EDITORS ix
AD HOC REVIEWERS xi
EDITORIAL xiii
Martin Freedman and Bikki Jaggi
v
vi
vii
EDITORS
Associate Editors
A.J. Stagliano Sara Reiter
St. Joseph’s University Binghamton University
Editorial Board
Bruce Avolio Arieh Ullmann
University of Nebraska Binghamton University
Walter Blacconiere Ora Freedman
Indiana University Villa Julie College
Nola Buhr Rob Gray
University of Saskatchewan, University of Glasgow, Scotland
Canada Carlos Larrinaga
Jeffrey Cohen University of Seville, Spain
Boston College Cheryl Lehman
David Cooper Hofstra University
University of Alberta, Canada Glen Lehman
Charl De Villiers University of South Australia
University of Pretoria, Lee Parker
South Africa University of Adelaide, Australia
Jesse Dillard Dennis Patten
University of Central Florida Illinois State University
Marc Epstein Bill Schwartz
Rice University Indiana University at South Bend
Paul Shrivasta Tony Tinker
Bucknell University Baruch College
ix
AD HOC REVIEWERS
xi
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
xiv
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 responsi-
bility (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
xv
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
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 con-
cern 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
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 improve-
ment 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
The Identification, Measurement, and Reporting of Corporate Social Impacts 5
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 com-
pany’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 Gröjer 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.
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 stake-
holders. 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.
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 stake-
holder 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 orga-
nizations 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,
10 MARC J. EPSTEIN
When the 1990s began there were few environmental reports produced, but as
the decade progressed, hundreds of companies began producing corporate envi-
ronmental 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 commu-
nity 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
The Identification, Measurement, and Reporting of Corporate Social Impacts 11
reports, the development of measurement and reporting frameworks still has not
surpassed the progress made in the 1970s.
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). Estab-
lished 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.
14 MARC J. EPSTEIN
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 per-
formance” (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 en-
vironmental impacts. Misconceptions about traditional accounting reports endow
them with unrealistically high levels of precision and reliability, provoking expec-
tations 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 corpo-
rate 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 mon-
etized 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 prin-
ciples 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 respon-
sibility, 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 strate-
gies, 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
The Identification, Measurement, and Reporting of Corporate Social Impacts 15
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 commu-
nity 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 internaliza-
tion. 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.
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 in-
dividual 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
The Identification, Measurement, and Reporting of Corporate Social Impacts 19
Further, government regulators (such as the SEC in the U.S.) establish regula-
tions 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.
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
22 MARC J. EPSTEIN
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):
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 indi-
cators 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.
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. How-
ever, 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
24 MARC J. EPSTEIN
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 environ-
mental 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, en-
vironmental, 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
26 MARC J. EPSTEIN
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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Limited.
LEGITIMACY AND THE INTERNET:
AN EXAMINATION OF CORPORATE
WEB PAGE ENVIRONMENTAL
DISCLOSURES
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.
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
Legitimacy and the Internet 33
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 dis-
closure 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 vari-
ables – 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
34 DENNIS M. PATTEN AND WILLIAM CRAMPTON
The Internet will provide both new (increasingly ‘wireless’) channels for existing forms of cor-
porate 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.
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 ad-
dition, 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 anal-
ysis 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.
Legitimacy and the Internet 39
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).
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
Legitimacy and the Internet 41
where
EDi = the positive/neutral environmental disclosure measure (either
content analysis score or sentence count) for firm i.
Firm Sizei = the natural log of firm i’s 1997 revenues (from the annual report).
Industryi = 1 if the firm is from the chemical industry and zero if it is from
the electrical equipment industry.
NegDisci = 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
Legitimacy and the Internet 43
Negative sentences
Total sample 15.37 1.42 6.166 0.000
Chemical 25.13 0.75 7.913 0.000
Elect. equip. 4.97 2.13 1.387 0.171
Positive/neutral sentences
Total sample 9.63 70.90 −4.067 0.000
Chemical 15.59 83.56 −3.286 0.002
Elect. equip. 3.27 57.37 −2.458 0.017
Negative content scores
Total sample 1.82 0.35 6.742 0.000
Chemical 2.66 0.41 8.414 0.000
Elect. equip. 0.93 0.30 2.369 0.021
Positive/neutral content scores
Total sample 3.63 3.73 −0.135 0.893
Chemical 5.28 4.69 0.598 0.552
Elect. equip. 1.87 2.70 −0.910 0.367
a The t-stat is for the t-test on the difference in means.
b All significance levels are two-tailed.
Positive/neutral disclosures
Economic
Current or past capital expenditures for pollution 25 9 10.373∗∗ (C−0.05)
abatement or control
Current or past operating costs for pollution 19 6 8.467∗∗ (C−0.01)
abatement or control
Projection of future expenditures for pollution 16 0 18.370# (C−0.001)
abatement or control
Projection of future operating costs for pollution 10 0 10.877# (C−0.01)
abatement or control
Pollution abatement
Air emission information is provided 10 19 3.645 (EE−0.05)
Water discharge information is provided 3 14 8.247∗∗ (C−0.05, EE−0.05)
Solid waste disposal information is provided 3 9 3.321
Pollution control or abatement facilities or 11 18 2.204
processes are discussed
Compliance status is mentioned or discussed 23 14 3.120 (C−0.05)
Other disclosures
Discussion or mention of environmental 25 12 6.509∗∗ (C−0.05)
regulations or requirements
Statement of environmental policies or company 31 38 1.600
concern for the environment
Conservation of natural resources discussed 5 13 4.158∗ (EE−0.05)
Mention or discussion of environmental awards 10 18 2.951
Recycling information provided 3 9 3.321 (EE−0.05)
Disclosure of an office or department for 6 10 1.148
environmental control
Discussion of environmental attributes of products 19 24 0.889
Discussion of environmental audit activities 8 17 4.058∗
Negative environmental disclosures
Discussion of exposures due to past or present 39 7 35.388# (C−0.001, EE−0.05)
remediation problems
Specific disclosure that the company has been 33 6 27.268# (C−0.001)
named as a potentially responsible party
Disclosure of monetary accruals and/or expenses 32 4 30.687# (C−0.001, EE−0.001)
incurred for remediation
Discussion of exposures due to other, 9 5 1.288
non-remediation-related environmental
problems
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.
Legitimacy and the Internet 47
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.
48 DENNIS M. PATTEN AND WILLIAM CRAMPTON
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
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.
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
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
50 DENNIS M. PATTEN AND WILLIAM CRAMPTON
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
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
DISCUSSION
The first major objective of this analysis was to identify how environmental disclo-
sure 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 environ-
mental 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,
52 DENNIS M. PATTEN AND WILLIAM CRAMPTON
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
Legitimacy and the Internet 53
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 dis-
closure 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
54 DENNIS M. PATTEN AND WILLIAM CRAMPTON
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 envi-
ronmental 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 vari-
ables 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
Legitimacy and the Internet 55
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 envi-
ronmental litigation or investigation disclosures on their web pages also had links to their
annual reports (which also included these disclosures).
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POLLUTION DISCLOSURES BY
ELECTRIC UTILITIES: AN
EVALUATION AT THE START OF THE
FIRST PHASE OF 1990 CLEAN AIR ACT
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 signif-
icantly lower than 1990 emissions. On an individual plant basis, the results,
however, indicated that some plants reduced emissions while others used
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 emis-
sions 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 require-
ments without having to adjust their plant configuration or generating process. The
weakness of the allowance system was that the managers might have been encour-
aged 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 gen-
erating 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 61
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 pol-
lution 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.
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
62 MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO
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).
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 emis-
sions. 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 stan-
dards. 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 pol-
lution 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.
64 MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO
Allegheny Power
Albright 1.29 9,528 12,000 11,444 2.57
Armstrong 2.75 30,927 29,840 21,907 2.61
Ft. Martin (DQE 2.68 82,393 82,790 74,369 2.68
part-owner)
Harrison 4.42 282,302 136,270 9,944 0.14
Hatsfield’s Ferry 3.25 159,242 115,420 164,841∗ 3.4
Total 3.48 564,392 376,320 282,505 1.81
American Electric Power
Beckjord (Cinergy 4.0 90,529 31,970 25,826 1.64
part-owner)
Breed Off line
Cardinal 4.63 143,838 72,590 105,307∗ 2.87
Conesville 4.64 98,821 63,370 90,818∗ 4.17
Gavin 5.68 365,307 156,640 23,478 0.30
Kammer 6.72 46,839 17,390 122,193∗ 5.64
Kyger Creek 6.03 243,023 93,200 92,806 2.32
Mitchell 2.06 59,316 89,490 61,623 1.49
Muskingham River 6.96 140,891 54,380 102,908∗ 7.10
Picway 4.84 14,817 4,930 4,722 5.27
Tanners Creek 4.58 70,430 24,820 29,318∗ 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 3.2 174,692 126,240 78,093 1.25
others part-owners)
Crane 3.0 28,625 19,560 12,162 1.20
Total 3.17 203,317 145,800 90,255 1.25
Centerior
Ashtabula 5.78 33,101 16,740 18,183∗ 6.60
Avon Lake 3.33 58,894 42,130 21,920 1.35
Eastlake (DQE 4.51 14,006 7,800 8,635∗ 4.09
part-owner)
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 1995 Emissions
Tons
lbs/MMBTU Tons Tons lbs/MMBTU
Table 1. (Continued )
Company (Plant) 1990 Emissions Allowances 1995 Emissions
Tons
lbs/MMBTU Tons Tons lbs/MMBTU
ICG/Nova
Baldwin 5.35 224,614 128,980 266,005∗ 5.31
Hennepin 4.76 26,794 18,410 27,926∗ 5.03
Vermillion 0 0 8,880 1,724 1.23
Total 3.32 251,408 156,270 295,655∗ 4.48
IPALCO
Elmer Stout 2.67 31,888 32,360 38,857∗ 2.52
HT. Pritchard 3.01 10,489 5,770 5,932∗ 2.06
Petersberg 2.41 114,417 48,810 89,102 1.68
Total 2.49 156,794 86,840 133,891∗ 1.88
Interstate Power Co.
Milton L. Kapp 3.51 19,151 13,800 7,450 1.30
Kansas City Power & Light
Montrose 0.76 8,594 25,680 7,834 0.51
Kentucky Utilities
EW Brown 3.09 53,691 44,120 27,706 1.97
Ghent 4.49 68,403 28,410 20,213 1.11
Green River 3.81 17,424 7,820 10,448∗ 4.22
Total 3.75 139,518 80,350 58,367 1.54
Lilco
Northport 1.00 36,250 70,400 10,927 0.39
Pt. Jefferson 1.08 10,117 22,500 6,276 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 2.98 32,398 23,580 9,376 0.81
Greenridge 3.24 12,129 7,540 9,824∗ 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
Northeast Utilities
Merrimack 1.53 39,144 32,190 36,129∗ 2.38
NIPSCO
Bailly 4.96 37,246 15,630 6,246 0.36
Michigan city 3.54 45,571 23,310 12,257 0.87
Pollution Disclosures by Electric Utilities 67
Table 1. (Continued )
Company (Plant) 1990 Emissions Allowances 1995 Emissions
Tons
lbs/MMBTU Tons Tons lbs/MMBTU
Table 1. (Continued )
Company (Plant) 1990 Emissions Allowances 1995 Emissions
Tons
lbs/MMBTU Tons Tons lbs/MMBTU
Union Electric
Labidie 4.22 243,465 154,070 128,804 1.79
Sioux 3.69 82,452 46,260 47,856∗ 2.56
Total 4.08 325,917 200,330 176,600 1.94
Utilicorp
Sibley 5.2 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 1.27 6,295 12,690 4,127 0.56
Edgewater 2.20 46,530 24,750 18,482 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
Non-Public Reporting Entities
Associated Electric Coop
New Madrid 5.0 164,683 60,720 16,753 0.44
Thomas Hill 3.0 63,729 29,640 16,970 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 2.39 18,138 22,770 18,389 2.08
H. L. Spurlock 2.61 25,872 22,780 38,735 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
Pollution Disclosures by Electric Utilities 69
Table 1. (Continued )
Company (Plant) 1990 Emissions Allowances 1995 Emissions
Tons
lbs/MMBTU Tons Tons lbs/MMBTU
Indiana-Kentucky Elec.
Clifty Creek 5.69 268,818 120,190 91,495 1.90
Kansas City Municipal
Quindaro 3.45 6,116 4,220 63 0.24
Owensboro, KY Municipal
Elmer Smith 5.26 49,123 20,930 7,854 0.56
Springfield, MO Municipal
James River 3.07 6,566 4,850 3,764 0.62
Tennessee Valley Auth.
Allen 3.32 57,797 47,760 48,274∗ 2.09
Colbert 2.53 74,089 96,870 76,908 2.04
Cumberland 4.50 295,572 181,540 25,829 0.21
Gallatin 4.38 137,382 76,460 99,796∗ 3.24
Johnsonville 3.43 84,465 80,670 114,677∗ 3.0
Paradise 4.44 112,232 59,170 155,612∗ 4.92
Shawnee 6.2 11,005 10,170 2,953 0.55
Total 4.09 772,542 552,610 524,049
a Needed to use more allowances to meet the standard.
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
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.
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 in-
formation 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.
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. govern-
ment, 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
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 mon-
itoring system (CEMS) in each smokestack before 1995. This system is used to
measure actual pollution emissions from the stack. We obtained the 1995 pollu-
tion emission data generated by this system from the EPA. This data set also pro-
vides 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
Item Weight
actual emissions and allowances granted by CAA in 1995 from 1990. Other
variables have been defined above.
Descriptive Statistics
81
82
Table 2. (Continued )
Company Year Mention # Eff. # Phase I Cost Payer Rate Emiss
Named
83
84
Table 2. (Continued )
Company Year Mention # Eff. # Phase I Cost Payer Rate Emiss
Named
85
90 Yes 8 0 LSC $400M 1%
86
Table 2. (Continued )
Company Year Mention # Eff. # Phase I Cost Payer Rate Emiss
Named
Key: SCR = scrubbers; LSC = low sulfur coal; Allow = allowances; Cust. = customer; CC = clean coal technology; Not Mat. = not material;
INS = insurance.
87
88 MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO
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.
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
Table 4. (Continued )
Variable Coefficient Std. Error t-Stat Probability
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.
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.
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 disclo-
sures, 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 compli-
ance 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 93
CMS Energy
JH Campbell Cannot determine No effect $25M
Kansas City P&L
Montrose Not material $16.6M $5.24M
Long Island Lighting
Port Jefferson Cannot determine Not significant Just cost of CEMS
Northport
Northern States Power
High Bridge Cannot determine In compliance No disclosure
Wisconsin Energy
North Oak Creek $50M $25M $45M
South Oak Creek
WPL Holdings
Nelson Dewey $8–12M $8–16M Insignificant
Panel B: Disclosure Index
Weighted Unweighted
1990 1995 1990 1995
CMS Energy 5 4 3 2
Kansas City P&L 6 4 3 2
Long Island Lighting 3 6 2 3
Northern States Power 3 0 2 0
Wisconsin Energy 6 8 3 4
WPL Holdings 8 3 3 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 Method of Abatement Differences in Cost Disc 89–95
Plants Abatement Needed
Needed in 1995 Proposed Actual Method 89, 90 95
Note: Total tons of SO2 over standard of plants exceeding the standard in 1995.
95
96 MARTIN FREEDMAN, BIKKI JAGGI AND A. J. STAGLIANO
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 by Electric Utilities
Table 8. Pollution Disclosures of Remaining Companies that in 1990 Needed to Abate SO2 (Least to Most).
Panel A: Disclosures
Company No. of Total Allowances Method of Abatement Differences in Cost Disc 89–95
Plants Abatement Needed
Needed in 1995 Proposed Actual Method 89, 90 95
97
98 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 em-
ployees. 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 99
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.
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FINANCIAL ANALYSTS’ VIEWS OF
THE VALUE OF ENVIRONMENTAL
INFORMATION
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.
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 manage-
ment; 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).
Financial Analysts’ Views of the Value of Environmental Information 103
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 exam-
ines 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.
104 HERBERT G. HUNT III AND D. JACQUE GRINNELL
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 cover-
ing 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 in-
vestors’ willingness to pay a “premium” for the equity and debt of companies that
Financial Analysts’ Views of the Value of Environmental Information 105
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 com-
ment 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
106 HERBERT G. HUNT III AND D. JACQUE GRINNELL
Title/responsibilities
Equity analyst 98 31.11
Credit analyst 21 6.67
Fixed income analyst 20 6.35
Mergers & acquisitions analyst 5 1.59
Director of research 6 1.90
Mutual fund or portfolio manager 98 31.11
Multiple titles/responsibilities 36 11.43
Other 31 9.84
Total 315 100.00
Years of experience as investment specialist
1–5 years 56 17.78
6–10 years 63 20.00
10–20 years 77 24.44
More than 20 years 116 36.83
No response 3 00.95
Total 315 100.00
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 them-
selves as “generalists” while 135 (47.9%) indicated that they followed one or more
specific industries.
In addition to three questions related to information about the respondent, the sur-
vey 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 re-
late 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
Financial Analysts’ Views of the Value of Environmental Information 107
and initiatives. This evidence provides one indication that environmental perfor-
mance 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 perfor-
mance 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
108 HERBERT G. HUNT III AND D. JACQUE GRINNELL
(1) If a firm has good environmental performance (i.e. 314 3.72 (1.46) 0.001
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 313 4.36 (1.68) 0.000
approach to environmental protection is a less risky
investment than that of a company that is not
(3) Environmentally responsible companies create 313 4.48 (1.57) 0.000
additional value through being less risky business
entities with a lower cost of capital
(4) If the amount of reliable information pertaining to 313 4.61 (1.56) 0.000
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
a Mean response based on a seven point scale with 1 = strongly disagree and 7 = strongly agree.
b Significance levels are based on a 2-tailed dependent sample t-test that the mean response was equal
to 4 (i.e. neutral).
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
Financial Analysts’ Views of the Value of Environmental Information 109
(1) Financial analysts should use environmental 314 4.17 (1.60) 0.067
performance indicators when valuing securities
(2) There is a gap between what should be done and 290 4.20 (1.56) 0.030
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 129 5.29 (1.25) 0.000
obtaining reliable information
(4) I incorporate measures of environmental 315 2.97 (1.70) 0.000
performance in my valuation model used to assess
firms
(5) If you do not incorporate environmental information 268 4.16 (1.74) 0.142
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 306 2.93 (1.61) 0.000
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’ 308 4.72 (1.45) 0.000
environmental activities create value tend to
communicate this view even if I fail to ask them
about such activities
a Mean response based on a seven point scale with 1 = strongly disagree and 7 = strongly agree.
b Significance levels are based on a 2-tailed dependent sample t-test that the mean response was equal
to 4 (i.e. neutral).
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”
110 HERBERT G. HUNT III AND D. JACQUE GRINNELL
(Schmidheiny & Zorraquin, 1998, p. 92). Interestingly, the 69% figure in the Lon-
don 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 hith-
erto 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 strate-
gies 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
Financial Analysts’ Views of the Value of Environmental Information 111
(1) The accounting numbers in financial statements 301 2.87 (1.35) 0.000
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 298 3.77 (1.38) 0.004
requirements related to environmental matters are
adequate
(3) Firms are generally complying with FASB and SEC 297 4.65 (1.19) 0.000
reporting requirements related to environmental
matters
(4) It is important for firms to endorse the CERES 278 4.03 (1.10) 0.624
principles
(5) There should be standardized reporting on 292 4.50 (1.50) 0.000
environmental performance (such as that established
by CERES or proposed by the GRI)
(6) It is important for firms to have their environmental 300 4.63 (1.63) 0.000
performance reports verified by independent third
parties
a Mean response based on a seven point scale with 1 = strongly disagree and 7 = strongly agree.
b Significance levels are based on a 2-tailed dependent sample t-test that the mean response was equal
to 4 (i.e. neutral).
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
Table 3, Stmt. 1 3.72 (1.46) 3.73 (1.50) 3.40 (1.31) 3.60 (1.51) 3.95 (1.47) 2.154 (0.093)
Table 4, Stmt. 4 2.97 (1.70) 2.64 (1.65) 2.78 (1.73) 2.78 (1.72) 3.32 (1.63) 2.985 (0.031)
Table 4, Stmt. 6 2.93 (1.61) 2.75 (1.54) 2.56 (1.45) 2.73 (1.64) 3.34 (1.62) 4.254 (0.006)
Table 7, Stmt. 6 4.63 (1.63) 5.02 (1.38) 4.98 (1.41) 4.59 (1.70) 4.33 (1.74) 3.294 (0.021)
a Mean responses based on a seven point scale with 1 = strongly disagree and 7 = strongly agree.
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 partic-
ularly 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 environ-
mental 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 man-
agers, 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 7, Stmt. 3 4.65 (1.19) 4.54 (1.17) 4.81 (1.21) 3.544 (0.061)
Table 7, Stmt. 4 4.03 (1.10) 3.88 (1.22) 4.13 (0.992) 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.
Financial Analysts’ Views of the Value of Environmental Information 115
most experienced analyst group had the highest mean indicating less disagreement
with the statements than the less experienced groups. The opposite is true with re-
spect 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
116 HERBERT G. HUNT III AND D. JACQUE GRINNELL
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 fol-
lows: 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 man-
agement, 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 sig-
nificantly different from one another. The authors would be glad to provide this information
to any interested reader.
Financial Analysts’ Views of the Value of Environmental Information 119
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 sugges-
tions. 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.
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efficiency, and sustainable development. Cambridge, MA: MIT Press.
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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 af-
fects 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
Accounting earnings (E) 1.00 0.968 0.9633 0.5320 0.2030 0.4496 0.7328 −0.4856
Social responsibility (SRP) 1.00 0.8867 0.0210 0.3823 0.6123 0.7231 −0.4123
Size (SIZE) 1.00 0.3670 0.3489 0.5051 0.7586 −0.4788
Growth opportunities (GROWTH) 1.00 0.0690 0.0067 0.3351 0.0103
Systematic risk (RISK) 1.00 0.1172 0.3417 0.0158
Leverage (DEBT) 1.00 0.1557 −0.0596
Earnings variability (VAR) 1.00 −0.2069
Earnings persistence (PERS) 1.00
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
125
price at the beginning of the period. The sample size is 404 firm-year observations.
126
Table 2. Summary Statistics for the Variables Used for the Second Hypothesis.
Panel A: Descriptive Statistics
AHMED RIAHI-BELKAOUI
Systematic risk (RISK) 1.00 −0.1341 −0.0704 0.1606 0.0818
Leverage (DEBT) 1.00 −0.2428 −0.2193 0.1183
Growth opportunities (GROWTH) 1.00 −0.1521 −0.0651
Earnings variability (VAR) 1.00 0.0808
Earnings persistence (PERS) 1.00
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.
The Impact of Corporate Social Responsibility 127
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 signif-
icantly 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
128 AHMED RIAHI-BELKAOUI
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 coef-
ficient 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 informa-
tiveness 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 responsibil-
ity levels in Table 3, thereby not imposing a constant residual assumption across
The Impact of Corporate Social Responsibility 129
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.
As stated earlier, additional considerations are recognized regarding both the infor-
mativeness 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
0.018 0.139 0.05 0.181 0.038 −0.096 0.463 −0.312 0.010 404 36.28% 248.61∗
(7.41)∗ (7.10) ∗ (5.16) ∗ (4.87) ∗ (4.26) ∗ (−7.21) ∗ (18.0) ∗ (−7.80) ∗ (6.25) ∗
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
AHMED RIAHI-BELKAOUI
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.
The Impact of Corporate Social Responsibility 131
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
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.
Parameter Estimates
␦0 ␦1 ␦2 ␦3 ␦4 ␦5 ␦6 ␦7
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.
The Impact of Corporate Social Responsibility 133
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, boot-
strapping 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.
The Impact of Corporate Social Responsibility 135
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
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.
INTRODUCTION
The business enterprise’s annual financial report is its most significant commu-
nication 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, environ-
mental 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.
An Assessment of the Quality of Environmental Disclosure Themes 139
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, environ-
mental 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).
140 W. DARRELL WALDEN AND A. J. STAGLIANO
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 in-
accurate 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
142 W. DARRELL WALDEN AND A. J. STAGLIANO
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 stake-
holders 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 be-
tween 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
An Assessment of the Quality of Environmental Disclosure Themes 143
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 fi-
nancial 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.
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 sepa-
rately 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.
146 W. DARRELL WALDEN AND A. J. STAGLIANO
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)
Table 2. (Continued )
Non-Financial Financial Both
Section Section Sections
Panel B: Industry
Chemical (n = 11)
Firms reporting 11 7 11
Average number of theme occurrences 11.9 3.9 14.4
Maximum 25 6 28
Average quality index 2.2 3.4 2.5
Maximum 3 5 5
Consumer products (n = 11)
Firms reporting 9 2 9
Average number of theme occurrences 3.1 1.0 3.3
Maximum 5 1 5
Average quality index 2.0 3.5 2.1
Maximum 3 5 5
Forest products (n = 16)
Firms reporting 14 14 16
Average number of theme occurrences 8.5 2.6 9.8
Maximum 16 4 19
Average quality index 2.5 3.4 2.8
Maximum 4 6 6
Oil (n = 15)
Firms reporting 15 14 15
Average number of theme occurrences 15.9 6.6 22.1
Maximum 28 14 31
Average quality index 2.3 3.8 2.7
Maximum 3 5 5
Total for four industries (n = 53)
Firms reporting 49 37 51
Average number of theme occurrences 10.2 4.3 12.9
Maximum 28 14 31
Average quality index 2.3 3.5 2.6
Maximum 6 6 6
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.
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.
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.
An Assessment of the Quality of Environmental Disclosure Themes 151
Chemical (n = 11)
Non-financial DS 22.09 19.32 0–60
Financial DS 7.91 7.31 0–18
Total DS 30.00 21.57 11–82
Superfund-PRP sites 27.82 14.87 8–58
Toxic releases 10.93 13.90 0.70–42.01
Size 9.27 0.73 8.14–10.48
Consumer industry (n = 11)
Non-financial DS 5.36 5.14 0–17
Financial DS 0.64 1.57 0–5
Total DS 6.00 5.14 0–17
Superfund-PRP sites 6.91 7.65 0–21
Toxic releases 0.23 0.32 0–1.10
Size 8.96 1.01 7.21–10.69
Forest products industry (n = 16)
Non-financial DS 19.94 16.17 0–46
Financial DS 7.63 4.35 0–14
Total DS 27.56 17.44 3–52
Superfund-PRP sites 8.19 6.43 0–22
Toxic releases 3.51 2.72 0.70–11.40
Size 8.31 0.69 7.11–9.34
Oil industry (n = 15)
Non-financial DS 36.20 12.76 13–56
Financial DS 23.20 15.30 0–55
Total DS 59.40 22.93 13–94
Superfund-PRP sites 26.13 11.06 2–43
Toxic releases 1.21 1.29 0.10–4.60
Size 9.81 1.12 6.57–11.46
Four industries (n = 53)
Non-financial DS 23.15 18.20 0–60
Financial DS 10.64 12.26 0–55
Total DS 33.79 26.25 0–94
Superfund-PRP sites 17.08 13.89 0–58
Toxic releases 3.72 7.43 0–42.01
Size 9.07 1.06 6.57–11.46
152 W. DARRELL WALDEN AND A. J. STAGLIANO
Table 4. (Continued )
Number of Theme Average Quality Disclosure
Occurrences Index Score
H1 and H2 : H1 : Theme Occurrences H2A : Average Quality Index H2B : Disclosure Score
Environmental
Disclosures and
Environmental
Performance (Superfund
Sites)
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.
An Assessment of the Quality of Environmental Disclosure Themes 157
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
158 W. DARRELL WALDEN AND A. J. STAGLIANO
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).
An Assessment of the Quality of Environmental Disclosure Themes 159
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.
160 W. DARRELL WALDEN AND A. J. STAGLIANO
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.
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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
An Assessment of the Quality of Environmental Disclosure Themes 163
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,
164 W. DARRELL WALDEN AND A. J. STAGLIANO
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 infor-
mation 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 environmen-
tal 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 system-
atic 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.