Accounting Study Reveals Firms' Failure to Disclose Environmental Sanctions

FAYETTEVILLE, Ark. – A University of Arkansas accounting researcher studied corporations with large environmental sanctions over a 10-year period and found that 72 percent of the companies failed to disclose that information to the Securities and Exchange Commission as required by law. SEC regulations require corporations to disclose environmental sanctions of $100,000 or more, regardless of the regulating entity.

The finding supports previous estimates by the Environmental Protection Agency that 74 percent of all companies involved in pending legal proceedings that could result in a sanction of $100,000 or more do not report the sanctions to the SEC. The high rate of noncompliance may be attributed to lenient regulatory enforcement, said Andrea Romi, research assistant at the Applied Sustainability Center in the Sam M. Walton College of Business.

“These companies are violating SEC regulations,” Romi said, “but they don’t suffer any consequences because this is an area that the SEC historically has not focused on enforcing.”

Regardless of enforcement, companies have an incentive to not disclose sanctions, Romi said. They fear adverse market reaction to the disclosure of bad news and thus withhold information. Romi’s investigation of stock-market reaction to sanction disclosures revealed that those firms that chose to follow mandatory regulations suffered financially. In other words, corporations that did not report environmental sanctions fared better on stock markets.

“I found significant stock-market penalties for the proper disclosure of environmental sanctions,” Romi said. “This finding was disturbing not only because it revealed a direct and intentional violation of federal regulations, but also because it provided support for the existence of so-called ‘greenwashing,’ the marketing of good environmental news and the obscuring of bad news.”

As Romi mentioned, greenwashing refers to the act of misleading consumers about the environmental practices of a company or the environmental benefits of a product or service. The term has existed for many years among environmental activists, but it has greater meaning lately as companies have begun to understand the public-relation benefits of corporate social responsibility, mainly that consumers generally favor products that have less or low impact on the environment.

Given the high rate of noncompliance and difficult public detection of sanctions against corporations, Romi wanted to know if incentives drove companies to adhere at all to mandatory environmental disclosure. She examined a large sample of sanctions administered by the Environmental Protection Agency from 1996 to 2006. The sample did not include Superfund projects, the federal government’s program to clean up uncontrolled hazardous waste sites.

Overall, Romi found that disclosure choice was influenced by firms’ environmental performance, size of penalties, inclusion in an environmentally sensitive industry and implementation of the Sarbanes-Oxley Act, the 2002 federal law that tightened reporting and accounting procedures in response to major corporate scandals in the late 1990s and early 2000s.

Romi’s work focuses on corporate sustainability reporting, an area of accounting in which professionals measure and analyze the voluntary reporting of information about an organization’s nonfinancial performance – environmental or social performance, for example – over a specified period. She emphasized that the information is voluntary. Unless corporations are penalized severely, they do not have to disclose their environmental record.