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By Denis Cormier & Michel Magnan
Illustration: Cathy Pentland
 CORPORATE ENVIRONMENTAL REPORTING IS FAR FROM STANDARD AND IT SEEMS MANY FIRMS DON'T TAKE ADVANTAGE OF IT AS A VALUE CREATION TOOL
The recent ratification and eventual monitoring for the Kyoto protocol may lead to a shift in attitude concerning the usefulness and relevance of corporate environmental disclosure. But questions remain. Why do firms incur costs to disclose environmental information and does it matter?
A recent assessment of environmental disclosure practices by the largest publicly traded nonfinancial and non-merchandising Canadian firms indicates that a higher quality of environment disclosure results from tough disclosure standards that are enacted by the CICA Handbook Section 3061 or by securities commissions. Most mandated disclosure focuses on environmental liabilities, explicit or implicit, and is usually not welcome by corporations. However, most disclosure goes beyond what is required.
Environmental reporting choices may influence how stakeholders interpret a firm's financial performance. In that regard, information that market participants may use to assess environmental risk is highly relevant and provides economic incentives for particular disclosure choices. For instance, by providing ample information that reassures a company's investors about its operations or performance, managers reduce the information gap between them and investors, thus gaining investor confidence. This, in turn, brings benefits to a firm by allowing it to lower its cost of capital, raise its stock valuation multiples, increase stock liquidity and enhance interest by institutional investors. However, there is a risk investors will view the information as noncredible if it is too self-serving. Hence, to be credible and value-relevant, environmental disclosure needs to be somewhat critical about the firm's environmental management.
While such a strategy enhances its reputation as a quality discloser, it can be costly to the firm if outside parties use the information in ways that are harmful to its interests. For instance, competitors or pressure groups could use evidence of poor environmental management to paint the firm as a poor business partner or as a case for government intervention. Therefore, it is not surprising that firms carefully determine their mode of disclosure for environment-related liabilities so that it does not compromise their financial condition and does not allow for third parties to take action against them.
Recent evidence from a large sample of Canadian firms reveals that these economic incentives drive managers' environmental disclosure decisions through various means. With an ownership that is widely distributed and that comprises an important proportion of foreign investors, most firms find it effective to provide higher quality environmental disclosure. These owners are far removed from management and need to incur extensive costs to collect pertinent environmental information so that the information gap between them and the managers is reduced. Such an action by managers is actually value-enhancing for shareholders. In addition, firms with low financial leverage do release potentially damaging, but credible, environmental information that will enhance their reputation as a quality discloser.
Finally, it is observed that firms with old production assets have an economic incentive to disclose environmental information as it may dissipate investors' perception that older facilities are more polluting than newer facilities.
Beyond investors, a firm's activities affect a wide range of stakeholders such as clients, suppliers, employees and governments. Ultimately, a firm's long-term existence depends upon its ability to legitimize its activities to society within the context of an implicit social contract. Hence, corporate managers may attempt to manage public impressions through environmental disclosure, thus ensuring the firm is perceived to be meeting the terms of its social contract. Failure to operate in a manner consistent with community or public expectations, potentially leads to its own demise.
The media plays a crucial role as it shapes community concerns about environmental issues, and serves as an outlet that conveys public pressures to corporate managers. The influence of public pressures on corporate environmental reporting is two-dimensional. On the one hand, large Canadian firms disclose more than small firms. Since large firms are more visible, they are likely to bear the brunt of the costs resulting from political or lobbying actions. On the other hand, Canadian firms do not appear to be sensitive to public pressures concerning their environmental management activities. In fact, the disclosure of such information by Canadian firms doesn't bear association with their media exposure.
Essentially, these factors determine close to 50% of the environmental information that is provided by Canadian firms through various print media. However, the strategic posture adopted by managers of Canadian firms for the disclosure of environmental information is decreasing over time. Many firms essentially convey the same information one year to the next, irrespective of their changing needs and conditions. Hence, for their managers, the disclosure of environmental information is a routine process: what worked last year should work this year.
In addition, there is convergence over time as firms set their environmental disclosure levels close to the levels exhibited by most firms within their industry. Such routine practices explain a sizable proportion of the disclosure of environmental information beyond the 50% already determined by economic incentives and public pressures.
If such trends continue, we can expect the disclosure of environmental information to become increasingly standardized across firms.
Despite highly different socio-economic contexts, economic incentives appear to determine the disclosure of environmental information in other countries such
as the US, Britain, Australia, Germany or France. In fact, surveys do reveal that, in most respects, environmental disclosure practices in English-speaking countries are quite similar.
Pressure by the public also influences corporate environmental reporting in most countries. However, in contrast to Canada, that impact is acutely felt in Germany and France, where firms disclosing sensitive environmental information are more susceptible to lobbying from environmental pressure groups, such as Greenpeace, and legal action from green parties in government.
Finally, institutions provide a disclosure frame of reference in most countries as firms imitate one another, follow leaders, and minimize year-to-year changes in reporting practices. It must be noted that mandated environmental reports are now a fact of life for firms in Germany.
The impact of environmental disclosure
At the other end of the spectrum are the stakeholders to whom corporations release information. Investors utilize information for firm valuation; however the manner in which they do so is not entirely clear. Does stakeholders' valuation of firms depend upon corporate environmental disclosure? If so, in what manner does such information influence their perceptions of firms?
Evidence from the adoption of Section 3060 of the CICA Handbook suggests firms rarely disclose environmental information that may negatively affect their stock market value. Section 3060 mandated the disclosure and recognition into financial statements of future site removal and restoration costs. Many firms took advantage of the phase-in period to implement the new standard, thus delaying disclosure of these implicit liabilities. However, it is interesting to note that investors found the information conveyed under Section 3060 to be extremely useful in assessing firm value.
Once disclosed, these future costs were immediately impounded into firm values as liabilities. The fact that no firm disclosed such liabilities beforehand despite their usefulness to investors confirms that managers act strategically in the determination of their environmental disclosure. Moreover, regulatory interventions appear to be needed when managers' interests conflict with investors' needs.
When voluntarily disclosing environmental information, firms trade off the costs of disclosing potentially damaging information with the potential advantages of an expanded disclosure. In particular, by enhancing firm transparency, environmental reporting increases credibility and may also reduce the risk apprehensions of investors. By offering stakeholders a greater amount of transparency, the credibility of the firm's reported earnings may also increase.
However, the disclosure of environmental information enables stakeholders to consider certain environmental factors and operating risks when evaluating a firm. This may increase investors' uncertainties about a firm and diminish firm valuation in the process. This point is further supported by evidence suggesting that a firm's pollution performance is negatively related to its market valuation. Such a finding implies the existence of implicit environmental liabilities that are not accounted for in the balance sheet, but are nonetheless considered by many stakeholders when assessing a firm. It is important to realize environmental disclosure decisions are likely to be sensitive and complex due to the high costs often attributed to firms believed to have been negligent or irresponsible in their interactions with the environment.
Overall, the evidence suggests that a Canadian firm's decision to report information regarding its environmental management reduces its perceived risk and, hence, enhances the perceived value of its earnings. In other words, the more a firm provides environmental management disclosure, the lower its implicit cost of equity capital. In most cases, such value creation is greater than any potential reduction in value resulting from the release of negative environmental information. Most studies on other countries provide similar evidence (US, France).
Corporate environmental disclosure is a process involving corporations, their managers, stakeholders, governments and society at large. Complicating matters is the fact that environmental disclosure is far from a standardized process. Thus comparison of it is difficult. However, it appears most firms do not take full advantage of environmental reporting as a value-creation tool, relying instead on routine and imitation to decide upon the extent of their disclosure.
Consistent with reluctance on the part of managers to engage into an active environmental disclosure process, investors and other key stakeholders are under-informed about a firm's environmental management and probably incur sizable information costs. Maybe further regulatory action, along the line of Section 3060, is needed to enhance corporate transparency in environmental matters.
While many corporate managers would agree useful environmental information is not being provided to stakeholders, no one wants to be the first to volunteer such information that may prove detrimental to the firm or to individual. However, if every firm must disclose the same specific information about environmental management, then all firms play the same disclosure game.
In their current form, financial statements do not adequately assess the implicit costs of a firm's environmental performance. For instance, analyses and ratios based upon financial statements do not explicitly consider environmental liabilities and may lead to flawed assessments of the monetary impact of such liabilities. Here are three suggestions to remedy this shortcoming in financial statements:
• the portion devoted to the management discussion and analysis of environmental issues should be expanded;
• a revision of accounting recognition and measurement in order to restrict the freedom of management and auditors to refrain from reporting environmental liabilities due to the uncertainty about their magnitude;
• a tightening of auditing standards in order to increase auditor consideration of environmental risks, the sources of these risks and the consequences of these risks from the perspective of the readers of financial statements (International Auditing Practice Statement 1010).
The future
The past 10 years have seen the emergence of the Web as a reporting platform. To what extent have Canadian firms seized the opportunity to leverage their environmental disclosure strategy through an intensive use of the Web? Some industrial and natural resources firms rely on the Web as an environmental disclosure platform. For example, compared with the annual report, we are likely to find much Web-based information about sustainable development, environmental management practices but limited disclosure about capital expenditures and risks. The determination of the extent of information disclosed through the Web still depends upon a firm's assessment of its investors' information needs as well as on its media exposure. Institutional trends —firm size, industry — also play an important role in explaining Web-based environmental reporting.
There is extensive overlap between print disclosure and Web disclosure, with the use of the Web as a disclosure platform still driven by traditional print-based considerations. Hence, even in 2001, the Web's potential as a reporting platform is not fully exploited with managers of Canadian firms still viewing the Web as an extension of traditional print disclosure means.
References:
• Berthelot, Sylvie; Cormier, Denis; Magnan, Michel 2003. "La gestion des résultats: le cas des provisions environnementales." Comptabilité-contrôle-audit. Forthcoming.
• Cormier, Denis, and Magnan, Michel (2003). "Environmental Reporting Management: A European Perspective." Journal of Accounting and Public Policy, 22(1), Forthcoming.
• R. Gray, R. Kouhy and S. Lavers (1995). "Corporate Social and Environmental Disclosure." Accounting, Auditing and Accountability Journal 8(1): 44-77.
• International Auditing Practice Statement (IAPS), The Consideration of Environmental Matters in the Audit of Financial Statements, IAPS No. 1010, IFAC, Brussels, 1998.
• Y. Li, G.D. Richardson and D.B. Thornton (1997). Corporate Disclosure of Environmental Liability Information: Theory and Evidence. Contemporary Accounting Research 14 (Fall): 435-474.
• A.J., Richardson and M. Welker. 2001. Social Disclosure, Financial Disclosure and the Cost of Capital. Accounting, Organizations and Society. 26 (7/8): 597-616.
• Cormier, Denis, and Magnan, Michel. 2002. "Web, Print or Both? The Case of Corporate Environmental Disclosure." Working paper."Environmental Reporting Strategies: An International Comparison." Working paper. "The Contribution of Environmental Reporting to Investors' Valuation of a Firm's Earnings: An International Comparison." Working paper.
Michel Magnan, PhD, FCA, holds the Lawrence Bloomberg Chair in Accountancy at the John Molson School of Business, Concordia University, and is the university associate at Raymond Chabot Grant Thornton LLP.
Denis Cormier, DScEA, CA, is a professor at the Université du Québec à Montréal
Technical Editor: Michel Magnan | 
