Risk & Compliance

It’s Easy Not Being Green

A wide majority of companies that are required to divulge impending environmental liabilities just don't bother, says new academic research.
Sarah JohnsonFebruary 18, 2009

The majority of companies that are about to get hit with environmental sanctions ignore the Securities and Exchange Commission’s requirement that they disclose that liability to investors, according to a University of Arkansas researcher.

In one of the SEC’s rare bright-line materiality guidelines, the agency tells companies to report when they are involved in certain legal proceedings involving the companies’ treatment of the environment. The proceedings affected are those in which a government agency could penalize the company more than $100,000. However, 72 percent of the 309 companies involved in such proceedings did not follow that rule between 1996 and 2005, says Andrea Romi, a research assistant at the university’s Applied Sustainability Center, which promotes sustainable business.

Romi’s findings are in line with a 1998 Environmental Protection Agency study that found that 74 percent of companies didn’t disclose their environmental liabilities in SEC filings. To be sure, since then, the green movement and its demand for higher corporate social responsibility has grown and companies are dealing with evermore expectations from so-called socially responsible investors. This year’s proxy season, for example, has seen a record 63 global-warming resolutions filed by climate-conscious shareholders, according to Ceres, a coalition of investors and environmental groups.

Indeed, Romi believes that one of the main reasons companies violate the SEC rule is that it could affect their stock price. The irony is that the penalties themselves could have little or no effect on a firm’s overall value. But in her working paper about the topic, Romi reports that more than half of 17 firms that revealed an EPA sanction saw an abnormal, significant decline in their stock. “The market perceives these penalties as an indication of additional penalties or poor environmental performance yet to come,” Romi concludes.

Moreover, Romi theorizes that companies’ violation of the disclosure rules reflect an increasing need for companies to show they are moral, environmentally friendly organizations – an image that a penalty, however small, could intrude upon. “I define management’s pursuit to hide EPA sanctions as an attempt to establish moral legitimacy, where the users of environmental financial information expect the firm to ‘do the right thing,’ as measured by adherence to environmental regulations,” Romi writes.

Other factors also affecting a company’s decision whether to come clean (so to speak) about an impending environmental liability include its industry’s sensitivity to environmental issues, its own overall environmental image, and the penalty’s dollar amount.

As it is, the EPA rarely publicizes sanctions widely itself, so interested stakeholders in general have must rely on the companies sharing information about their environmental liabilities, Romi says. In addition, FAS 5 (Accounting for Contingencies) requires companies to disclose environmental contingencies if the liabilities are material to the company’s financial condition.

As far as the SEC disclosure rule is concerned, companies have little incentive to adhere to it, except to avoid the possible impact on their stock, Romi contends. The SEC apparently doesn’t enforce the rule, or consider it a priority among the other financial-reporting areas being monitored. “Ultimately, though, it is a regulation and companies are violating the regulation,” Romi says. An SEC spokesman did not immediately respond to CFO.com’s request for comment.

To be sure, just the fact that companies are ignoring a disclosure rule could make one wonder what other disclosures they may be avoiding. “After the last several months and years with the banking crisis and other issues, I think this [report] calls for additional transparency and accountability in all areas,” Romi says.