3. Essay one
3.3 Data and methodology
3.3.2 Variable construction
3.3.2.1 Measures of environmental performance
Previous literatures use four methods to measure environmental performance in China, namely environmental reputation indicators (such as Hexun score or Rankins Ratings) (Ma, Zhang, & Yin, 2020; Hu, Wang, & Xie, 2018; Zhang et al., 2021; Shahab et al., 2020), environmental investment or expenditure (Akbar et al., 2021; Zhou et al., 2021), pollution emissions (Li et al., 2018), and content analysis of environmental disclosure (Xu et al., 2020; Du et al., 2018; Qian & Chen, 2021; Wang, Wilson, & Li, 2021; Wong et al., 2018; Meng & Zhang, 2022; Wei & Zhou, 2020; Xi & Xiao, 2022). I employ four measures to gauge firm environmental performance across two different dimensions. Because of the limited number of observations, the last two measurements Cost/Sales and EI are used for robustness tests.
The first measure is a continuous variable to gauge a firm’s environmental performance, which is denoted as ER. ER is constructed according to industry-year adjusted Hexun environmental responsibility score. Hexun is a top-ranked rating agency that provides professional financial and CSR rating of listed companies on the basis of rating reports users’ satisfaction. Hexun was founded in 1996 and launched the CSR rating database in 2010. Listed firms’ social responsibility reports and their annual reports are assessed by Hexun based on the framework of stakeholder theory. Environmental responsibility is a component of Hexun’s CSR rating, which is evaluated through five dimensions including environmental awareness, environmental certification, environmental input,
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sewage discharge and energy conservation. The corporate environmental responsibility score of Hexun adopts the weighted sum of the above five dimensions (10%, 15%, 25%, 25% and 25%, respectively). Raw data of Hexun environmental responsibility score ranges from 0 to 30. This measurement is also adopted by Ma, Zhang, & Yin (2020), Hu, Wang, & Xie (2018) and Zhang et al. (2021). Because Hexun evaluation system varies in different year and industries, referring to the method of Li, Wang, & Wu (2021), I make industry-year adjustment. The industry-year adjusted score is calculated as a firm’s overall Hexun score minus the mean value for all firms in the same industry in a given year.
According to the Guidelines on Enhancing Environmental Information Disclosure of Listed Companies issued by the Shanghai Stock Exchange (2008), Chinese listed companies should actively disclose the following CER information in their annual social responsibility reports: (1) the company's environmental protection policies, objectives, and effects; (2) the company's total annual resource consumption; (3) the company's environmental protection investment and environmental technology development; (4) the company's types, quantity, concentration, and destination of pollutants discharged; (5) the construction and operation of the company's environmental protection facilities. Based on the above provisions, referring to Xu et al. (2020), I construct a comprehensive environmental disclosure measurement, which covers four dimensions, e.g., legal consciousness, social evaluation, eco-friendly production, and green management, and 11 sub indicators. The disclosure data is
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collected from CSMAR. Legal consciousness examines whether companies have violated laws and regulations on environment. The social evaluation dimension reflects the recognition of a company’s environmental performance. The eco-friendly production dimension identifies whether a company adopts the eco-friendly production modes. The green management dimension explores whether environmental factors are considered in daily operations. The four dimensions contain a total of 11 disclosure indicators as shown in Appendix 1.3. A disclose factor takes a value of 1 if a company reaches the relevant criteria, and 0 otherwise. Then I add up the scores of the 11 items as the disclosure score used for this variable. Because I study the Chinese market, our research methods are based on the Shanghai Stock Exchange standards, which is different from Du et al. (2018), Qian & Chen (2021) and Wang, Wilson, & Li (2021), whose measurements are based on the Global Reporting Initiative Sustainability Reporting Guidelines. Our measurement is also different from Wong et al. (2018), Meng & Zhang (2022), Wei & Zhou (2020), and Xi & Xiao (2022), whose measurements are based on other regulations.
I employ Cost/Sales, which is the expenditure on environmental performance divided by sales and multiplied by 1000, as the third measurement. Referring to the method of Li, Wang, & Wu (2021), I make industry-year adjustment on this variable. According to the file “The Stand Statement of Environmental Costs and Financial Statements”
approved in the fifteenth meeting of United Nations international accounting and reporting standards intergovernmental experts Working Group, environmental cost
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refers to the management cost that the enterprises take or are required to take for the impact on environment caused by enterprise’s activities, and other cost because the enterprises implement environmental objectives and requirements based on the principle of environmental responsibility. It includes all the expenses on solving environmental pollution and ecological damage from resource exploitation, production, transportation, use, recovery to disposal in a certain commodity production activity (Li, 2005). I manually collect the relevant environmental cost data from the notes to sample firms’ financial statements in CSMAR database.
The final measure, corporate environmental investment, which is denoted as EI, is calculated as the natural logarithm of company environmental investment plus 1, with the data collected from the CSMAR base. Unlike environmental costs, a company’s investment behavior is a function of the expected future profitability (Khan, Akbar, &
Akbar, 2016). Companies often intend to allocate their resources effectively to maximize firm value (Ahmed et al. 2021). Therefore, compared with environmental expenditure, environmental investment is more long-term oriented. Following Akbar et al. (2021) and Zhou et al. (2021), I use environmental investment as the fourth variable to measure environmental performance.
3.3.2.2 Measurement of accounting conservatism
Accounting conservatism is an important feature of accounting information quality, which requires more timely disclosure of negative news and delays the disclosure of positive news (Basu, 1997). The measurement adopted in this paper is the annual
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accounting conservatism level developed by Khan and Watts (2009). Firstly, based on Basu's (1997) cross-sectional regression model, accounting conservatism measure is constructed as follows:
𝑋𝑖 = 𝛽0+ 𝛽1𝐷𝑖+ 𝛽2𝑅𝑖+ 𝛽3𝐷𝑖𝑅𝑖 + 𝜀𝑖 (1)
Where 𝑋𝑖 is earnings per share divided by the beginning-of-period stock price; 𝑅𝑖 is the stock return of company i in a given year; 𝐷𝑖 is a dummy variable equal to1 if 𝑅𝑖 is less than 0, and 0 otherwise. Coefficient 𝛽2 represents the timeliness of positive news disclosure. 𝛽3 shows a gap in the timeliness of information disclosure of negative news relative to positive news, which can be used to measure accounting conservatism. 𝛽2+ 𝛽3 indicates the timeliness of information disclosure of negative news. Timeliness of positive news confirmation 𝛽2, and accounting conservatism 𝛽3 can be expressed as a linear function:
𝐺𝑆𝑐𝑜𝑟𝑒 = 𝛽2 = 𝜇0+ 𝜇1𝑆𝐼𝑍𝐸𝑖+ 𝜇2𝑀𝐵𝑖 + 𝜇3𝐿𝐸𝑉𝑖 (2) 𝐶𝑆𝑐𝑜𝑟𝑒 = 𝛽3 = 𝜔0+ 𝜔1𝑆𝐼𝑍𝐸𝑖 + 𝜔2𝑀𝐵𝑖 + 𝜔3𝐿𝐸𝑉𝑖 (3)
where 𝑆𝐼𝑍𝐸𝑖 is the natural logarithm of firm i’s total assets, 𝑀𝐵𝑖 is the ratio of the market value of equity to its book value, 𝐿𝐸𝑉𝑖 is firm i’s leverage ratio. Then equation (4) is obtained combining equations (2) and (3) into equation (1) to estimate conditional accounting conservatism, as follows:
𝑋𝑖 = 𝛽0+ 𝛽1𝐷𝑖 + 𝑅𝑖(𝜇0+ 𝜇1𝑆𝐼𝑍𝐸𝑖 + 𝜇2𝑀𝐵𝑖+ 𝜇3𝐿𝐸𝑉𝑖) + 𝐷𝑖𝑅𝑖(𝜔0+ 𝜔1𝑆𝐼𝑍𝐸𝑖+ 𝜔2𝑀𝐵𝑖+ 𝜔3𝐿𝐸𝑉𝑖) + 𝜀𝑖 (4)
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Using equation (4), coefficients 𝜔0, 𝜔1, 𝜔2 and 𝜔3 can be estimated by regression with the annual cross-sectional data. Then, by plugging them into equation (3), the firm-year conditional accounting conservatism measure CScore (𝛽3) can be calculated, which is the measurement of accounting conservatism in this study.
3.3.2.3 Control variables
To ensure that the results are accurate, I also control other variables that may affect environmental performance based on the literature (Anagnostopoulou et al., 2021; Cho et al., 2020; Pan & Zhang, 2021). Those factors include a dummy variable equals one if a firm’s ultimate controller is the government agent or a state-owned enterprise (SOE), and 0 otherwise; listed companies’ market-to-book value (M/B Ratio); growth in sales (Sales Growth); leverage ratio (LEV); firm size, calculated as the natural logarithm of total assets (Size); R&D expenses scaled by Sales (R&D/Sales); profitability calculated as net profit after tax over total assets (ROA); shareholding of the largest shareholder (Top1); logarithm of the number of board of directors (Board Size); ratio of the number of independent directors on the board (Board Independence); a dummy variable if a listed company hires international Big-4 auditor firm, and 0 otherwise (Big 4); and provincial GDP growth where a listed firm is headquartered (GDP Growth Rate).
Detailed definitions of variables are shown in Appendix 1.1