097) is significant at the 0.01 level), and to variability of earnings (a7 (−0.312) is significant at the 0.01 level). It is also positively related to firm size (a3 (0.181) is significant at the 0.01 level), growth opportunities (a4 (0.039) is significant at the 0.01 level), leverage (a6 (0.469) is significant at the 0.01 level), and earnings persistence (a8 (0.010) is significant at the 0.01 level).3

EARNINGS MANAGEMENT CONDITIONAL ON SOCIAL RESPONSIBILITY The second-hypothesis states that the magnitude of adjustments in managers’ accounting choices is systematically related to social responsibility. The higher the level of social responsibility, the higher is managers’ reliance on discretionary accruals, as measured by the magnitude of discretionary accrual adjustments. An abnormal accruals research design will be used to test the hypothesis of managers’ accounting choices conditional on reputation.4 Basically, the abnormal accounting accrual (AAC) is computed as the current period accrual (AC) minus the expected normal accrual (E(AC)), and then standardized by beginning-of-year stock price (P): AACi,t =

ACi,t − E(AC)i,t P i,t−1

(3)

The accounting accrual (AC) is defined as the change in non-cash working capital (i.e. change in non-cash current assets less current liabilities) less depreciation expense.5 An accrual prediction model is used to estimate normal accruals. It is specified as: 


DREVi,t PPEi,t b0 + b1 + b2 + u i,t (4) ACi,t = P i,t−1 P i,t−1 P i,t−1

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where the new variables are defined as follows: DREVi,t = changes in revenues from year t to t−1 for firm i. PPEi,t = Gross property plant, and equipment in year t. A time-series regression using available prior years’ data for seven years, generated firm-specific and time-period-specific predictions of E (ACi,t ) which are then used in Eq. (3) to generate estimate of abnormal accruals (AACi,t ). Because the interest in this study is with the magnitude of the accrual adjustments, rather than the direction of the accrual, the absolute value of the abnormal accrual i.e. /AACi,t / is used as a dependent variable in the following model:6 /AACi,t / = d 0 + d 1 × SRPi + d 2 × SIZEi + d 3 × GROWTHi + d 4 × RISKi + d 5 × DEBTi + d 6 × VARi + d 7 × PERSi + u i,t

(5)

Equation (5) is a multivariate-pooled cross-sectional regression model to be used to investigate the joint interaction of social responsibility and the level of abnormal accounting accruals. Table 6. Regression of Absolute Abnormal Accruals on Social Responsibility and Other Determinants of the Magnitude of Discretionary Accruals. |AACi,t | = d 0 + d 1 × SRPi + d 2 × SIZEi + d 3 × GROWTHi + d 4 × RISKi + d 5 × DEBTi + d 6 × VARi + d 7 × PERSi + u i,t

Parameter Estimates ␦0

␦1

␦2

␦3

␦4

␦5

␦6

␦7

−0.008 (−0.12)

0.002 (5.203)∗

−0.006 (−7.75)

0.00001 (5.23)∗

0.130 (4.52)∗

0.0008 (7.38)∗

0.008 (16.24)∗

0.0003 (0.62)∗ (7.20)∗

Sample Size

Adj. R2

F-value

336

20.34%

70.58∗

Note: Absolute abnormal accruals, /AACi,t /, is defined as the current-period accrual loss of the expected normal accruals, where the difference is standardized by the beginning-period stock price. All other variables are as defined in Table 3. An asterisk (∗ ) designates statistical significance at the 0.01 level, two-tailed tests. The sample is comprised of firm-year observations drawn from the 1994–1998 calendar years.

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The model includes, in addition to the social responsibility variable, other factors that have been shown in previous research to affect the magnitude of abnormal accruals (Warfield et al., 1995). These factors include size of the firm, growth, systematic risk, leverage, earnings variability and earnings persistence. Consistent with the second hypothesis, a positive relation between the level of reputation and the magnitude of abnormal accruals is predicted (i.e. d 1 > 0). The evidence in Table 6 supports the hypothesis that the magnitude of abnormal accruals is positively related to the level of social responsibility, i.e. d1 equals 0.001, which is significantly greater than zero at the 0.01 level.7

SUMMARY AND CONCLUSIONS The article presented two hypotheses linking the level of social responsibility to both the informativeness of earnings and the magnitude of discretionary accounting accrual adjustments. The hypotheses exploit: (a) influence of corporate social responsibility on the actions of corporate audiences; and (b) managers’ incentives in using discretionary accounting accrual adjustments. The first hypothesis postulates that the informativeness of earnings in explaining stock returns varies systematically with the level of social responsibility in the corporation. The second hypothesis postulates that managers’ accounting choices are systematically related to the level of social responsibility. The results on a sample of U.S. firms show a significantly greater earnings coefficient for firms with higher social responsibility, and a positive relation between the magnitude of discretionary accruals and the level of social responsibility. The major implication of this study is that a favorable image of the firm produced by its level of social responsibility, led corporate audiences to attach more weight to the relevance of earnings in the determination of stock returns. In addition, the high level of social responsibility deemed necessary by management, creates an additional incentive for the use of discretionary accrual adjustments. What appears from the results of this study is that corporate social responsibility accentuates the relevance of earnings in explaining stock returns and at the same time motivates managers to be more aggressive in the use of discretionary accounting accruals. The present research focuses on the relevance of corporate social responsibility as perceived by corporate audiences rather than social performance as evidenced by the realization of some social objectives. Accordingly, future research may need to investigate how the extent of social performance as disclosed by the firms, affects both the informativeness of earnings and the magnitude of discretionary social adjustments, and how the results compare with the effects of social responsibility shown in this study.

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NOTES 1. One notable exception, provided by Warfield et al. (1995), showed that the level of managerial ownership affects both the informativeness of earnings and the magnitude of discretionary accounting accrual adjustments. 2. Systematic risk is measured by the market model beta using the most recent 60 months’ stock returns prior to the test period. 3. To measure the degree of collinearity among the regression variables, condition indexes are calculated. The condition index shows the regression was 23.6 which is between the 30 level, considered as indicative of moderate to strong multicollinearity. Similarly, to assess the effect of cross-correlation in the residuals for the estimation of parameters, bootstrapping analysis were conducted. The results showed bootstrapping estimates qualitatively identical to the estimates reported in the Table 5. 4. The abnormal accruals research design was pioneered by Healey (1985), DeAngelo (1986, 1988), Liberty and Zimmerman (1986) and others. 5. Specifically, the accounting accrual per share is calculated as follows (Compustat data item numbers are in parenthesis): ACi,t = [∩ Accounts receivablei,t (2) + ∩ Inventoriesi,t (3) + ∩ Other Current Assetsi,t (68)] − [∩ Current Liabilitiesi,t (5)] − [Depreciation and Amortization Expensei,t (14)] Where the change (∩) is the difference between years (t and t − 1). The Compustat data item numbers for Stock Price, P i,t−1 is (24). 6. A similar methodology is used by Warfield et al. (1995). 7. Similar results were obtained when the Jones model (1991) was replaced by either the Modified Jones Model (Dechow et al., 1995) or the cross-sectional Jones model (Defond & Jiambalvo, 1994).

REFERENCES Ackerman, R. W., & Bauer, R. A. (1975). Corporate social responsiveness. Reston, VA: Reston Publishing. Backman, J. (1975). Social responsibility and accountability. New York: New York University Press. Bernard, V. (1987). Cross-sectional dependence and problems in inference in market-based accounting research. Journal of Accounting Research (Spring), 1–48. Bernard, V. (1989). Capital markets research in accounting during the 1980s: A critical review. The State of Accounting Research as we Enter the 1990. University of Illinois Golden Jubilee Symposium, 72–120. Collins, D. W., Pincus, M., & Xie, H. (1999). Equity valuation and negative earnings: The role of book value of equity. The Accounting Review, 74, 29–62. Committee for Economic Development (1971). Social responsibilities of business corporations. New York: Committee for Economic Development. Davis, K. (1960). Can business afford to ignore social responsibilities? California Management Review, 2(3), 70–76.

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DeAngelo, L. F. (1986). Accounting numbers as market valuation substitutes: A study of management buyouts of public stockholders. The Accounting Review, 41, 400–420. DeAngelo, L. F. (1988). Managerial competition, information costs, and corporate governance: The use of accounting performance measures in proxy contests. Journal of Accounting and Economics, 10, 3–36. Dechow, P. M., Sloan, R. G., & Sloan, A. P. (1995). Detecting earnings management. The Accounting Review, 70, 193–225. Defond, M. L., & Jiambalvo, J. (1994). Debt coveneant violations and manipulation of accruals. Journal of Accounting and Economics, 17, 145–176. Drucker, P. F. (1977). People and performance. New York: Harper & Row. Eelles, R., & Walton, C. (1961). Conceptual foundations of business. Homewood, IL: Irwin. Forbrum, C., & Shanley, M. (1990). What’s in a name? Reputational building and corporate strategy. Academy of Management Journal, 33, 233–258. Friedman, M. (1962). Capitalism and freedom. Chicago: University of Chicago Press. Hay, R. D., Gray, E. R., & Gates, J. E. (1976). Business and society. Cincinatti: South-Western. Healey, P. (1985). The effects of bonus schemes on accounting decisions. Journal of Accounting and Economics, 7, 85–107. Jones, J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29, 193–228. Karpik, P., & Riahi-Belkaoui, A. (1989). Determinants of the corporate decision to disclose social information. Accounting, Auditing and Accountability Journal, 2. Lev, B. (1989). On the usefulness of earnings and earnings research: Lessons and directions from two decades of empirical research. Journal of Accounting Research (Suppl.), 153–192. Liberty, S. F., & Zimmerman, J. I. (1986). Labor union contract negotiations accounting choices. The Accounting Review, 61, 692–712. Manne, H., & Wallich, H. C. (1972). The modern corporation and social responsibility. Washington, DC: American Enterprise Institute for Public Policy Research. McGuire, J. W. (1963). Business and society. New York: McGraw-Hill. Murray, H. B., & Montanani, J. R. (1986). Strategic management of the socially responsible firm: Integrative management and marketing theory. Academy of Management Review, 11, 815–827. Riahi-Belkaoui, A. (1974). The whys and wherefores of measuring externalities. Certified General Accountant (November), 16–18. Riahi-Belkaoui, A. (1976). The impact of the disclosure of the environmental effects of organizational behavior on the market. Financial Management (Winter), 26–31. Riahi-Belkaoui, A. (1980). The impact of socio-economic accounting statements on the investment decision: An empirical study. Accounting, Organizations and Society (September), 263–283. Riahi-Belkaoui, A. (1991). Organizational effectiveness, social performance and economic performance: An empirical investigation. Research in Corporate Social Performance and Policy, 12, 143–153. Riahi-Belkaoui, A. (1992). Executive compensation, organizational effectiveness, social performance and firm performance: An empirical investigation. Journal of Business Finance and Accounting (January), 25–38. Riahi-Belkaoui, A. (1999a). Corporate social awareness and financial outcomes. Westport, CT: Greenwood. Riahi-Belkaoui, A. (1999b). Social responsibility, internalization and market valuation. Journal of Global Business, 10, 65–72.

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Riahi-Belkaoui, A., & Pavlik, H. (1991). Asset management performance and reputation building for large U.S. firms. British Journal of Management, 1, 231–238. Ullmann, A. A. (1985). Data in search of a theory: A critical examination of the relationship among social performance, social disclosure and economic performance of U.S. firms. Academy of Management Review, 10, 540–557. Warfield, T. D., Wild, J. J., & Wild, K. L. (1995). Managerial ownership, accounting choices, and informativeness of earnings. Journal of Accounting and Economics, 20, 61–91.

AN ASSESSMENT OF THE QUALITY OF ENVIRONMENTAL DISCLOSURE THEMES W. Darrell Walden and A. J. Stagliano ABSTRACT An understanding of disclosure themes used in annual reports can provide a foundation for improving communication of environmental information. The objective of this study is to provide insight into environmental disclosure themes that are used to provide management communication in the financial and non-financial sections of corporate annual reports. The study also explores the relationship between these disclosure themes and environmental performance. Findings from a sample of 53 U.S. companies in four major industry groups suggest that environmental disclosures in the financial section of annual reports contain information focused on expenditures and contingencies. Environmental disclosures in the non-financial section of the annual report mostly contain information about pollution abatement and various other environmental data. The highest perceived quality of disclosure is associated with environmental expenditures and contingencies. Other environmental information and pollution abatement disclosures appear to be of lower quality. These findings support previous studies showing that there is little relationship between environmental disclosures and environmental performance.

Advances in Environmental Accounting and Management Advances in Environmental Accounting and Management, Volume 2, 137–165 © 2004 Published by Elsevier Ltd. ISSN: 1479-3598/doi:10.1016/S1479-3598(03)02006-5

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INTRODUCTION The business enterprise’s annual financial report is its most significant communication vehicle. Stakeholders of all sorts look to this source for information regarding the financial health of the firm and the success of management’s various financing, investing, and operating decisions. Companies often use the annual report to describe their performance in the environmental, social, and corporate citizenship areas. Such disclosures are mostly narrative in form, cover various environmental and community issues, and can be found variously placed throughout the corporate annual report. The firm adjusts disclosures of this nature based upon the impact it wishes the information to have on its readers. By understanding the quantity and quality of environmental reporting, the direction of future research and possible regulation to improve environmental disclosures can be established. Discretionary environmental disclosures, usually enclosed in non-financial parts of the annual report, may provide important information aside from mandated disclosures typically found in the report’s financial section. Such voluntary non-financial environmental disclosures may inform the accounting profession and authoritative bodies about environmental themes and practices. With more adequate authoritative guidance, environmental disclosures can be made more informative. Reporting consistency within firms and comparability between firms would be enhanced. Previous research has not addressed adequately the issue of environmental disclosure themes from a “financial” vs. “non-financial” perspective. Nor does the extant literature provide a reasonable basis to make comparisons of disclosure themes feasible. From a financial perspective, the possible effect that environmental disclosures can have on the perception of a firm’s future cash flows and earnings potential is reason for concern. Blacconiere and Patten (1994) suggest that investors may interpret more extensive environmental disclosures as a positive sign of the firm managing its exposure to future regulatory costs. Environmental matters impact a company’s short-term financial position as well as its chances for long-term success (Surma, 1992). Environmental issues have been, and continue to be, a major social problem facing many corporations (Post, 1991). The Financial Accounting Standards Board (FASB), U.S. Securities and Exchange Commission (SEC), and others have begun to realize the importance of these external matters. Authoritative guidance for both recordation and display is necessary so that appropriate environmental information is provided in a manner helpful to assessing the impact on cash flows and future earnings. New empirical research is needed to understand and improve environmental disclosures.

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The objective of this study is to provide additional insight into environmental disclosure practices. This is accomplished by examining the nature and extent of disclosure themes, in terms of quantity and quality, between the financial and non-financial sections of corporate annual reports for 1989. In addition, the study seeks to explore the relationship between disclosure themes and environmental performance. The next section presents relevant background studies. The research methodology, hypotheses, and expectations are in the following two sections. The fourth section below describes the study sample. Next, the empirical findings are presented. Concluding discussion and implications of the study appear in the last section. The Appendix details the content analysis and coding scheme used to conduct the research.

RELEVANT STUDIES Introduction By 1989, numerous U.S. environmental laws and regulations had been enacted and public policy regarding the environment had changed (Roussey, 1992). The disaster of the Alaskan Exxon Valdez oil spill on March 24, 1989, is an event that focused much attention on environmental issues and public policy debates (Benoit, 1989; Grover, 1989).1 The magnitude of this disaster led to development of the “Valdez Principles” (Gray, 1990; Sanyal & Neves, 1991).2 The level of disclosure in corporate annual reports also has changed. Findings by Walden and Schwartz (1997) and Gamble et al. (1995) suggest significant positive differences in the level of disclosures for 1989 and the several years thereafter.3 Given this change, there is a need to analyze and evaluate the nature and extent of environmental disclosure themes made by firms in their corporate annual reports beginning with 1989. Post (1991) suggests that the prevalence and seriousness of environmental problems are becoming increasingly evident to business. Simply put, environmental matters can no longer be ignored. An objective of financial reporting is to provide information to potential investors, current owners, creditors, and other stakeholders that will aid in assessing the future earnings and cash flows of an enterprise (FASB, 1986). Management can communicate environmental information to those outside the enterprise through various types of disclosure. And, methods besides annual report disclosure are used to influence stakeholder perception of the firm (Zeghal & Ahmed, 1990). Information is disclosed because of regulatory requirements or it is voluntarily provided because management considers it useful (to itself and those outside the enterprise).

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The most significant American environmental legislation – the Comprehensive Environmental Response, Compensation, and Liability Act of 1980 – established “Superfund.” This legislation made potentially responsible parties (PRPs) liable for remedial cleanup of hazardous waste sites (Roussey, 1992). These potential liabilities, together with other environmental costs and cleanup expenses of hazardous waste sites, directly affect current and future earnings and cash flows. They may not be disclosed even though required by regulatory rule (Roussey, 1992). Regulation S-K mandates disclosure of any material potential environmental liability in the “Legal Proceedings” section of Form 10-K, the SEC annual filing report. In 1989, SEC Financial Reporting Release No. 36 (SEC, 1989) required firms to disclose in the “Management Discussion and Analysis” section the effects of PRP status and to quantify the impact whenever reasonably practicable. The SEC position of requiring disclosure of environmental problems was strengthened in 1989 by an agreement with the U.S. Environmental Protection Agency (EPA). Starting in that year, the EPA provided information on PRPs to the SEC in order to target environmental disclosures for enforcement (Roussey, 1992). This disclosure requirement is at a “reasonably likely to occur” level as opposed to the FASB Statement No. 5 (FASB, 1975) threshold regarding contingent liabilities that is based on “probable of being asserted.” Epstein (1991) and Epstein and Freedman (1994) suggest that investors value the availability of environmental disclosures in annual reports. According to Epstein and Freedman (1994), the vast majority of investors want environmental disclosure and a large minority would like these disclosures to be covered by the independent accountant’s attestation. Ideally, disclosure should relate the environmental outcomes that corporate actions have on stakeholders in a manner that is meaningful, fair, and provides an adequate basis for decision making (AAA, 1976). Unfortunately, most environmental disclosures are narrative, cover a variety of topics, and are difficult to analyze or interpret.

Environmental Disclosures and Environmental Performance Many researchers investigating environmental disclosures and environmental performance have found little support for a relationship between the two. A number of studies used the Council on Economic Priorities’ (CEP) 1977 Pollution Audit of environmental performance indices which are based on investigations of pollution control records of the leading firms in five industries known to have environmental problems. According to Freedman and Wasley (1990), the CEP indices are the most comprehensive objective measures of environmental performance. The following are representative of content analysis studies, with

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most involving the CEP, the quantity and/or quality of disclosures, and a potential relationship with environmental performance. Ingram and Frazier (1980) examined the relationship between CEP measures of environmental performance and environmental disclosures found in annual reports for a sample of 40 firms. Insignificant results suggested the content analysis scores of firms’ disclosures do not relate to CEP indices of sample firms’ environmental performance. The only important relationship identified was that, except for disclosures related to litigation, the annual reports of the poorer performers contained more environmental disclosures than the better performers. The greater disclosure by poorer performers appeared as narrative information in the discretionary section of the annual report. Freedman and Jaggi (1982) used content analysis to investigate the association between environmental disclosures in Form 10-Ks and the environmental performance rated by the CEP for 109 firms in four highly polluting industries. The results confirmed earlier findings that there is no identifiable association between environmental disclosures and environmental performance. Wiseman (1982) compared the annual report disclosures made by 26 firms in three industries with their environmental performances as ranked by the CEP. Her content analysis measured the extent of disclosures using 18 items and four categories to evaluate the quality and accuracy of environmental disclosures. The findings indicated that voluntary environmental disclosures were incomplete, providing inadequate disclosure for most of the environmental performance items included in the content analysis. Her findings also demonstrated that no relationship existed between the contents of firms’ environmental disclosures and their environmental performance. Rockness (1985) used 128 participants in a field experiment to examine the reliability of voluntary environmental disclosures. She tested whether annual report users were able to make accurate comparative judgments among U.S. firms’ environmental performance based on their annual report disclosures. The CEP 1977 Pollution Audit provided an external evaluation of environmental performance for 26 firms in three industries included in her study. Results showed that users formed reasonably consistent comparative evaluations of firms’ environmental performance within an industry, but that these evaluations were inaccurate interpretations of actual performance as measured by the CEP. Rockness concluded that environmental disclosures are incomplete or inaccurate reports of actual performance. Freedman and Wasley (1990) examined the relationship between environmental performance and environmental disclosures made in both annual reports and in the Form 10-K reports filed with the SEC. They used the CEP indices from 1977 for 50 firms in four industries. The results of the content analysis, similar in

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structure to the Wiseman study described above, indicated that neither voluntary annual report environmental disclosure nor mandatory Form 10-K disclosure is indicative of actual firm environmental performance. These findings imply that for environmental disclosures to be beneficial for financial statement users regulation of their production may be necessary. Freedman and Stagliano (1995) used content analysis to examine the 1987 Form 10-K environmental disclosures of firms named potentially responsible parties under Superfund. Their objective was to detail both the existence of disclosures and the type of discussion provided by identified firms. A computerized search by keywords of all 1987 financial reports resulted in a sample of only 193 firms. They suggested that firms potentially impacted in the same way report the environmental event in a variety of ways, and often in a conflicting manner. According to these researchers, the disclosures fail to help stakeholders reach an informed judgment as to the potential impact Superfund will have on the firm. Their study concludes that even when disclosure regulations exist, corporations disregard them to avoid disclosing potentially damaging information.

Summary Studies using the 1977 CEP indices have suggested that no relationship exists between environmental disclosures and environmental performance. Disclosures in this area have been incomplete and inaccurate. Public policy with respect to the environment has changed over the last decade. Freedman and Stagliano (1995) propose that, even with regulation, environmental disclosures can mislead stakeholders due to the variety of reporting options available and the fact that some firms provide conflicting information about their Superfund PRP status. Environmental reporting may mislead stakeholders since there seems to be no relationship between disclosures and the firm’s actual environmental performance. This concurs with the various studies cited by Ullmann (1985) that find no association between social disclosures and social performance. Additional new research that takes a different approach is needed to confirm these prior studies and inform public policy makers.

METHOD OF STUDY The CEP’s Corporate Environmental Data Clearinghouse (CEDC) used the year 1989 to monitor, gather, and analyze information on corporate environmental performance for firms in the Fortune 500 (CEP, 1991, 1992).4 Companies in the

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present study were chosen based on those previously analyzed by the CEDC. These firms represent leaders in their industry, as defined by the CEDC. The major task of accumulating this information was accomplished by the CEDC over an extended period of time. By the middle of 1992, environmental reports for 57 firms, grouped into four industries, were available.5 These four industries are “chemical,” “consumer products,” “forest products,” and “oil.” Using content analysis,6 1989 corporate annual reports for these 57 firms were reviewed for environmental disclosures using a computerized search. From preliminary analysis, a keyword descriptor listing of environmental terms was developed to search for the disclosures.7 The text of each environmental disclosure found was read and its content coded in stages using the analysis technique described in the Appendix below. Descriptive analyses and statistics summarize and characterize the outcome of this analysis. These provide some insight into environmental disclosure in terms of quality and quantity that was specifically designed to differentiate between display in the financial and non-financial sections of the corporate annual reports studied. One measure is used to capture the quantity of disclosure, and two measures are used to capture the perceived quality, or information content, of disclosure. The quantity measure is the number of theme occurrences (NTO). This measures the number of specific themes occurring within five broad categories. The quality measures are a four-element index (QI), with a maximum of six points for each specific theme occurrence, and a disclosure score (DS) representing a summation of the QI for each specific theme category identified. Separate analyses for the financial and non-financial sections of each annual report provide information about the usage/selection of these sections for disclosure. It is expected that accounting and regulatory requirements will have a greater impact on disclosures made in the financial portion of the report because the auditors review that portion. It also is believed that disclosures located in the non-financial section should be affected more by social change than regulation since management has wide discretion to include in the non-financial section information that is considered to be important.8 Analyses are performed in aggregate for the four industries and separately by industry to investigate the nature and extent of the disclosures.

HYPOTHESES AND EXPECTATIONS Correlation analysis is used to explore the relationship between the quantity and quality of disclosures and environmental performance. The following two null hypotheses of no association are tested:

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H1. There is no significant association between the quantity of environmental disclosures and environmental performance. H2. There is no significant association between the quality of environmental disclosures and environmental performance. The availability of environmental performance factors is problematic. Reports from the EPA regarding information such as Superfund PRP status and toxic releases often are difficult to obtain and compile. Fortunately, the CEDC does provide information on PRP status9 and toxic releases per $1,000 of sales.10 These two factors are used as proxy variables for a firm’s environmental performance. Neither the Superfund-PRP status nor toxic releases proxy variables indicates the “severity” of the Superfund site or toxicity of releases by the firm.11 This is an inherent weakness in the proxies chosen. Beyond these basic hypotheses, this study does investigate the relationship between environmental contingency disclosures in the financial section and the two environmental performance proxies just described. To do this, the following additional null hypotheses are tested: H3. There is no significant association between the quantity of environmental contingency disclosures in the financial section and environmental performance. H4. There is no significant association between the quality of environmental contingency disclosures in the financial section and environmental performance. Accounting and regulatory requirements should affect the environmental disclosures made in the financial section of the report that are reviewed by auditors. Disclosures related to environmental contingencies are of particular interest. If these disclosures are useful and informative, there is an expectation of association between contingency disclosures and environmental performance. A potential relationship between the quantity and quality of disclosures and firm size is considered in addition to the environmental performance factors used.12 Studies by Patten (1991, 1992) suggest that the level of social disclosures, including environmental disclosures, is related to public policy pressure (see also, Walden & Schwartz, 1997).13 Patten used the natural log of sales as a size variable.14 It is used in this study also. This proxy variable may represent many other things besides, or in addition to, public policy pressure. With respect to the size factor, the following two null hypotheses of no association are tested: H5. There is no significant association between the quantity of environmental disclosures and size of the firm.

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H6. There is no significant association between the quality of environmental disclosures and size of the firm. Every fundamental hypothesis dealing with the quality of disclosure has allied with it a specific hypothesis for each quality measure, the average quality index, or the disclosure score. These specific hypotheses are simply denoted as “A” for the average quality index, and “B” for the disclosure score. For example, the null Hypothesis 2A can be stated as follows: H2A. There is no significant association between the quality of environmental disclosures as measured by the average quality index and environmental performance.

STUDY SAMPLE The final sample for study consists of 53 companies in four industries. The companies are shown in Table 1 along with their three-digit primary standard industrial classification code number (SIC). The four companies listed separately in Table 1 did not have annual reports available due to privatization or reorganization. There are 11 companies each from the chemical and consumer products industries, 16 companies from the forest products industry, and 15 oil companies. The keyword descriptors discussed above were used to perform a computerized search by company using the electronic annual report database from the National Automated Accounting Research System (NAARS). Once the searches for a company were complete, identified disclosures were marked for analysis. Coding was done for each disclosure using the two systems of enumeration discussed in the Appendix below. Due to the subjective nature of the coding process, two other coders besides the researchers independently coded the data to test reliability.15 Panel A of Table 2 presents a descriptive analysis of the four industries in total. The financial and non-financial sections of the annual reports are analyzed by five broad environmental theme categories. A total of 51 of the 53 companies had environmental disclosures in their 1989 annual report. The quantity and quality of disclosure themes varies across the financial and non-financial sections. The number of companies reporting on each theme also varies. The average number of specific theme occurrences (ANTO) is 10.2 in the non-financial section of the annual report compared with 4.3 in the financial section. The average quality index (AQI) is 3.5 for disclosure in the financial section of the annual report vs. 2.3 in the non-financial section.

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Table 1. Companies Reported on by the CEDC in Four Industries (n = 57). Chemical (n = 11) American Cyanamid (283) BASF (369) Ciba Geigy (283) Dow Chemical (282) Du Pont (291) Eastman Kodak (386) FMC (281) ICI (286) Monsanto (282) 3M (267) Union Carbide (282) Consumer products (n = 11) Archer Daniels Midland (207) Borden (202) Clorox (284) Colgate-Palmolive (284) Dial (284) General Mills (204) H. J. Heinz (203) Kellogg (204) Philip Morris (209) Proctor & Gamble (284) Unilever (207) Forest products (n = 16) Boise Cascade (262) Champion International (262) Federal Paperboard (263) Georgia Pacific (243) International Paper (262) James River (267) Kimberly Clark (267) Louisiana Pacific (242) Maxxam (242) Mead (511) Potlatch (263) Scott Paper (267) Stone Container (263) Union Camp (267) Westvaco (262) Weyerhaeuser (262) Oil (n = 15) Amoco (131) Ashland Oil (291)

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Table 1. (Continued ) ARCO (286) British Petroleum (291) Chevron (291) Exxon (131) Louisiana Land & Exploration (291) Mobil (131) Occidental Petroleum (281) Phillips Petroleum (291) Shell Oil (291) Sun (291) Texaco (131) Unocal (291) USX (131) Annual reports unavailable (n = 4) Fort Howard (Forest products) (267) Jefferson Smurfit (Forest products) (263) RJR Nabisco (Consumer products) (211) Sandoz (Chemical) (283) Note: 3-Digit primary SIC shown parenthetically.

For environmental contingencies, there was reporting by 24 companies (45%) when considering both sections of the annual report. Environmental contingency information is noticeably absent from the non-financial section, with only five of the companies reporting. For firms reporting, the ANTO for environmental contingencies is 2.8 times per annual report. The AQI is 3.2 of the possible six-point maximum. Thirty-nine companies (74%) reported the environmental expenditures disclosure theme between both sections. This information appears to be balanced between the financial and non-financial sections. The ANTO for environmental expenditures is 3.3 times per annual report; the AQI is 3.6 for firms reporting. For pollution abatement disclosures, 46 companies (87%) reported on this theme between both sections of the annual report. The vast majority of this information is reported in the non-financial section. For firms reporting, the ANTO for pollution abatement is 4.3 times per annual report; the AQI is 2.3. Thirty-one companies (58%) reported on environmental preservation in both sections. Only one firm reported this theme in the financial section. The ANTO for pollution abatement is 2.3 times per annual report; the AQI is 2.6. Forty-five companies (85%) reported other environmental information in both sections of the annual report. The majority of this information is disclosed in the

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Table 2. Descriptive Content Analysis by Theme, Industry and Section (n = 53). Non-Financial Section

Financial Section

Both Sections

Panel A: Environmental theme Environmental contingencies Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

5 1.4 2 2.9 4

23 2.6 9 3.3 5

24 2.8 11 3.2 5

Environmental expenditures Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

29 2.0 5 3.2 6

31 2.2 5 3.9 6

39 3.3 7 3.6 5

Pollution abatement Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

46 4.1 12 2.3 4

8 1.1 2 2.6 4

46 4.3 12 2.3 4

Environmental preservation Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

30 2.4 6 2.6 6

1 1.0 1 2.0 2

31 2.3 6 2.6 6

Other environmental information Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

41 4.2 16 1.9 3

18 1.1 2 2.9 6

45 4.3 17 2.1 6

Total for four industries (n = 53) Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

49 10.2 28 2.3 6

37 4.3 14 3.5 6

51 12.9 31 2.6 6

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Table 2. (Continued ) Non-Financial Section

Financial Section

Both Sections

Panel B: Industry Chemical (n = 11) Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

11 11.9 25 2.2 3

7 3.9 6 3.4 5

11 14.4 28 2.5 5

Consumer products (n = 11) Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

9 3.1 5 2.0 3

2 1.0 1 3.5 5

9 3.3 5 2.1 5

Forest products (n = 16) Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

14 8.5 16 2.5 4

14 2.6 4 3.4 6

16 9.8 19 2.8 6

Oil (n = 15) Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

15 15.9 28 2.3 3

14 6.6 14 3.8 5

15 22.1 31 2.7 5

Total for four industries (n = 53) Firms reporting Average number of theme occurrences Maximum Average quality index Maximum

49 10.2 28 2.3 6

37 4.3 14 3.5 6

51 12.9 31 2.6 6

non-financial section. For firms reporting other environmental information, the ANTO is 4.3, and the AQI is 2.1. Panel B of Table 2 presents the descriptive analyses by industry. The consumer products group had the smallest number of environmental disclosures. Based on firms reporting and the ANTO for all industries, the majority of disclosure themes reported on are pollution abatement and other environmental information.

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These disclosures are found mostly in the non-financial section. The highest perceived average quality of disclosure (based on AQI) appears to be associated with environmental expenditures (3.6) and environmental contingencies (3.2). Environmental contingency information is reported, as expected, mostly in the financial section of the annual report.

EMPIRICAL RESULTS AND ANALYSIS Descriptive Statistics on Disclosure Score, Environmental Performance, and Size Table 3 shows the descriptive statistics for the disclosure score (DS) and various performance factors displayed by industry. A large degree of variability exists for DS and the performance factors across industries and sections of the annual report. The largest average total DS is found in the oil industry (59.4), followed by chemical (30.0), forest products (27.6), and consumer products (6.0). The largest average Superfund sites disclosure is found in the chemical industry (27.8), followed very closely by the oil companies (26.1). Across industries, chemicals had the largest average toxic releases (10.9) followed by the forest products (3.5), consumer products (1.2), and oil industries (1.2) respectively. Size, on average, appears to be comparable across industries.

Association between Disclosure, Environmental Performance Factors, and Size Spearman rank correlations are presented in Table 4 for the four industries in total.16 The strongest significant positive associations are between the number of Superfund sites and the quantity of environmental disclosures as measured by NTO (H1). There also appear to be significant positive associations between the number of Superfund sites and the quality of disclosures measured by AQI (H2A) and the DS (H2B) found in the financial section. There are no associations between toxic releases and the quantity or quality of disclosure. There are significant positive associations between size, the quantity of disclosure (H5), and the DS (H6B). The strongest associations are in the non-financial section. There is no association between firm size and AQI. Panels B through E of Table 4 present the Spearman rank correlations for each industry. There is an obvious lack of consistency in the relationships across industries.

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Table 3. Descriptive Statistics by Industry and Variable. Industry and Variable

Mean

S.D.

Chemical (n = 11) Non-financial DS Financial DS Total DS Superfund-PRP sites Toxic releases Size

22.09 7.91 30.00 27.82 10.93 9.27

19.32 7.31 21.57 14.87 13.90 0.73

0–60 0–18 11–82 8–58 0.70–42.01 8.14–10.48

5.36 0.64 6.00 6.91 0.23 8.96

5.14 1.57 5.14 7.65 0.32 1.01

0–17 0–5 0–17 0–21 0–1.10 7.21–10.69

Forest products industry (n = 16) Non-financial DS Financial DS Total DS Superfund-PRP sites Toxic releases Size

19.94 7.63 27.56 8.19 3.51 8.31

16.17 4.35 17.44 6.43 2.72 0.69

0–46 0–14 3–52 0–22 0.70–11.40 7.11–9.34

Oil industry (n = 15) Non-financial DS Financial DS Total DS Superfund-PRP sites Toxic releases Size

36.20 23.20 59.40 26.13 1.21 9.81

12.76 15.30 22.93 11.06 1.29 1.12

13–56 0–55 13–94 2–43 0.10–4.60 6.57–11.46

Four industries (n = 53) Non-financial DS Financial DS Total DS Superfund-PRP sites Toxic releases Size

23.15 10.64 33.79 17.08 3.72 9.07

18.20 12.26 26.25 13.89 7.43 1.06

0–60 0–55 0–94 0–58 0–42.01 6.57–11.46

Consumer industry (n = 11) Non-financial DS Financial DS Total DS Superfund-PRP sites Toxic releases Size

Range

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Table 4. Spearman Rank Correlations between Disclosure by Section and Environmental Performance. Number of Theme Occurrences Panel A: For four industries (n = 53) Superfund-PRP sites Non-financial 0.5370 (0.000)*** Financial 0.5868 (0.000)*** Total 0.6103 (0.000)*** Toxic releases Non-financial Financial Total

0.1378 (0.325) 0.2009 (0.149) 0.1608 (0.250)

Size Non-financial Financial Total

0.4061 (0.003)*** 0.2671 (0.053)* 0.4041 (0.003)***

Panel B: For the chemical industry (n = 11) Superfund-PRP sites Non-financial 0.3326 (0.318) Financial 0.5376 (0.088)* Total 0.4818 (0.133)

Average Quality Index

Disclosure Score

0.0823 (0.558) 0.3748 (0.006)*** 0.1949 (0.162)

0.4764 (0.000)*** 0.5874 (0.000)*** 0.5796 (0.000)***

0.2101 (0.131) 0.2338 (0.092)* 0.2013 (0.148)

0.1193 (0.395) 0.1953 (0.161) 0.1590 (0.255)

−0.0328 (0.816) 0.1842 (0.187) −0.0163 (0.908)

0.3674 (0.007)*** 0.2703 (0.050)** 0.3730 (0.006)***

0.2909 (0.385) 0.3071 (0.358) 0.4966 (0.120)

0.1011 (0.767) 0.4005 (0.222) 0.2276 (0.501)

Toxic releases Non-financial Financial Total

−0.6150 (0.044)* 0.2337 (0.489) −0.5545 (0.077)*

−0.3636 (0.272) −0.0512 (0.881) −0.1686 (0.620)

0.1482 (0.664) 0.2734 (0.416) 0.2454 (0.467)

Size Non-financial Financial Total

0.6424 (0.033)* −0.1636 (0.631) 0.4727 (0.142)

0.4182 (0.201) −0.0512 (0.881) 0.0410 (0.905)

0.2192 (0.517) −0.0539 (0.875) 0.1416 (0.678)

0.2719 (0.419) 0.4005 (0.222) 0.4401 (0.176)

0.1011 (0.767) 0.4005 (0.222) 0.2276 (0.501)

Panel C: For the consumer products industry (n = 11) Superfund-PRP sites Non-financial 0.0256 (0.940) Financial 0.3752 (0.255) Total 0.0930 (0.786) Toxic releases Non-financial Financial Total

0.1054 (0.758) 0.2267 (0.503) 0.1054 (0.758)

0.2459 (0.466) 0.2734 (0.416) 0.4408 (0.175)

0.1482 (0.664) 0.2734 (0.416) 0.2454 (0.467)

Size Non-financial Financial Total

0.2125 (0.530) −0.0745 (0.828) 0.1524 (0.655)

0.4531 (0.162) −0.0539 (0.875) 0.3753 (0.255)

0.2192 (0.517) −0.0539 (0.875) 0.1416 (0.678)

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Table 4. (Continued ) Number of Theme Occurrences Panel D: For the forest products industry (n = 16) Superfund-PRP sites Non-financial −0.0222 (0.935) Financial 0.2029 (0.451) Total −0.0481 (0.860)

Average Quality Index

Disclosure Score

−0.3159 (0.233) −0.1542 (0.569) −0.2244 (0.404)

−0.1674 (0.535) 0.2502 (0.350) −0.1689 (0.532)

Toxic releases Non-financial Financial Total

0.4291 (0.097)* −0.1134 (0.676) 0.3826 (0.144)

0.4024 (0.122) −0.1383 (0.610) −0.1415 (0.601)

0.4345 (0.093)* −0.1542 (0.569) 0.3181 (0.230)

Size Non-financial Financial Total

−0.4384 (0.089)* 0.1179 (0.664) −0.4812 (0.059)*

−0.3402 (0.197) −0.1464 (0.588) 0.0898 (0.741)

−0.4341 (0.093)* 0.1452 (0.592) −0.3974 (0.128)

−0.1137 (0.687) −0.0233 (0.934) 0.1549 (0.582)

0.4772 (0.072)* 0.4014 (0.138) 0.4258 (0.114)

Panel E: For the oil industry (n = 15) Superfund-PRP sites Non-financial 0.3862 (0.155) Financial 0.4293 (0.110) Total 0.5621 (0.029)** Toxic releases Non-financial Financial Total Size Non-financial Financial Total

−0.1244 (0.659) −0.0746 (0.791) −0.2453 (0.378) 0.4097 (0.129) 0.3091 (0.262) 0.5619 (0.029)**

−0.3014 (0.275) 0.3497 (0.201) −0.1172 (0.677) −0.3271 (0.275) 0.3092 (0.262) −0.1340 (0.634)

−0.3013 (0.275) −0.0779 (0.783) −0.1376 (0.625) 0.4910 (0.063)* 0.3238 (0.239) 0.4750 (0.074)*

∗p

< 0.10 (two-tailed test). < 0.05 (two-tailed test). ∗∗∗ p < 0.01 (two-tailed test). ∗∗ p

Association between Environmental Contingencies in the Financial Section and Environmental Performance Factors Table 5 gives the Spearman rank correlations for environmental contingency disclosures reported in the financial section of the annual report and the two environmental performance factor proxies. This disclosure theme shows no association with toxic releases. For Superfund sites, there appears to be a significant positive association in total with the four industries combined for all measures (H3, H4A,

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Table 5. Spearman Rank Correlations between Environmental Contingencies and Environmental Performance in the Financial Section by Industry. Number of Theme Occurrences

Average Quality Index

Disclosure Score

Four industries (n = 53) Superfund-PRP sites Toxic releases

0.6049 (0.000)*** 0.1072 (0.445)

0.6073 (0.000)*** 0.1865 (0.181)

0.6065 (0.000)*** 0.1289 (0.357)

Chemical (n = 11) Superfund-PRP sites Toxic releases

0.6928 (0.018)** 0.2309 (0.494)

0.5586 (0.074)* 0.3467 (0.296)

0.5586 (0.074)* 0.3467 (0.296)

Consumer (n = 11) Superfund-PRP sites Toxic releases

0.0503 (0.883) −0.2028 (0.550)

0.0503 (0.883) −0.2028 (0.550)

0.0503 (0.883) −0.2028 (0.550)

Forest products (n = 16) Superfund-PRP sites Toxic releases

0.4212 (0.104) −0.0995 (0.714)

0.4266 (0.099)* −0.0863 (0.751)

0.4266 (0.099)* −0.0863 (0.751)

Oil (n = 15) Superfund-PRP sites Toxic releases

0.4896 (0.064)* 0.0619 (0.826)

0.3780 (0.165) 0.3866 (0.155)

0.5267 (0.044)** 0.0523 (0.853)

∗p

< 0.10 (two-tailed tests). < 0.05 (two-tailed tests). ∗∗∗ p < 0.01 (two-tailed tests). ∗∗ p

and H4B). On an industry-by-industry basis, significant positive association in terms of quantity and quality for these disclosures appears only in the chemical industry for all measures (H3, H4A, and H4B). The forest products industry shows a significant positive association to the quality of disclosures (H4A and H4B), while the oil industry has a significant positive association to the quantity of disclosures (H3) and the quality of disclosures as measured by DS (H4B). There are no associations for Superfund sites and these disclosure themes in the consumer products industry.

DISCUSSION AND IMPLICATIONS This research explores various aspects of management’s communication of the firm’s environmental impact to its many constituencies. The overall objective of the study is to provide insight into environmental disclosure practices by examining the nature and extent of disclosure themes in terms of quality and

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quantity between the financial and non-financial sections of corporate annual reports. In addition, the research explores the relationship between quantity and quality of disclosure themes and environmental performance. From the findings, it is evident that environmental disclosures occur throughout the annual report with a great degree of variability. The vast majority of disclosures were found in the non-financial section. Based on five broad categories of disclosure themes in total, 87% of the firms in the sample disclosed pollution abatement information, followed by 85% of the firms disclosing other environmental information. Both of these categories occur most often in the “Letter to Shareholders” and other portions of the non-financial section of the annual report. In the financial section, the majority of environmental disclosures involve expenditures and contingency data, but only 58% and 43% of the firms reported information in these two areas, respectively. Table 6 is a summary of significant positive differences by industry. The first set of hypotheses tested relates to the quantity and quality of disclosures and environmental performance factors. For the four industries in total, a significant positive association was found between the quantity of disclosures and Superfund sites, but not with toxic releases. A significant positive association is supported for H2B between the disclosure score and Superfund sites, but only for the financial section’s average quality index and Superfund-PRP sites. For H2, there appears to be no association between the quality of disclosures and toxic releases. When these two hypotheses are analyzed across industries, inconsistent results are noted. These findings suggest definite industry effects with regard to the quantity and quality of disclosure and the environmental performance proxies. They further suggest that the quantity and quality of environmental disclosures may make differentiation between high-polluting and low-polluting industries feasible, even though firms within a given industry do not appear to be susceptible to such differentiation.17 A second set of hypotheses was tested for the environmental contingency disclosures in the financial section of the annual report. The results were similar. For the four industries in total, all three measures for quantity and quality showed significant positive associations with Superfund sites (H3, H4A, and H4B), but not for toxic releases. However, across industries, only the chemical company group confirmed this finding (H3, H4A, and H4B). These results suggest definite industry effects, but variability of disclosures made between industries and companies. There remains the potential, though, that the environmental performance factors selected may represent proxies, albeit noisy ones, for actual environmental performance. A third set of hypotheses was tested to determine the relationship between the quantity and quality of disclosures and firm size. For the four industries in total, a significant positive association was found between the quantity of disclosures

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Table 6. Summary of Significant Positive Differences by Industry. Non-Financial Section/Financial Section/Both Sections (Total) H1 and H2 : Environmental Disclosures and Environmental Performance (Superfund Sites)

H1 : Theme Occurrences

Chemical Consumer products Forest products Oil Four industries

ns/∗ /ns ns/ns/ns ns/ns/ns ns/ns/∗ ∗ ∗∗∗ ∗∗∗ ∗∗∗ / /

H3 and H4 : Environmental Contingencies Disclosure and Environmental Performance (Superfund Sites)

H3 : Theme Occurrences

Chemical Consumer products Forest products Oil Four industries H5 and H6 : Environmental Disclosures and Size Chemical Consumer products Forest products Oil Four industries

H2A : Average Quality Index

ns/ns/ns ns/ns/ns ns/ns/ns ns/ns/ns ns/∗ ∗ ∗ /ns H4A : Average Quality Index

H2B : Disclosure Score

ns/ns/ns ns/ns/ns ns/ns/ns ∗ /ns/ns ∗∗∗ ∗∗∗ ∗∗∗ / / H4B : Disclosure Score

∗∗

∗

∗

ns ns

ns

ns

∗

∗

∗

ns

∗∗

∗∗∗

∗∗∗

∗∗∗

H5 : Theme Occurrences

∗ /ns/ns ns/ns/ns ns/ns/ns ns/ns/∗∗ ∗∗∗ ∗ ∗∗∗ / /

H6A : Average Quality Index

ns/ns/ns ns/ns/ns ns/ns/ns ns/ns/ns ns/ns/ns

H6B : Disclosure Score

ns/ns/ns ns/ns/ns ns/ns/ns ∗ /ns/∗ ∗∗∗ ∗∗∗ ∗∗∗ / /

Two-tailed tests: ns = not significant, ∗ p < 0.10; ∗ ∗ p < 0.05; ∗ ∗ ∗ p < 0.01.

and firm size. For H6, a significant positive association is supported between the disclosure score and firm size (H6B), but not the average quality index. For individual industries, the results are inconsistent and mixed. Of particular interest is the oil industry, since significant positive associations were found for the quantity of disclosure (H5) in total, and the disclosure score and size (H6B) in the non-financial section and complete annual report. This lends support to Patten (1992) who suggested that environmental disclosures in the oil industry were related to public policy pressure associated with the 1989 Alaskan Exxon Valdez oil spill. As with the previous findings, a definite industry effect is evident.

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The quantity of environmental disclosure themes varies across sections of the annual report, and the quality of themes is relatively low and varies across themes as well. There is no relationship between the quality (as measured by average quality index) of environmental disclosures and environmental performance. It appears that the quantity of disclosures may increase the perceived information content of environmental information (as measured by the number of theme occurrences and the disclosure score); these disclosures may make differentiation between high- and low-polluting industries feasible. Researchers should concern themselves with possible industry effects in future studies. Finally, it is interesting to note that the majority of environmental disclosures in the non-financial section of company reports are concerned with pollution abatement and other environmental information, not the environmental expenditure and contingency information found in the financial section. It would seem that management is attempting to inform stakeholders of environmental information that is not prescribed currently by regulatory requirement. Yet, based on the disclosure themes observed, information in the non-financial section tends to be more positive than negative in its content. In conclusion, many firms and industries do not appear to provide adequate or informative environmental disclosures in their annual reports. It is doubtful that extant disclosures provide environmental information in a manner appropriate for assessing properly the impact of environmental actions on cash flows and earnings of the firm. Perhaps it is time to reconsider the recommendation of the 1989 American Accounting Association’s Committee on Accounting and Auditing Measurement (AAA, 1991): Reporting entities should report explicitly on the cost to a company of pollution prevention and correction, where ascertainable. Absent improved voluntary disclosure by companies of costs that they impose on society, such disclosure should be required by regulation (emphasis added). Initially, such required disclosure might be limited to environmental damage, measured in terms of cost (if practicable) or in physical terms such as the weight of particulate emissions discharged.

The minority report of this AAA group went further by suggesting a report form that would serve a variety of stakeholders and use data that already are available. This type of environmental report would be structured on a multidimensional approach and use units of measure that are of interest to particular stakeholders (e.g. tons of particulate emissions and gallons of toxic discharge) in combination with dollar amounts. Additional regulation of environmental disclosures is necessary as suggested by the issuance of SEC Staff Accounting Bulletin 92 (SEC, 1993).18 Many firms minimize disclosures not covered by specific accounting pronouncements from the FASB and/or the SEC (Stanko & Zeller, 1995). For instance, a survey

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reported that 36% of U.S. companies did not plan to mention current and potential environmental liabilities in their annual reports as required by SAB 92 (“Many companies fail,” 1994). Only 9% of the 200 companies surveyed indicated that environmental information would be given significant space in their annual reports. This is not inconsistent with the evidence provided by Welch (1994) that the quality and quantity of environmental information disclosed by companies in the United Kingdom is declining. Since the majority of non-financial environmental disclosures deal with pollution abatement and other environmental information, it seems appropriate to direct research toward developing more meaningful reporting practices on these two theme categories for future inclusion in the financial section of annual reports. Pollution abatement and other environmental information disclosures scored lowest in quality in this study, even though they were used frequently by management. It also is evident that more meaningful reporting practices are needed for environmental contingency disclosures in the financial section. These represent large potential financial liabilities for companies. Unfortunately, firms presently provide very limited information to assess adequately the potential impact of these liabilities on a company’s future earnings and cash flows. Finally, the environmental information disclosed currently by companies makes it difficult to differentiate between firms with “good” and “bad” environmental performance. This is particularly true for companies in the same industry. It is apparent that a firm’s environmental performance is multidimensional and may require more complex measures than are now being applied. That, though, is no reason to forsake attempts to develop new, creative reporting schemes that will more adequately inform stakeholders about the financial consequences of the firm’s activities with regard to the environment. As the goal of global sustainability gains in prominence, so too must the evidence provided by business enterprises regarding their stewardship in the environmental arena. Robust disclosure about the environmental impact of production activities, and the costs attached thereto, also is a goal worthy of emphasis by the world’s financial community.

NOTES 1. Exxon’s total damages were reported to have reached $9 billion when it was ordered by a jury to pay an additional $5 billion as punishment for the oil spill (Solomon, 1994). 2. The Valdez Principles require companies to adopt and implement specific policies designed to safeguard the environment. They were developed by The Coalition for Environmentally Responsible Economies (CERES) project of the Social Investment Forum, which had the backing of large investors. Companies were invited to adopt the Principles publicly. Large investors suggested that they would invest only in companies that adopted the Principles (Gray, 1990).

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3. The work of Walden and Schwartz (1997) lends support to environmental disclosures being time- or event-specific and made in the firm’s self-interest as a response to public policy pressure. For instance, it has been suggested that the 1989 Alaskan Exxon Valdez oil spill contributed to an apparent shift in public policy regarding the environment during this period (see, for example, Benoit, 1989; Grover, 1989). Gamble et al. (1995) contend that the significant increase in environmental disclosures by U.S. companies is associated with the 1989 oil spill and companies’ adoption of the Valdez Principles. In contrast, Welch (1994) reported that the quantity and quality of environmental information disclosed by United Kingdom companies have been declining rather than increasing since 1992. 4. The CEP is a non-profit public interest research organization founded in 1969. The CEDC monitors environmental information from an array of sources such as annual questionnaires to each company monitored, individual interviews, publications, company literature, government data, and other databases. CEDC also relies on expert advisors who specialize in various environmental fields. 5. From discussions with CEDC staff members it was learned that companies were selected for analysis based on their rank within industries, with the top-ranked firms selected first. When a reasonable number of reports for a specific industry were completed, the industry “batch” was released to the public. Thus, the initial 57 companies released were selected solely by the CEDC, not the researchers. 6. A discussion of content analysis and the coding scheme used in this study is provided in the Appendix. 7. The keyword listing included more than 50 descriptors to locate the environmental disclosures and associated themes. For example, “ecolog!” was used to locate words like “ecological” and “ecology.” A systematic, comprehensive, and thorough analysis was made for each company. 8. Patten (1992) was the first to apply this financial vs. non-financial section dichotomy. It is not absolute with regard to social change and regulatory effects. Disclosures driven by regulatory effects also can be found in the non-financial section, and vice versa. 9. The CEDC measures PRP status using the number of sites per firm. 10. The Superfund Amendments and Reauthorization Act (SARA) created the toxic chemical release inventory (TCRI), an annual listing that documents the types and amounts of toxins released by manufacturing facilities. It covers approximately 300 toxins and 20 chemical categories. However, it represents only a first step and is limited in scope of coverage. Firms must report to the EPA the quantity of chemicals released into the environment and the amount sent off-site to treatment or disposal facilities. The CEDC reports toxic releases based on the SARA disclosures for the TCRI. 11. The National Priorities List (NPL) does “rank” Superfund sites by severity. An option, although one not chosen here, is to “weight” the PRP proxy according to state-level NPL ranking. 12. According to Patten, company size is a “decisive” factor for social disclosures. Larger firms tend to receive more attention from the public and to be under greater pressure to exhibit social and environmental responsibility. Patten (1991) noted that size is, at best, a very noisy proxy for public policy pressure. 13. Public policy pressure consists of three non-market environments according to Boulding (1978). These are the cultural, political, and legal environments. In the context of this study, the cultural and political environments can be thought of simply as “social change,” while the legal environment might be thought of as a “regulatory” one.

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14. The rationale for this choice is the fact that annual report “space” available for these types of disclosures is finite, and the level of disclosures based on sales is best explained using a log transformation. 15. Huck et al. (1974) suggest that without a relatively high degree of agreement (usually above 85%) between researcher and coders, it is difficult to make an accurate statement about the behavior of the variables being measured. Reliability for the quantity and quality variables is within an acceptable range. The total average agreements between the researchers and coders are 97% and 90% for the variables for quantity and quality respectively. Average variability in differences between the researchers and coders are −0.6% and 2.3% for variables for quantity and quality respectively. 16. The Spearman rank correlation coefficient is the comparable non-parametric test to the Pearson product-moment correlation coefficient (Huck et al., 1974). Due to the small sample size, variability in the data, and the need to avoid specification of the underlying distribution, the Spearman rank correlation coefficient is used to report on the associations. 17. Industries known to have environmental problems may be more responsive and disposed toward disclosure than others that have not encountered such problems according to Ness and Mirza (1991). 18. According to Early (1994), the SEC has indicated that it will accept nothing less than full disclosure of a public firm’s environmental liabilities. One estimate is that this may amount to $750 billion over 30 years for American industry. It is not enough to simply mention that liabilities and potential liabilities exist. With SAB 92, a firm must accrue at least the minimum amount of the liability in its financial statements without regard to possible third party offsets. A potential problem with SAB 92 is that of measuring the liability.

REFERENCES American Accounting Association (AAA) Committee on Accounting and Auditing Measurement (1991). Report of the committee on accounting and auditing measurement. Accounting Horizons, 5(3), 81–105. American Accounting Association (AAA) Committee on Accounting for Social Performance (1976). Report of the committee on accounting for social performance. The Accounting Review (Suppl.), 38–69. Benoit, E. (1989). The Valdez legacy. Financial World, 158(13), 82–83. Blacconiere, W. G., & Patten, D. M. (1994). Environmental disclosures, regulatory costs, and changes in firm value. Journal of Accounting and Economics, 18(3), 357–377. Boulding, K. E. (1978). The legitimacy of the business institution. In: E. M. Epstein & D. Votaw (Eds), Rationality, Legitimacy, Responsibility: Search for New Directions in Business and Society (pp. 83–97). Santa Monica, CA: Goodyear Publishing. Council on Economic Priorities (CEP) (1991). CEDC reports now available. Research Report, 3. Council on Economic Priorities (CEP) (1992). New CEDC reports available. Research Report, 6. Early, K. (1994). The SEC’s toxic solution to environmental reporting. Corporate Cashflow, 15(5), 60. Epstein, M. J. (1991). What shareholders really want? The New York Times, Forum, April 28, 140, 11. Epstein, M. J., & Freedman, M. (1994). Social disclosure and the individual investor. Accounting, Auditing and Accountability Journal, 7(4), 94–109. Financial Accounting Standards Board (FASB) (1975). Statement of financial accounting standards no. 5: Accounting for contingencies. Stamford, CT: FASB.

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APPENDIX Content analysis uses a set of procedures to make inferences from messages (Weber, 1990). The method of creating and testing a coding scheme developed here is similar to that used in other social accounting studies (e.g. Freedman & Stagliano, 1992; Freedman & Wasley, 1990; Wiseman, 1982). Coding is the process by which raw data are transformed systematically and aggregated into units that permit precise description of relevant content characteristics (Holsti, 1969, p. 94) The development of a coding scheme begins with selection and definition of categories. Data are coded and classified into these categories by units. These units include the recording unit, the context unit, and the system of enumeration (Holsti, 1969). Figure 1 shows details of the coding scheme developed for use in this study. Choice of recording unit is the first step in the coding process. The unit selected for this study is the “theme” of the environmental disclosure. According to Holsti (1969), the most useful unit of content analysis is the theme. Unfortunately, it is also the most time-consuming to develop and code. Weber (1990) suggests that while this form of coding is labor-intensive, it leads to much more detailed and sophisticated comparisons. Wiseman (1982) and Freedman and Wasley (1990) used the following four broad theme categories: (1) “litigation”; (2) “pollution control equipment and facilities”; (3) “pollution abatement”; and (4) “other environmentally related information.” The present study uses an updated version of these four categories and a new category for “environmental preservation” which includes recycling and conservation of natural resources. These five broad themes, and their related sub-categories, are shown in Fig. 2. Categorization of a recording unit or theme relies on the context unit. This is the largest body of content which can be examined to categorize a recording unit (Holsti, 1969). The financial and non-financial sections of the annual report are

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Fig. 1. Content Analysis Coding Scheme.

the context units. Patten (1992) also used these sections of the annual report as the context unit. For purposes of this study, the financial section of the annual report includes the Management Analysis and Discussion, financial statements,

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Fig. 2. Broad and Specific Theme Categories.

supplemental schedules, and footnotes. The non-financial section includes the Letter to Shareholders and all other portions of the report not classified as financial. Freedman and Stagliano (1992, 1995) quite correctly suggest that it is much more important for a method of content analysis to focus on what is included in the theme, rather than how much is said. The meaning of the message is what is essential. Considering only the quantity of disclosures does not capture the importance of the disclosures. Most studies use only quantity as the enumeration system. For example, Patten (1991, 1992) used only a portion of the page (1/100th of a page intervals) containing the disclosure. Blacconiere and Patten (1994) used the presence or absence of statements relating to five areas of environmental concern as a measurement scheme.

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Two systems of enumeration are developed for this study to capture the quantity of disclosure and to establish an assessment of quality. Freedman and Stagliano (1992, 1995) suggest that the latter are more important since this method of content analysis focuses on what is included in the theme, rather than how much is said. The first system of enumeration here considers the quantity of disclosures made by counting the number of theme occurrences (NTO). Each time a specific theme was found, it was counted. Blacconiere and Patten (1994) used a similar method. This was done to indicate the strength of usage of various themes. The second system of enumeration considers the quality, or perceived information content, of the disclosures. A four-element quality index (QI) is used to assess the quality of disclosures related to the themes. This follows a study by Freedman and Stagliano (1992). The four elements used are: (1) effect – significant or not significant; (2) quantification – monetary or not monetary; (3) specificity – specific as to actions, persons, events, or places; or not specific; and (4) time frame – past, present, or future. For this study, significant effects were based on location in the annual report. Those disclosures found in the Letter to Shareholders and financial sections of the annual report were deemed significant. The remaining three elements of each disclosure were judged independently by the researchers and two coders. Each element of the index that is present in the disclosure receives one point. If the disclosure involves the current reporting period, it receives one point. No points are given if the disclosure involves the past or the element is not present. Therefore, each environmental disclosure assessed by the quality index (QI) by theme could receive a minimum of zero points and a maximum of six points based on the four-element index. In addition, a second quality measure was computed. This is referred to as the disclosure score (DS). The DS is a summation of the quality index per environmental theme. For example, assume that company X has two observed environmental disclosures assessed for quality by theme. If QI1 and QI2 are rated as five and three points, respectively, the DS is eight. This procedure is the same as that used by Walden (1993) and Walden and Schwartz (1997). The rating procedure is based on the presence or absence and the degree of specificity for each environmental disclosure theme. This type of differential rating is consistent with other studies (e.g. Freedman & Stagliano, 1992; Freedman & Wasley, 1990; Wiseman, 1982). The nature and extent of environmental disclosures are examined to measure objectively the information contained in the disclosures and to provide a systematic numerical basis for comparing the environmental disclosure themes. Once the ratings for quantity and quality assessment are tabulated, the environmental disclosure themes are compiled by various sections of the annual report for use in further statistical analysis.