Accounting Forum 28 (2004) 8797

Discussion

Environmental disclosures and share pricesa discussion about efforts to study this relationship
Craig Deegan
School of Accounting and Law, RMIT Business, RMIT University, P.O. Box 2476V, Melbourne, Vic. 3001, Australia

1. Introduction This edition of Accounting Forum includes two articles that consider the relationship between environmental performance information and share prices. The papers by Freedman and Patten (2004), and by Lorraine, Collison and Power (2004), respectively, embrace the methodology inherent within capital market research. It is in regard to these papers that the editor of Accounting Forum has kindly asked me to contribute some comments. Some of my comments relate to the papers themselves, and the methodology they employ. Some other comments are made about the demand for social and environmental information by the market and other interested stakeholders, and how this demand has appeared to change across time. Specically, the issues that I discuss relate to: concerns that capital markets research ignores the information needs and reactions of non-market participants; concerns that capital markets research supports and potentially sustains the shareholderprimacy focus of corporate disclosure regulators; the inherent assumptions about market efciency made by capital market researchers; the difculty in controlling for confounding events; the apparent changes in recent years in the markets demand for, or use of, social and environmental information (and hence bringing into question the relevance of research about market reactions that use dated information); the apparent xation of some research on the manipulative intents associated with corporate disclosure policies.

Tel.: +61-3-9925-5750; fax: +61-3-9925-5741. E-mail address: craig.deegan@rmit.edu.au (C. Deegan).

0155-9982/$ see front matter 2004 Elsevier Ltd. All rights reserved. doi:10.1016/j.accfor.2004.04.007

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The discussion that follows also addresses some issues associated with the research method employed within the two papers, and it also briey provides some suggestions for future research. As somebody who has had an interest in corporate social and environmental performance and accountability for some time I must note at the outset that I have never been persuaded personally to undertake analysis which seeks to investigate the relationship between share prices and social and environmental disclosures and my comments must be read in this light. There are a number of reasons for this which, in part, are reected in the following discussion.

2. Capital markets research ignores the information needs and reactions of non-market participants Whilst disclosures pertaining to nancial performance are of direct importance to stakeholders with a nancial interest (for example, shareholders), disclosures relating to social and environmental performance will be of interest or relevance to a broad cross section of stakeholders, other than simply just shareholders. Hence, I have never really been concerned about whether the market in isolation reacts or not given that stakeholders that do not directly impact the market are still entitled to information about an organisations social and environmental impacts. It is interesting to see how the capital market reacts to various items of information, but it is not clear what somebody should or would do with the results given that the testing excludes the information uses or responses of other stakeholder groups. It is also of some concern that if market studies of social and environmental disclosures indicate no market reaction (consistent with the view that there is no information content) then a view might be promoted that the environmental and social disclosures have no relevanceeven though the market does not encapsulate all stakeholders.

3. Capital markets research supports and potentially sustains the shareholder-primacy focus of corporate disclosure regulators Following on from the above discussion, the failure to nd associated changes in market prices has the potential to be used to support arguments against regulating or mandating a particular disclosure given that the market does not seem to need or respond to the data. Given the apparent xation that regulators have on the information needs of capital market participants, a lack of market response might be important in the decision not to require particular disclosures. Given the general paucity of regulation in the area of corporate social and environmental reporting, I do not believe that regulators need to be provided with any more ammunition to quell calls for further social and environmental disclosure requirements.1
1 This appears to particularly be the case within the Australian context. One of the few corporate social and environmental disclosure requirements for annual reports is provided by Section 299(1)(f) of the Corporations Act (2001). This requirement was introduced to the Senate by a minority party (the Australian Democrats). The government agreed to the amendment so as to facilitate the passing of the Corporate Law Review Bill 1997

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Accounting regulators universally have tended to xate on the information interests of shareholders. There are extensive protection measures in place to ensure that shareholders receive true and fair or unbiased information about the nancial performance of an organisation. For example, within Australia the Australian Accounting Standards Board (AASB), Australian Securities and Investments Commission (ASIC), and the Australian Stock Exchange (ASX) have, with one or two limited exceptions, no disclosure requirements pertaining to corporate social and environmental performance, even though at the same time there is a multitude of requirements pertaining to nancial performance related disclosures.2 Recently (2003) the Australian Stock Exchange developed, through the ASX Corporate Governance Council, its best practice recommendations in relation to corporate governance. The document, entitled Principles of Good Corporate Governance and Best Practice Recommendations tends to xate on the interests of shareholders. Like the ASX Listing rules themselves, the Corporate Governance Guidelines appear to embrace a shareholder primacy view towards reporting. On page 15 of the Guidelines, when discussing the roles and responsibilities of corporate boards and management, the Guidelines state the companys framework should be designed to clarify the respective roles and responsibilities of board members and senior executives in order to facilitate board and management accountability to both the company and its shareholders. The document seems to miss the point that corporations have an accountability to other stakeholders as well. Principle 3 of the Guidelines (there are 10 principles in total) is promote ethical and responsible decision-making. No mention is made within the material that accompanies this Principle of social or environmental responsibilities.3 The xation of regulators upon the interests of shareholders and the market has been conceded by senior corporate executives including the former Chief Executive Ofcer of National Australia Bank, Cicutto (2002) (one of Australias largest companies) who recently stated:4 In recent decades the efcient use of shareholder funds has been carefully protected by the creation of ASIC and the continuing development of the ASX listing rules. In a regulatory sense the focus of legislative change has been around accountability to investors rather than to the community.

through the Senate. Subsequently the Australian government attempted to remove the disclosure requirement from the law (the disclosure requirement was greatly opposed by industry who tended to favour voluntary social and environmental disclosure regimessomething that the government also favours)but Government did not have sufcient numbers in the Senate to remove the requirement. 2 One exceptions is Section 299(1)(f), which as noted in the preceding footnote, the government has sought to remove. For more details on the efforts to remove the section, and the associated justications used, see Deegan (1999). 3 By way of international comparison, the nal King Report on Corporate Governance was released in South Africa in 2002 (Institute of Directors in South Africa, 2001). It made corporate governance recommendations relating to numerous issues, including social and environmental issues. It was endorsed by the Johannesburg Stock Exchange and incorporated within its listing rules, effective from March 2002. 4 As quoted in the Journal of Banking and Financial Services, December 2002, p. 17at a time when he was still CEO of National Australia Bank.

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Again, at the risk of labouring the point, this shareholder primacy approach to corporate disclosure regulation has been a key reason why I personally have not had a great interest in share-price studies in areas pertaining to non-nancial performance informationI do not want to have a hand in perpetuating this focus. While shareholders and their information demands are important (and these information demands are often considered to relate more to information about nancial information), shareholders are only part of the community and a more holistic perspective of information demand (and related accountabilities) is arguably warranted.

4. Inherent assumptions about market efciency made by capital market researchers Both capital market studies published in this edition of Accounting Forum implicitly accept the maintained assumption that the capital market is semi-strong form efcient which in itself has been challenged by authors such as Kothari (2001).5 The reality or extent of market efciency is an issue that has been greatly debated before, so I will not go into the various arguments other than to emphasise that market based research is embedded within a paradigm that assumes markets are efcient from an economic (not ecological) basis, and that economic efciency occurs as a result of individuals competing for advantage and guided by notions of self-interest. Such efciency has obviously led to environmental degradation. The free hand of the market continues to lead to global warming, loss of habitat, site and water contaminations, and so forth. Markets promote unsustainable growthrewarding companies for continuous prot growth (the bigger the prots the better), but penalising them for prot downturns. The assumptions inherent in this research means that, for philosophical reasons, many researchers in the social and environmental area do not care to embrace capital markets research. Perhaps this is more of an observation than a criticism. I was also left wondering that if the market is efcient and providing positive environmental performance information can offset negative price adjustments to certain events, then why would not all organisations provide the information? Would not that have been consistent with economic rationality? Research such as this implicitly assumes that all managers are homogeneous in their expectations about how the market will react to particular disclosures so some uniformity in approach would be expected.

5. The problem of confounding events There has been much written about the potentially confounding events associated with events studies. In the Freedman and Patten article there are obvious issues associated with disentangling the effect of the nancial report environmental performance disclosures from the multitude of other disclosures being made within the nancial report. To some extent,
5 Although Lorraine et al. introduces the possibility of a 7-day reaction lagwhich left me wondering whether this is consistent with the assumption of market efciencyor is a bit of an each-way-bet?

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Lorraine et al. control for this by considering the release of externally produced information that apparently is released at a time when no other signicant news is released.

6. The apparent changes in recent years in the markets demand for, or use of, social and environmental information In reading the Freedman and Patten paper one central thing that struck me was the dated nature of the data. The paper examines environmental disclosures that were made in 1989. Whilst I accept that using 15-year-old data might not be unusual in share price/event studies, any reactions made in 1989 in relation to social and environmental disclosures are arguably not that relevant today. The year 1989 is a period before the (re)birth of social disclosures, the evolution of triple bottom line reporting and sustainability reporting. It is prior to the advent of initiatives such as AA 1000 and the Global Reporting Initiative (2002) and the move towards greater use of assurance services in the area of social and environmental reporting.6 It (1989) was an era when environmental reporting was commonly considered as nothing more than greenwash and it was generally at a time before the use of stand-alone environmental (and then social, triple bottom line, and sustainability reports). Broadly speaking, it was a time when many users of annual reports were dubious about the credibility of corporate environmental and social disclosures.7 The world has changed since 1989 and the communitys views about corporate accountabilities have changed (as reected by the changes in corporate disclosure policies). The authors make no comment about such changes and whether we could really believe that whatever results were generated from data that is 15 years old would really occur today. I would have found this an interesting issue for discussionbut as it was I felt I was left in limbo wondering about the relevance of the results. The stated focus of corporate executives, as reected in places like recent annual reports, has shifted from shareholders to stakeholders and discussions of community licenses to operate are commonly made within annual reports (and stand-alone sustainability and triple bottom line reports) along side discussions of corporate accountability (nevertheless, it is conceded that the regulators still xate on shareholders and nancial performance measures). When looking at the reaction of the market to the TRI disclosures, as addressed in Freedman and Patten, I was also left wondering whether analysts and other share market participants actually reviewed the TRI data back in 1989 (the authors assumed that the market did use the data). It does not automatically follow that they did, particularly back in the 1980s. It is argued by Freedman and Patten that the TRI information can lead to
6 Assurance services in themselves would arguably enhance the credibility of the data, and if credibility of data is important to the stock market, then more of a market reaction could be anticipated for disclosures that are accompanied by an assurance statement (with obvious caveats related to the quality of the assurance provider and so forth). A recent study by Deegan, Cooper and Shellya summary version of which is available at: http://www.cpaaustralia.com.au/01 information centre/26 tbl/1 26 0 7 summary.aspshows that relative to previous years, the market (and other stakeholders) is increasingly demanding independent assurance of social and environmental/triple bottom line reports. 7 Indeed, if the market did respond to these disclosures as Freedman and Patten indicate then this in itself might signify that the market is not that efcientbut this is an argument that needs greater development.

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market effects, which in turn could serve as incentives for rms to improve their pollution performance. It is also stated that: While it is possible that some investors might choose to punish highly polluting rms on ethical grounds, a more likely explanation for TRI information having a negative market impact centres on cash ow effects. Firm specic emissions data would appear to have value for revising the likelihood that worse performing companies will have to incur future cash ows relating to improving pollution technologies or paying nes for non-compliance. But if we embrace the methodology inherent in market studies then poor pollution control might actually be valued if it saves costs relative to having sound controls. After all, the literature is based on assumptions of self-interest and quests to amass personal wealthregardless of the related social and environmental consequences. Indeed as Lorraine et al. state: Bad news might intuitively be expected to be penalised by markets although even here a contra rationale can be applied if polluting incidents are accepted as an occupational hazard that may cost less in terms of penalties than the alternative costs of avoidance. Such each-way-bets referred to by Lorraine et al. are often found in market based research which investigates reactions to social and environmental disclosures, and such each-way-bets are probably necessary because of the under-developed nature of the research. Further, do we really think that the market (and the argument might be particularly pertinent back in the 1980s) is/was sophisticated enough to be able to determine cash ows associated with the necessary actions to improve particular attributes of environmental performance? From what I have read about the time I thought that institutional investors ignored such dataperhaps because they did not know what to do with it. In this regard Deegan and Rankin (1997) studied the information demands of a broad cross-section of stakeholders. The study was conducted in 1995 (6 years later than the time period analysed in the Freedman and Patten paper). At least within the Australia context, stockbrokers, in particular, were found to give relatively little weight to environmental performance information relative to nancial performance information. They were seen as down-playing the materiality of environmental information. According to Deegan and Rankin (1997), their ndings were consistent with the ndings in Business in the Environment (1994) in which evidence is provided that indicates that British analysts considered environmental issues to be largely irrelevant. Freedman and Patten utilised the corporate disclosures made to the Toxic Release Inventory. In this regard questions can be raised about whether the market is expected to react to TRI in a mechanistic waybig emission numbers mean it is bad news, low numbers mean it is good newsor is the market sophisticated enough to take into account the carrying capacity of the receiving environment, the proximity to particular environmental laws, load licenses and so forth? Againwhat are the assumptions behind this market based research? Who actually has the skills or expertise in this areais it really the stock market participants? Because this type of research (capital markets research) has been done a fair bit now, people who continue to do this research really need, at least in my opinion, to address these issues (or at least highlight what assumptions they are making) if this type of research

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is to progress. I really had great doubts about whether the market knows what to do with environmental performance datasuch as emission levels of toxic substancesand this concern would have been even greater in 1989. It can be conjectured that if the study by Freedman and Patten was redone now using current data (and obviously the event would be different) then there would be a stronger market reaction to new social and environmental disclosures (if the research method is sensitive enough to pick up a market reactionand I will address certain research methods issues shortly). This heightened sensitivity would be expected because it is becoming generally accepted today that there are very real links between corporate social and environmental performance and risks, and nancial performance and risks. As such, institutional investors and the like could be expected to react to corporate social and environmental disclosures. For example, a report from the University of Cambridge (2003, p. 5), based on a survey of Chief Executive Ofcers (CEOs) from the Global Fortune 500 (worlds largest companies by revenue), shows that despite recent nancial scandals (Enron, WorldCom, etc.), CEOs predict that in the near future social credibility will be as important as nancial credibility, and environmental credibility will only be marginally less important. The survey also found (p. 12) that: CEOs appear to believe that six key elements will contribute most towards the preservation of a positive corporate reputation. Conversely, any neglect of these key elements could result in the formation of a negative reputation. Notably, these six key elements include both environmental and social credibility (rated as being individually important). Further, in a study by Ernst and Young (2002) that involved interviews being conducted with senior executives at 147 of the Global 1000 companies, they found (p. 5) that: Companies are increasingly acknowledging that corporate ethical, environmental and social behaviour can have a material impact on business value (that is, the market utilises the information). The great majority of companies (79 percent) forecast the importance of this issue to rise over the next ve years as companies across a range of industry sectors recognise its relevance to their business. Research has found that a companys reputation in respect to issues pertaining to CSR is a factor in purchasing decisions for 70 percent of all consumers. Banks, a major player in stock markets, are increasingly requiring corporate disclosures about environmental and social performance. In specic reference to the operating procedures of Lloyds TSB, Deni Greene Consulting Services (2001, p. 9) states: Lloyds TSB feels that it is better placed to assess a customer s all-round credit-worthiness if it understands the environmental risk the business faces and the measures it puts in place to counter those risks. Other banks in the United States and United Kingdom are beginning to take this approach, and Australian banks are following. It is quite common for due diligence procedures to be required as part of major nancial transactions, to demonstrate to a bank or other lender that there are no hidden environmental liabilities that could become the responsibility of the lender or that could diminish the value of the property or organisation.

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Again, the quotes above emphasise how the relevance of this information, to the market, is increasing across time. As further evidence of the demand for social and environmental information, a study of the materiality of environmental risk to Australias nance sector Ernst and Young (2003) found that 61% of nance industry participants view environmental issues as quite or very signicant to investment analyses. Fund managers are also using their power to demand that corporations provide environmental performance information. According to Deni Greene Consulting Services (2002): Funds managers are beginning to use their nancial clout to impose environmental disclosure requirements on companies. Morley Fund Management, a major London-based asset manager, recently announced it would begin requiring large UK companies to publish environment reports. Morley is the asset manager of CGNU plc, the UKs largest insurer and the worlds sixth largest insurance group. It manages assets equivalent to 2.5% of the UK stock market. With this kind of market inuence, Morleys policy changes are sure to be felt by a signicant number of companies. Hence, I believe that there is clear evidence that capital market participants are demanding and using environmental and social performance information but this seems to be more so today than it would have been in 1989 (and I do not actually have to do share price studies that rely upon secondary data to come to this conclusion).

7. The apparent xation of the research on the manipulative intents associated with corporate disclosure policies In the Freedman and Patten study the authors consider the market reaction to the 1989 revisions to the Clean Air Act and whether the reaction is impacted by an organisations performance as reected by disclosures made under the TRI program. The authors also consider whether non-negative environmental disclosures made by the company might act to minimise any negative market effects that might otherwise occur as a result of the TRI related disclosures. They consider whether the organisations can manipulate the markets reaction through selectively making environmental performance disclosures. It is interesting that the authors seem to stress the notion of market manipulation throughout the paperbut this is consistent with the adopted paradigm that in itself accepts self interest as a guiding principle.8 Specically, the authors state: this study provides additional evidence that the market does reward higher nancial report environmental disclosure at times of regulatory threat. This nding further suggests that corporations may be using nancial report environmental disclosure as a tool to manipulate market perceptions and reduce the negative impacts of actual pollution performance.

8 However, if the market can be easily manipulated then I would think this brings into question the assumptions inherent in capital markets research that markets are efcient.

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It does not appear that the authors admit the possibility that disclosures might be made in an objective manner.9 However, it is obviously possible that the disclosures related to real actions undertaken by the organisations, perhaps which related to pollution control, and which are reported in an unbiased way. Some consideration of this possibility is warranted (rather than assuming every organisation set out to manipulate the market). Apart from the various issues discussed above I also had some concerns about the research methods employed. For example, in relation to the Freedman and Patten paper the environmental disclosure scoring system used is perhaps too simplistic when trying to test for market reactions. Given the history of this research I would hope for a bit more development. Using a 01 scoring system clearly ignores the extent of disclosure (and therefore the relative emphasis given to certain attributes of environmental performance and associated controls). Utilising this scoring system, if an organisation was to produce a sentence about a particular issue it would get the same score as an organisation that produced ve pages on the issue. Further, there is no consideration of quality of the disclosures (which in itself might be dependent upon beliefs about the credibility of management teams, and so forth). Also, in relation to the choice of the eight different areas of environmental information to be measured, I thought better justication could have been provided. There are many facets of environmental performance and related controls that were ignored. Whilst I appreciate that this sort of approach to disclosure measurement has been used a number of times in the past, if this type of research is to be progressed then we need to develop more sophistication into the analysis. It is also interesting that Freedman and Patten only considered the non-negative environmental disclosures being made by the organisations (Lorraine et al., on the other hand, considered both positive and negative news).10 The fact that disclosures relating to negative attributes (such as disclosures relating to environmental litigation or liability) are ignored really was not properly justied. Perhaps when considering the negative and non-negative disclosures being made by the organisations in totality the disclosures might have actually been balanced and objective? I would have thought the market would react to both, so I was not sure why the testing only looked at the positive disclosures and not the negative disclosures. Apart from developing more sophistication within capital market research (for those researchers who decide to work in this area), how else can we go forward with research that investigates users reactions to corporate environmental disclosures? Whilst a great deal of existing research relies upon secondary data, such as share prices, external news releases, corporate disclosures, and so forth there is obvious scope for undertaking more behavioural investigations and experiments to investigate how different stakeholder groups use environmental performance information, and whether disclosures are actually made with an intent of manipulating the market. In this regard it is worth reviewing the papers by ODonovan (2002), Milne and Patten (2002), and ODwyer (2002) that appeared in a recent edition of Accounting, Auditing and Accountability Journal [vol. 15 (3) (2002)]an edition that was devoted to corporate social and environmental disclosures. Consistent

9 Although I do acknowledge that in the period in which the analysis was undertaken environmental disclosures were largely considered to amount to little more than greenwash. 10 Negative information is only used by Freedman and Patten in supplementary testing.

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with the previous discussion in this paper, such investigation would not be restricted to shareholders alone. The role of government regulation in this debate also needs to be considered further. For example, whilst the study by Freedman and Patten is embedded within the capital markets research paradigm, they do also borrow from other paradigms to raise some interesting pro-regulation arguments (something which is perhaps uncommon with members of the capital markets research clan). The authors argue that consistent with legitimacy theory, organisations will be motivated to make non-negative environmental disclosures to offset the negative market effects that might result from the TRI disclosures. That is: While the TRI information may be inducing market effects that could in turn work as a quasi-regulatory device, nancial report environmental disclosures reduce its impact. If concern about the environment is important, therefore, it appears that environmental disclosures under a largely voluntary regime is inadequate. This argument really needs further development, and this can be a key issue for people working in the area of corporate social and environmental disclosure. What has to be appreciated is that what ever regulation is put in place, organisations will always have the ability to make additional legitimising disclosuresregulation can provide a minium level of disclosure, not a maximum level of disclosure. Perhaps (and this is unashameably an anti market forces argument), it is the role of the regulators to determine important areas for disclosure (hopefully based on broader notions of corporate accountability than are current being embraced by corporate regulators) such that any further disclosure is corporate uff that would not really count that much and which could not be used by corporations to legitimise ongoing operations which are potentially damaging to the environment and society. However, at this stage this is just an unrened thought that came to mind as a result of reading the other papers in this edition of Accounting Forum. Indeed, I thank the authors for stimulating me to think about a multitude of issues, some of which are reected in my discussion.

References
ASX Corporate Governance Council (2003). Principles of good corporate governance and best practice recommendations. ASX, Sydney. Business in the Environment (1994). City analysts and the environment. London: Business in the Environment. Cicutto, F. (2002). Banks and their corporate social responsibility. Journal of Banking and Financial Services, December, 1619. Deegan, C. (1999). Mandatory public environmental reporting in Australia: Here today, gone tomorrow? Environmental and Planning Law Journal, 16(6), 473481. Deegan, C., & Rankin, M. (1997). The materiality of environmental information to users of accounting reports. Accounting, Auditing and Accountability Journal, 10(4), 562583. Deegan, C., Cooper, B., & Shelly, M. (2004). An investigation of TBL report assurance statements: International evidence. Melbourne: CPA Australia. Deni Greene Consulting Services (2001). A capital idea: Realising value from environmental and social performance. Melbourne: Deni Greene Consulting Services. Deni Greene Consulting Services (2002). Socially responsible investment in Australia 2002: Benchmarking survey conducted for the Ethical Investment Association. Sydney: Ethical Investment Association.

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Ernst, & Young (2002). Corporate social responsibility: A survey of global companies. Melbourne: Ernst & Young. Ernst, & Young (2003). The materiality of environmental risk to Australias nance sector. Canberra: Environment Australia. Freedman, M., & Patten, D. M. (2004). Evidence on the pernicious effect of nancial report environmental disclosure. Accounting Forum, 28(1), 2741. Global Reporting Initiative (2002). Sustainability reporting guidelines. Boston: GRI. Institute of Directors in South Africa (2001). King Committee on Corporate Governance for South Africa (King Report). South Africa: Parktown. Kothari, S. P. (2001). Capital markets research in accounting. Journal of Accounting and Economics, 31 (1). Lorraine, N. H. J., Collison, D. J., & Power, D. M. (2004). An analysis of the stock market impact of environmental performance information. Accounting Forum, 28 (1), 726. Milne, M., & Patten, D. (2002). Securing organisational legitimacy: An experimental decision case examining the impact of environmental disclosures. Accounting, Auditing and Accountability Journal, 15(3), 372405. ODonovan, G. (2002). Environmental disclosures in the annual report: Extending the applicability and predictive power of legitimacy theory. Accounting, Auditing and Accountability Journal, 15(3), 344371. ODwyer, B. (2002). Managerial perceptions of corporate social disclosure: An Irish story. Accounting, Auditing and Accountability Journal, 15(3), 406436. University of Cambridge (2003). Forecasting the impact of sustainability issues in the reputation of large multinational corporations. UK: University of Cambridge.