Corporate Disclosure of Environmental Liability Information : Theory and Evidence

The decision to disclose information concerning a firm's environmental liabilities is modeled as a sequential game involving the firm, a capital market and outside stakeholders who can impose proprietary (political) costs on the firm. A partial disclosure equilibrium is derived in which firms reveal information strategically, maximizing share value net of expected political costs. Inherent uncertainty regarding the existence and size of the liabilities creates a setting where outsiders are uncertain if management is informed about them, so firms can plausibly withhold bad news, i.e., they do not disclose liabilities that exceed a threshold level. Three novel hypotheses are that a firm is more likely to disclose as (1) its pollution propensity increases; (2) outsiders' knowledge of its environmental liabilities increases; and (3) the risk of incurring proprietary costs decreases. Empirical support is found for the hypotheses, based on the accounting disclosures made by sample firms selected from the records of the Ontario Ministry of the Environment and Energy. Improved accounting and auditing standards for environmental disclosure would build on at least three implications of the study: 1. To the extent that inherent uncertainty leaves managers with discretion as to what to disclose, our partial disclosure equilibrium result suggests that not all firms will comply with disclosure standards. 2. Publishing broad environmental performance-indicators for companies in non-accounting outlets would increase public awareness of a manager's private information endowment, making voluntary accounting disclosures of the liability more likely. 3. If a significant decline in stakeholder tolerance of pollution occurs, the expected proprietary costs of disclosing increase and companies become less likely to disclose