To Disclose or Not to Disclose Climate-Change Risk in Form 10-K: Does
Materiality Lie in the Eyes of the Beholder?
Ella Mae Matsumura University of Wisconsin–Madison
Wisconsin School of Business [email protected]
Rachna Prakash University of Mississippi Patterson School of Accountancy
Sandra C. Vera-Muñoz University of Notre Dame Mendoza College of Business
To Disclose or Not to Disclose Climate-Change Risk in Form 10-K: Does Materiality Lie in the Eyes of the Beholder?
ABSTRACT
We examine the relation between managers’ decisions whether to disclose climate-change risk (CCR) in Form 10-K and firm risk. Ambiguity about the materiality of CCR and the SEC’s inconsistent enforcement of CCR disclosures cause uncertainty about whether disclosing CCR is mandatory or voluntary. We hand-collect data over a seven-year period from about 3,000 Form 10-K filings of S&P 500 firms on whether they disclosed CCR. We use SASB’s Materiality Map™ to proxy for report users’ judgments of the materiality of CCR. We find that the cost of
equity (COE) of disclosing firms is 21.3 bps lower than the COE of non-disclosing firms. More importantly, we find that for firms where report users judge CCR as material, the COE of disclosers is 49.1 bps lower than that of non-disclosers. In contrast, we find no association between disclosing CCR and COE for firms where report users judge CCR as not material.
Keywords: Regulation S-K; risk assessment; voluntary disclosure; mandatory disclosure; enforcement; Sustainability Accounting Standards Board’s (SASB) Materiality Map™; cost of equity capital; self-selection.
“We recommend that the Commission now move to promote and enforce mandatory and meaningful disclosures of the material effects of climate change on issuers, and also that the SEC work to provide more industry-specific guidance on how to account for climate risk.”
(Former Secretaries of the Treasury H. M. Paulson, R. E. Rubin, and G. P. Shultz, Comment Letter to the SEC, 1/20/16)
I. INTRODUCTION
Federal securities regulation and case law uphold managers’ affirmative duty to disclose
all material information in their firms’ Securities and Exchange Commission (SEC) filings (SEC
2016; Sommer Report 1977). Yet, managers’ decisions whether to disclose climate-change risk
(CCR) in Form 10-K are confounded by two key institutional factors.1 First, there is little
consensus on whether CCR is a material risk to the firms (Hulac 2016; Coburn and Cook 2014).
Second, federal CCR disclosure regulation has been inconsistently enforced across firms (GAO
2016, 21; Gelles 2016). We argue that these factors, along with managers’ unobservable
evaluations of the costs and benefits of disclosing versus not disclosing CCR, create ambiguity
about whether disclosing CCR in Form 10-K is voluntary or mandatory. This, in turn, hinders
investors’ ability to discern whether managers who choose to not disclose CCR are deliberately
trying to conceal useful but adverse information, or are instead acknowledging that CCR is not a
material risk. This complex institutional context raises a fundamental empirical question: Are
managers’ decisions whether to disclose CCR associated with firm risk, as measured by the cost
of equity capital?
Regulation S-K requires firms to disclose in their SEC filings “the most significant
factors that make an investment in the registrant speculative or risky” (Regulation S-K, Item
503(c), SEC 2004). The 2010 SEC interpretive guidance clarifies Regulation S-K and specifies
that if managers assess CCR as material to the firm, then they are mandated to disclose it (SEC
2010).2 Yet, according to analysts, “for investors interested in managing the economic risks of
climate change, the SEC is among the least helpful places to look” (Hulac 2016). On one hand, if
managers perceive that CCR disclosure regulation is strongly enforced but choose to not
disclose, then they likely assess CCR as not material. Alternatively, managers may assess CCR
as material but choose to not disclose it if they perceive that regulation is weakly enforced and
conclude that the costs of disclosing CCR exceed the benefits. Thus, if managers choose to not
disclose CCR, then it is difficult for the market to reliably infer managers’ assessments of the
materiality of CCR for the firm. The lack of consensus about whether CCR is material to the
firm, and the SEC’s inconsistency in enforcing disclosure of material CCR provide the primary
motivation for our inquiry on the association between managers’ decisions whether to disclose
CCR and firm risk.
The importance of our inquiry is threefold. First, firms’ failure to disclose material CCR
in 10-K filings may leave investors, who are looking for information to assess and reduce risks in
their portfolios, exposed to potentially significant losses (McCann 2016; Olson and Viswanatha
2016; Newlands 2015). We discuss a recent example of CCR related to the concept of stranded
assets. The United Nation’s 2015 Paris Agreement set a worldwide goal to curb greenhouse gas
(GHG) emissions to keep global temperatures from rising more than 2° C (3.6° F) above
pre-industrial levels.3 To achieve this goal, scientists estimate that three-quarters of the fossil fuel
reserves, including oil, gas, and coal, will need to stay in the ground (i.e., stranded).4
2For a detailed discussion of the guidance, see Shorter (2013). 3 Source: http://bigpicture.unfccc.int/#content-the-paris-agreemen
If fossil fuel companies are required to leave a significant bulk of their reserves (i.e., their
assets) stranded, then their valuations could take a deep dive. This is the key argument invoked
by ExxonMobil’s shareholders in a recently filed class-action lawsuit against the firm. The
lawsuit alleges that shareholders suffered financial losses after paying inflated prices for the
firm’s stock, even though the firm knew that the value of its oil reserves was significantly less
than what it disclosed. Exxon publicly represented that none of its assets were stranded because
the impacts of climate change, if any, were uncertain and far off in the future (Hasemyer 2016).
Yet, in its 10-K filings in 2017, Exxon wrote off 3.3 billion barrels of oil equivalents which the
company deemed as stranded (Smith 2017). Further, in a recent nonbinding resolution led by
Exxon’s two largest shareholders, Vanguard Group and BlackRock, Inc., 62 percent of
shareholders called for the company to disclose more open and detailed analyses of the risks
posed by climate change regulation. The proposal also pushes Exxon to conduct a climate “stress
test” to measure how new energy technologies to reduce GHG emissions could impact the value
of its oil assets (Cardwell 2017; Olson 2017).
Second, our inquiry is important because mainstream investment analysts’ decisions to
buy, sell, or hold a security are increasingly influenced by sustainability disclosures (SASB
2016, 2). In a 2015 CFA Institute survey of 1,325 institutional investors, 73 percent of
respondents indicated that they take environmental, social, and governance (ESG) issues into
account in their investment analyses and decisions. The top reason investors incorporate
ESG-related information in their decisions is to determine whether a company is adequately managing
risk (CFA Institute 2015). Relatedly, BlackRock, Inc. has urged investors to incorporate climate
all asset owners (BlackRock Investment Institute 2016).5 Notably, 52 percent of shareholder
proposals in proxy filings in 2015 related to environmental and social issues (EY 2015).
Finally, our inquiry regarding the capital-market effects of mandating disclosure of
material CCR in SEC filings is important in light of recent global trends towards increasingly
requiring such disclosures. These trends include, among others, the European Union’s (EU)
recent mandate (European Parliament 2014/95/EU) on ESG disclosures and the ESG disclosure
guidance developed by the World Federation of Exchanges (WFE 2015). These global trends
highlight the need to better understand the association between disclosing CCR and firm risk.
We hand-collect 2,996 firm-year observations of S&P 500 firms’ choices whether to
disclose CCR for 2008 to 2014. We obtain our sample from the intersection of the S&P 500
index firms and the Ceres, SASB, and CDP databases.6 We collect our sample firms’ decision to
disclose CCR from the Ceres database. A majority of the firms in our sample voluntarily report
CCR through the CDP climate change survey. Therefore, we control for this voluntary disclosure
by including firms’ decision to participate in the survey. Because users’ judgments of CCR
materiality are industry-specific (Khan, Serafeim, and Yoon 2016), we use SASB’s Materiality
Map™, an industry-based classification of CCR materiality.
To proxy for firm risk, we construct a composite implied cost of equity (COE) measure
using the median of the following four measures suggested by the accounting and finance
literatures: Easton’s price earnings growth (PEG) model (2004), Gebhardt, Lee, and
5 In addition, corporate board responsibility for climate change has increased from 67 percent to 95 percent from 2010 to 2015, according to a 2015 climate change report from CDP (CDP 2015, 6).
6 Ceres is a coalition of investors, companies, and public interest groups whose mission is to build a sustainable global economy. In 1997, Ceres launched the Global Reporting Initiative (GRI), which has been widely adopted as the standard for sustainable reporting worldwide. The first year of data availability in Ceres is 2008. See
Swaminathan (2001) (GLS), Claus and Thomas (2001) (CT), and the price-earnings ratio. Our analyses using propensity score matching and doubly robust regressions offer two important
results. First, even after controlling for firms’ decisions to voluntarily disclose CCR in the CDP
survey, we find a negative association between disclosing CCR and COE. Specifically, our
doubly robust regression results indicate that the COE of disclosing firms is significantly lower,
by 21.3 bps, than the COE of non-disclosing firms.
More importantly, and central to our materiality prediction, we find that, in industries
where users judge CCR as material, the COE of disclosing firms is 49.1 bps lower than the COE
of non-disclosing firms. In contrast, we find that disclosing vs. not disclosing CCR is not
significantly associated with the COE for firms in industries where users judge CCR as not
material. We conduct several robustness tests to assess the sensitivity of our main results and our
inferences are unchanged.
We contribute to and extend in several ways the growing literature on capital-market
implications of voluntary and mandatory sustainability disclosures. First, most of the extant
research examines disclosures that are either unambiguously mandatory (Kravet and Muslu
2013), or unambiguously voluntary (Dhaliwal et al. 2011). Unlike prior research, we examine a
setting where there is considerable ambiguity as to whether CCR is a mandatory or voluntary
Form 10-K disclosure.
Second, recent studies urge researchers to examine interactions between mandatory and
voluntary disclosures (Beyer, Cohen, Lys, and Walther 2010; Heitzman, Wasley, and
Zimmerman 2010). Our study extends Matsumura, Prakash, and Vera-Muñoz (2014), who find a
negative association between firm value and carbon emission levels. They also find a higher
for non-disclosing firms. Our study further contributes to the literature by examining the risk
relevance of disclosing CCR in 10-K filings, incremental to voluntary CCR disclosures to CDP.
Our findings lend support to the concerns that managers’ failure to disclose CCR imposes
additional risk on firms, but only in industries where users judge CCR as material. Our results
also extend those of Khan et al. (2016), who find a positive association between sustainability
investments and future abnormal stock returns, but only in firms that have strong ratings on
material sustainability issues.
Finally, our study sheds light on the SEC’s recent call for public comment on whether
certain Regulation S-K disclosure requirements need to be updated to better serve the needs of
investors and registrants (SEC 2016). The materiality principle is intended to balance investors’
need for information to make informed decisions, without being burdened with excessive
information, against the cost to registrants of providing information. Our findings provide
evidence that disclosing CCR is associated with lower COE, but only when users judge CCR to
be material.
The remainder of this paper is organized as follows. The next section discusses
institutional background on CCR, while section III reviews the research literature and develops
our hypotheses. Sections IV and V describe our research design and provide the results of
hypotheses tests, respectively. The last section briefly summarizes the findings and discusses the
study’s limitations and implications for research and practice.
II. INSTITUTIONAL BACKGROUND ON CLIMATE-CHANGE RISK
According to Item 503(c) of Regulation S-K, a registration statement filed with the SEC
must contain a discussion of the most significant factors that make the offering speculative or
filings must set forth any material changes to the risk factors described in the annual filings. The
2010 SEC interpretive guidance clarifies Regulation S-K and specifies that companies are
expected to disclose CCR that can materially affect registrants’ business operations and financial
performance (SEC 2010). Climate-related risks include those related to the transition to a
lower-carbon economy (e.g., policy, legal, technology, reputation, and market changes to address
mitigation and adaptation requirements related to climate change); and risks related to the
physical impacts of climate change (e.g., due to floods, rising sea levels, and water availability,
with direct damage to assets and indirect impacts from supply chain disruption) (SEC 2010).
Despite the growing importance of CCR to investors’ understanding of a company’s
performance (Deloitte & Touche LLP 2016; Gelles 2016; UBS 2012), a recent study that
examines CCR disclosures of the 20 largest publicly traded U.S. companies in their 2012 through
2014 Form 10-K filings finds that most companies reported little or no information on CCR
(InfluenceMap 2015). For example, GE did not disclose in its 10-K filings the risk that climate
change poses to its supply chain (e.g., water shortages, severe weather patterns), despite having
more than 130 manufacturing facilities in 40 countries (InfluenceMap 2015, 2).7 Further, Boeing
failed to mention CCR in its 10-K filings, even though its 2014 annual report stated that, “costs
incurred to ensure continued environmental compliance could have a material impact on our
results of operations, financial condition or cash flows” (Olson and Viswanatha 2016).
In a high-profile case analogous to the ExxonMobil case, Peabody Energy privately
projected a devaluation of its coal reserves as a result of passage of regulations to curb emissions
from the combustion of coal. However, the company withheld this information from investors,
choosing instead to state in its 2011 through 2014 10-K filings that “it was not possible to
reasonably predict the impact that any such laws or regulations may have on [Peabody’s] results
of operations, financial condition or cash flows” (New York Attorney General 2015). Although
Peabody eventually agreed to fully disclose in its 10-K filings the potential impact of climate
change regulation on the value of its coal reserves, investors suffered millions of dollars in losses
as the company’s shares dropped from $1,000 in 2011 to around $4 four years later, and it filed
for bankruptcy in April 2016.
III. THEORY AND HYPOTHESES DEVELOPMENT
According to federal securities laws, materiality is “the cornerstone” of the corporate
disclosure system and serves as a “standard for determining whether a communication (filed or
otherwise) omits or misstates a fact of sufficient significance that legal consequences should
result” (Sommer Report 1977, 320). In Basic, Inc. v. Levinson (485 U.S. 224 (1988)), the
Supreme Court upheld the definition of materiality as laid out in TSC Industries, Inc. v.
Northway, Inc. (426 U.S. 438, 439 (1976)), further clarifying that to fulfill the materiality
requirement there must be “a substantial likelihood that disclosure of the omitted fact would have
been viewed by the reasonable investor as having significantly altered the 'total mix' of
information made available.”
Heitzman et al. (2010, 111) state that “materiality defines the threshold between the
important and the trivial.” Drawing on both federal securities regulation and case law, Heitzman
et al. (2010) assert that if a given item meets a materiality threshold, then managers have an
affirmative duty to disclose it in the firm’s SEC filings. Regulation S-K articulates the
non-financial statement disclosure requirements under both the Securities Act and the Exchange Act
the Commission, in the public interest, or for the protection of investors (SEC 2016, 23928).8
The 2010 SEC interpretive guidance requires registrants to apply existing materiality rules,
consistent with the Supreme Court’s definition of materiality and case law, to guide their CCR
disclosure decisions.
Cost of Equity Effect: Materiality and Enforcement of CCR Disclosures
Notwithstanding the existing regulation, managers’ decisions whether to disclose CCR
are complicated due to two key institutional factors. First, there is little consensus, even across
firms within the same industry, on whether climate change is a material risk to firms (Hulac
2016; Coburn and Cook 2014).9, 10 For instance, Wells Fargo has not been disclosing CCR in its
10-K filings, even though the company includes detailed GHG emissions data in its corporate
social responsibility report. Second, the SEC has not consistently enforced regulations on CCR
disclosure. Therefore, managers’ perceptions of SEC enforcement of these disclosures likely
vary along a continuum from weak to strong. As Figure 1 shows, managers’ ultimate CCR
disclosure decisions are the observable outcome of their unobservable assessments of the
materiality and SEC enforcement of CCR disclosures, as well as their evaluations of the costs
and benefits of disclosing versus not disclosing CCR. We use Figure 1 to guide our discussion
and motivate our hypotheses.
| Insert Figure 1 about here |
8 Although the initial materiality determination is management’s, this judgment is subject to challenge or question by the Commission or in the courts (Sommer Report 1977, 332). To determine whether information is material, courts evaluate whether the “likelihood exists that the event is reasonably likely to occur” (Schwartz and Mussio 2007). If a firm determines that a trend, demand, commitments, event, or uncertainty is unlikely to occur, then the firm has no duty to disclose (Wallace 2008, 307).
9 In fact, disagreements regarding CCR materiality surfaced in the SEC commissioners’ 3-2 vote on the 2010 interpretive guidance. One dissenting commissioner did not believe that the guidance “will result in greater availability of material, decision-useful information geared toward the needs of the broad majority of investors” (Casey 2010).
Disclosing Material CCR is Mandatory
Due to disclosure requirements laid out by federal securities laws, disclosing information
in regulatory filings may signal that managers assess the information as material. A recent study
finds that mining-related citations and injuries of firms that disclose mine safety records in SEC
filings are significantly lower than those of non-disclosing firms (Christensen, Floyd, Liu, and
Maffett 2016). The authors reason that investors and other stakeholders might perceive
managers’ decisions to disclose mine safety records as an implicit signal that managers assess
this information as material. Importantly, these records are already publicly available through the
Mine Safety and Health Administration’s (MSHA) website. Further, SEC filings broadcast mine
safety records to a wide range of interested parties at a low incremental acquisition cost—even if
investors are not explicitly looking for them.
There are at least two mechanisms to compel firms’ disclosure of material information.
First, the SEC ensures that firms are providing mandatory disclosures by periodically reviewing
firms’ SEC filings and issuing comment letters if the filings are deficient. Research shows that
the SEC’s comment letter review pressures companies to disclose material firm-specific risks in
their SEC filings (Johnson 2010; Bozanic, Dietrich, and Johnson 2015). Recent research also
documents lower bid-ask spreads and higher earnings response coefficients following SEC
comment letter resolution (Johnston and Pettachi 2015). Second, stakeholders continue to
pressure firms—via a flurry of shareholder resolutions—and to demand the SEC to enforce
disclosures of material CCR (EY 2015; Coburn and Cook 2014; Gelles 2016; Hulac 2016; Ceres
2007). As discussed earlier, ExxonMobil’s shareholders recently filed a class-action lawsuit
Based on the above discussion, if managers assess CCR as material to the firm and view
the regulation regarding these disclosures as strongly enforced (e.g., through the SEC’s periodic
review of registrants’ filings), then they will comply with mandatory disclosure under Regulation
S-K (see Figure 1, box 5). Disclosing (not disclosing) signals that managers assess climate
change as a material (not material) risk to the firm. Therefore, we expect that firms disclosing
CCR will have higher COE than non-disclosing firms to compensate investors for material CCR.
Managers View Disclosing Material CCR as Essentially Voluntary
Despite mounting pressure from regulators and investors, managers may perceive SEC
regulation as weakly enforced. Although the SEC issued interpretive guidance on reporting CCR,
related legislation on cap-and-trade that registrants had anticipated was ultimately not enacted.
This led some public companies to view enforcement of CCR disclosures in general as a lower
priority for the Commission (GAO 2016, 21).11 Indeed, the SEC has issued only a small number
of CCR-related comment letters (Coburn and Cook 2014, 5). In 2010 and 2011 combined, the
SEC issued only 49 comment letters specifically addressing these disclosures, while they issued
only three such comment letters in 2012 and none in 2013 (Coburn and Cook 2014, 5). Some
parties have interpreted the lack of CCR-related SEC comment letters as indicative of the SEC
not enforcing CCR disclosure regulation (Gelles 2016).
If managers assess CCR as material to the firm but perceive the regulation regarding
these disclosures as weakly enforced, then they will view disclosing material CCR as essentially
voluntary. This will likely trigger an analysis of the benefits versus the costs of disclosing
material CCR (see Figure 1, boxes 3 and 4). The costs of disclosing CCR include the deleterious
effects of revealing proprietary information (Verrecchia 1983) and CCR-related supply chain
risk. The benefits of disclosing CCR include avoiding potential climate change-related lawsuits
(McCann 2016; Olson and Viswanatha 2016; Hasemyer 2016).12 Thus, if managers conclude that
the perceived benefits of disclosing material CCR outweigh the perceived costs, then they will
choose to disclose (see box 4). Otherwise, managers will choose to not disclose, even if they
assess CCR as material (Figure 1, box 3).
If managers view disclosing material CCR as essentially voluntary, consistent with the
voluntary disclosure literature (Healy and Palepu 2001; Botosan 2000, 1997; Verrecchia 1983), a
perceived benefit of disclosure is a potential decrease in the firm’s COE. Research on voluntary
disclosures of corporate social responsibility (CSR) reports documents that firms that issue CSR
reports experience a decrease in their COE if the firms show superior CSR performance
(Dhaliwal et al. 2011). Voluntary disclosures are also used to reduce potential regulatory
intervention (Blacconiere and Patten 1994). If managers view disclosing material CCR as
essentially voluntary, then disclosing (not disclosing) signals that managers view the benefits of
disclosing as greater (lower) than the costs of disclosing (boxes 4 and 3, respectively). Based on
these arguments, we expect that firms that disclose material CCR will have a lower COE than
non-disclosing firms.
Disclosing Nonmaterial CCR is Voluntary
Much like boxes 3 and 4 in Figure 1, boxes 1 and 2 reflect the results of managers
evaluating the perceived benefits of disclosing relative to the perceived costs of disclosing if they
assess CCR as not material to the firm. Disclosing (not disclosing) implicitly signals that
managers view the benefits of disclosing as greater (lower) than the costs of disclosing (boxes 2
and 1, respectively). Again, consistent with the voluntary disclosure literature (Healy and Palepu
2001; Botosan 2000, 1997; Verrecchia 1983), a perceived benefit of disclosure is a potential
decrease in the firm’s COE. Based on these arguments, we expect that firms that disclose CCR
will have a lower COE than firms that do not disclose CCR.
The above competing arguments lead to our first hypothesis:
H1: The COE of firms that disclose CCR in Form 10-K is different from the COE of firms that do not disclose CCR in Form 10-K.
Our hypothesis may not obtain if the market considers that firms’ voluntary CCR
disclosures through non-SEC mechanisms are sufficiently informative to investors.
Alternatively, the market may view CCR disclosures as mandatory but boilerplate in nature
(Merkl-Davies and Brennan 2007). In both cases, managers’ decision to disclose CCR may
provide no incremental information to investors about firm risk. In addition, if CCR is a
diversifiable risk (Sharpe 1964; Lintner 1965), then there will be no association between
disclosing CCR and COE.
The above discussion highlights the importance, both theoretically and empirically, of
recognizing that disclosing firms may be systematically different from non-disclosing firms.
Both economic theory (Akerlof 1970) and voluntary disclosure theory (Beyer et al. 2010) posit
that, if disclosure is voluntary, then managers choose to disclose when the benefits of disclosing
outweigh the costs of disclosing. This underscores the importance of correcting for self-selection
when estimating disclosure models. Therefore, using data from disclosing firms to draw
inferences about non-disclosing firms without adjusting for the systematic differences between
Inter-Industry Materiality Differences
Our first hypothesis examines the association between investors’ inferences regarding
managers’ CCR materiality assessments (which are unobservable), their CCR disclosure
decisions (which are observable), and firms’ COE. Both the SEC and the FASB recognize that
materiality is context specific, varying greatly with the nature of business. The Sommer Report
(1977, 340) specifically discusses differences in materiality of information across industries and
states that “… disclosures material to one industry should not be required for other industries as
to which they are not applicable.” We draw on prior research examining the differences in
materiality of information across different types of firms to probe deeper into the association
between managers’ decisions whether to disclose CCR and firm risk.
Cheng, Liao, and Zhang (2013) find that smaller reporting companies that chose to
continue disclosing certain non-financial information in SEC filings after a
mandatory-to-voluntary regime shift by an SEC rule experienced an increase in market illiquidity. However,
the increase in illiquidity was even larger for firms that discontinued disclosing this information.
The authors argue that the association between the choice to disclose and market illiquidity
depends on the materiality of the potentially reduced information. They further reason that
material information provided in firms’ SEC filings may be especially useful to smaller reporting
companies’ investors because, relative to larger firms, these companies have a poor information
environment, including lower analyst following and media coverage. The findings from Cheng et
al. (2013) point to the important role of the materiality of nonfinancial disclosures for smaller
companies’ investors, but do not address the materiality of such disclosures for investors of
Christensen et al. (2016) examine reporting requirements in mining companies. The
Dodd-Frank Act of 2010 requires mining companies to disclose in Form 10-K their mine health
and safety records, information which is uniquely material to this industry. The authors find a
lower incidence of mining-related citations and injuries for disclosing firms relative to
non-disclosing firms, even though these records are already publicly available elsewhere. The authors
reason that investors may perceive managers’ decisions to disclose mine safety records in SEC
filings as an implicit signal of that information’s materiality. In addition, disclosing reduces
investors’ cost of gathering this information.
To our knowledge, the Khan et al. (2016) study is the first to examine inter-industry
differences in the materiality of ESG issues for investors. Using the newly-available SASB
Materiality Map™, they hand-map sustainability investments to independent ratings of firms’
ESG performance (specifically, KLD ratings) to measure investments on material and immaterial
ESG issues for each of their sample firms across 45 industries.13 Importantly, SASB’s
Materiality Map™ relies on the Supreme Court’s definition of materiality. Khan et al. (2016)
report that firms with strong ratings on material ESG issues have better future accounting
performance than firms with inferior ratings on the same issues. In contrast, firms with strong
ratings on immaterial ESG issues do not outperform firms with poor ratings on these same
issues. Further, firms with strong ratings on material ESG issues and concurrently poor ratings
on immaterial ESG issues have the best future accounting performance. The authors conclude
that materiality guidance enhances the informativeness of ESG data for investors.
The above studies indicate that the relationship between firms’ decisions whether to
disclose CCR and COE will likely vary depending on report users’ judgments regarding the
materiality of CCR across industries. Based on these arguments, our next hypothesis examines
the role of materiality on the association between disclosing CCR and COE:
H2: The association between disclosing CCR in Form 10-K and COE is stronger for firms where users judge such disclosures as material than for firms where users judge such disclosures as not material.
IV. RESEARCH DESIGN Sample and Data
We obtain our sample from the intersection of the S&P 500 index firms and the Ceres
and CDP databases for the period 2008 to 2014. In order to minimize changes in our sample over
this period we use firms that were included in the S&P 500 index on December 31, 2008. We
hand-collect data on whether or not firms disclose CCR in Form 10-K from Ceres’ SEC
sustainability disclosure search tool.14 The tool searches the text of SEC annual filings of S&P
500, Russell 3000, and FT Global 500 firms and identifies the relevant issue of the disclosure
(e.g., climate change risk, water risk). We choose 2008 as the initial year of our analyses because
Ceres’ database provides SEC filings starting in fiscal year 2008. The last year of our analyses is
2014 because that is the last year for which CDP climate change data are publicly available.15
To proxy for CCR materiality based on users’ judgments, following Khan et al. (2016)
we use SASB’s Materiality Map™ to identify the materiality of CCR on an industry-by-industry
basis. To identify whether an issue is judged to be material for companies in a given industry,
SASB gathered input from a panel of over 200 industry experts and SASB staff. The panel scored
14 Available at http://ceres.org/resources/tools/sec-sustainability-disclosure.
sustainability issues based on three components: evidence of investor interest, evidence of
financial impact, and forward-looking impact (see Appendix A for further details). We use the
Materiality Map™ scoring on two sustainability issues directly related to CCR, namely (1) GHG
emissions, and (2) environmental and social impacts on assets and operations, to classify each
sample firm as in an industry where users judge CCR as either material or not material to
investors.
We collect data on our sample firms’ participation in the CDP climate survey to control
for voluntary disclosures of CCR information through channels other than the SEC filings. The
CDP survey elicits voluntary information on, for example, climate change risks and
opportunities, carbon emissions in metric tons, emission reduction targets, and managerial
compensation. CDP does not mandate independent assurance on the data.
Table 1 provides our sample selection criteria. We start with all S&P 500 firms available
in the Ceres and CDP databases from 2008 to 2014. The result is 3,226 firm-year observations
(496 unique firms). We lose 227 firm-year observations for which we are unable to calculate our
COE measure. This is because we exclude firms with negative book value of equity or negative
earnings forecasts for years one and two, or we are unable to obtain analyst forecasts for these
firms. The sample is further reduced by three observations for unavailable Compustat data,
resulting in a final sample of 2,996 firm-year observations (465 unique firms) for Hypothesis 1
tests. We further exclude 49 firm-year observations that are missing a 4-digit SIC code needed to
match with SASB’s industry codes for user-based materiality classification. Thus, our final
sample for Hypothesis 2 tests consists of 2,947 firm-year observations (458 unique firms).
Descriptive Statistics
Figure 2, Panel A provides the percentage of firms that disclosed CCR information and
the percentage of firms that participated in the CDP climate survey from 2008 to 2014. In 2008,
less than half of the firms (46.2 percent) disclosed CCR information. Notably, that percentage
increased almost ten percentage points from 2008 to 2009, and a further five percentage points in
2010. These increases make intuitive sense, as the years coincide with the issuance of the SEC’s
2010 interpretive guidance on climate change disclosures, which became effective in February
2010. There was a steady growth in the percentage of firms disclosing CCR until 2012, but the
growth then tapers off. In 2014, almost two-thirds of the firms disclosed CCR information.
Figure 2, Panel A also shows growth in the firms’ participation in the CDP climate survey, from
58 percent in 2008 to 67 percent in 2014.
Figure 2, Panel B shows percentages of firms that disclosed CCR, partitioned by
user-based (SASB) materiality. From 2008 to 2014, the number of CCR disclosers for both the
material and not-material groups grew by 20 percentage points. Over the same period, the
percentages of CCR disclosers are consistently higher, by an average of 20 percentage points, for
the material-CCR group relative to the not-material-CCR group.
| Insert Figure 2 about here |
Panel A of Table 2 shows that, averaged over our sample period, 60 percent of the firms
disclosed CCR and 65.2 percent participated voluntarily in the CDP climate survey. Further,
while 40.5 percent both responded to the CDP climate survey and disclosed CCR (cell 4), about
15 percent neither responded to the CDP climate survey nor disclosed CCR (cell 1). Notably,
almost 25 percent responded to the CDP climate survey but chose to not disclose CCR (cell 3).16
This is counter-intuitive, since these firms have voluntarily committed scarce resources to
respond to the CDP survey (and some firms also provided independent assurance on this
information), and yet they chose to not disclose CCR. Panel B of Table 2 shows materiality as
judged by users (i.e., based on SASB’s panel of experts), partitioned by whether firms disclosed
CCR. Averaged over the seven-year period, the majority of firms in our sample (61.4 percent)
belong to industries where users judge CCR as not material.
| Insert Table 2 about here |
Table 3 shows the sub-samples of firms that participated in the CDP climate survey
(Panel A) and those that did not participate (Panel B), partitioned by users’ materiality judgments
and by whether firms disclosed CCR. Notably, both panels show that the majority of firms
disclosed CCR, regardless of whether they participated in the CDP climate survey.
| Insert Table 3 about here |
Empirical Models and Variable Definitions
As discussed earlier, using data from disclosing firms to draw inferences about
non-disclosing firms without adjusting for the systematic differences between them can give rise to
biased coefficients, and thus, erroneous conclusions. This is likely the case in Griffin, Lont, and
Sun (2017), who use the GHG emissions of the disclosing firms to estimate the GHG emissions
of the non-disclosing firms. This method incorrectly treats the non-disclosing firms as if they
were identical to the disclosing firms, thus assuming away self-selection. Thus, Griffin et al.’s
puzzling finding—the market penalizes firms that choose to voluntarily disclose their GHG
emissions—runs counter to both economic and voluntary disclosure theories and leaves
unanswered the question, “why would firms choose to voluntarily disclose their GHG emissions
Following Matsumura et al. (2014), we correct for self-selection using propensity score
matching to compare the COE of the firms that disclose CCR with the COE of non-disclosing
firms (H1). Further, we examine the COE differences between disclosers and non-disclosers after
partitioning by user-based CCR materiality judgments based on SASB’s panel of experts (H2).
Implied COE is the internal rate of return that equates the current stock price to the present value
of all expected future cash flows to equity. This rate is an ex-ante estimate of the COE, given
market expectations about future growth. Specifically, the value of the firm at time t is expressed
as:
1
where Ptis the market value of common equity on the date of the earnings forecast at time t from
the daily CRSP files, FCFEt+iis free cash flow to equity at time t + i, and reis the implied COE.
We rely on prior accounting and finance research (e.g., Hail and Leuz 2009; Hann,
Ogneva, and Ozbas 2013) to estimate the implied COE. COE, our measure of implied COE, is a
composite COEconstructed using the median of four measures: Easton’s (2004) price earnings growth (PEG) model, Gebhardt et al. (2001) (GLS), Claus and Thomas (2001) (CT), and the price-earnings ratio.17The four models differ in the assumptions made to forecast expected future cash flows. We follow Hann et al. (2013) in operationalizing these models.
Following prior research, we use median analyst forecasts as our proxy for FCFE.
Analyst forecasts for year 1 correspond to the fiscal year that ends after the forecast date. That is,
if the first-year analyst forecast (year 1 in I/B/E/S) is for the previous year because the earnings
for the previous year have not yet been announced, we do not use that forecast. Instead, we use
the second-year forecast, which is the forecast for the current fiscal year, as the year 1 forecast.
In residual earnings models such as CT and GLS that require an estimate of book value, we use
the book value at the end of the prior year (beginning of current year). Since the first forecast is
only for part of the year, we discount only for the proportionate number of days remaining
through the year end.
Prior studies retain only one earnings forecast per year (e.g., Hail and Leuz 2009; Hann et
al. 2013). Unlike these other studies, we retain all earnings forecasts made during the year for
each firm to calculate the COE numbers used in our composite measure. Prior research shows
that analyst forecasts tend to exhibit an upward bias earlier in the fiscal year, but are then revised
downwards over the year, and finally exhibit a downward bias at earnings announcement
(Richardson, Teoh, and Wysocki 2004). Such biases in analyst forecasts can lead to systematic
biases in COE calculations (Easton and Sommers 2007). Using all available forecasts reduces
this bias as well as any errors that may arise in the COE measure from errors in the retained
forecast. We take the median of all the COE numbers for each measure for each firm-year. We
then take the median across the four measures to calculate our composite COE measure for each
fiscal year for each firm. In robustness analyses we also aggregate the four measures using their
means, rather than medians, to calculate the composite COE.
Propensity Score Matching
We use propensity score matching (Rosenbaum 2005) to compare the COE of the firms
that disclose CCR with the COE of the non-disclosing firms. We use the probit model in
DISC_10K =
0 +
1BETA +
2BM +
3SIZE +
4FI/PI +
5ROA +
6EXCH+
7STRNG +
8CNCRN +
9CDP +
(1)where DISC_10K is an indicator variable that is coded 1 if the firm discloses CCR information in
Form10-K in year t, and 0 otherwise. All independent variables, discussed below, are measured
contemporaneously.
We match the disclosers with the non-disclosers on the Fama-French three factors:
market beta (BETA), book-to-market ratio (BM), and firm size (SIZE). BETA is the correlation
between firm-specific returns and market returns. We use monthly returns for the firm and the
CRSP value-weighted index for the market returns. We calculate betas using returns for the five
years prior to and including fiscal year t, but require a minimum of ten months of data. For
firm-years with fewer than ten months of data, we substitute the mean beta for the firm as the beta for
that fiscal year.18 Following Francis, Nanda, and Olsson (2008), we predict a positive association
between BETA and DISC_10K. We control for firm growth by including the firm’s
book-to-market ratio (BM), measured as the book value of common equity divided by the market value of
common equity at the end of the fiscal year. Because larger firms are more likely to provide
more environmental disclosures (Stanny 2013; Matsumura et al. 2014), we include the log of
firms’ total assets as our proxy for SIZE.
International product market interactions affect environmental disclosures (Matsumura et
al. 2014; Khanna, Palepu, and Srinivasan 2004; Stanny and Ely 2008), and EU firms with higher
proportions of international sales are more likely to provide CCR disclosures. Therefore, to
control for international product market interactions, we include annual pre-tax foreign income
as a proportion of total pre-tax income (FI/PI) and expect a positive coefficient for this variable.
Consistent with prior research that documents a positive association between firm performance
and disclosures (e.g., Miller 2002), we expect a positive coefficient on our measure of firm
performance, ROA, measured as income before extraordinary items divided by total assets.
Firms choose the exchange on which to list their securities and this choice is a function of
both firm-level characteristics and the exchange’s listing requirements, including disclosure
requirements (Corwin and Harris 2001). Therefore, we also match firms on the stock exchange
(EXCH) on which they trade. In general, larger and older firms are more likely to list on the
NYSE, but since the vast majority of our sample firms (80 percent) are listed on the NYSE (the
remaining firms trade on NASDAQ) and are likely to be among the largest global firms, we do
not predict a sign on EXCH.
Empirical evidence indicates that firms that are more environmentally proactive are more
likely to disclose environmental information (Matsumura et al. 2014). Thus, similar to
Matsumura et al. (2014), we control for the firms’ environmentally proactive performance
ratings, measured as STRNG, and for their environmentally damaging actions ratings, measured
as CNCRN, to proxy for the firms’ environmental performance. We collect environmental
performance ratings data using the KLD database. Consistent with prior research (Cho et al.
2012; Matsumura et al. 2014) we do not aggregate STRNG and CNCRN because KLD’s
proactive dimensions are distinct from the damaging dimensions. Similar to Matsumura et al.
(2014), we expect a positive coefficient for STRNG, and do not predict a sign for CNCRN. If the
KLD score is missing for an observation, we set it equal to zero.
To address the possibility that firms may be providing CCR information through channels
other than Form 10-K, we include an indicator variable, CDP. If, according to CDP, the firm
CDP response status is AQ, AQ(L), or AQ(SA)), then we code the firm as 1, and 0 otherwise.19
To test H2, we classify each sample firm as in an industry where users (i.e., SASB’s panel of
experts) judge CCR as either material (coded = 1) or not material (coded = 0).
V. RESULTS Descriptive Statistics
Table 4 provides summary statistics for the variables in Equation (1). We winsorize all
continuous variables at the one percent level on both tails of the distribution. Panel A of Table 4
shows that the mean (median) COE is 8.14 percent (8.05 percent).20 The firms’ mean (median)
BETA is about 1.15 (1.07), which is consistent with the relatively low risk of S&P 500 firms in
general. The firms’ mean (median) BM is 0.522 (0.423), indicating that on average, the firms are
healthy and have growth opportunities. For a few firms, foreign income represents a large
proportion of their total income. The mean FI/PI is 30.2 percent, although the median is only
12.1 percent. The first three quartiles of the EXCH variable are 1. This reflects the composition
of our sample, whereby 2,417 firm-years (80.7 percent) trade on NYSE (coded = 1), and 19.3
percent trade on NASDAQ (coded = 3) (untabulated).21 The mean STRNG and CNCRN is 1.021
and 0.454, respectively. Finally, about 65 percent of the firms participated in the CDP climate
survey and allowed their responses to be publicly available.
Panel B of Table 4 shows summary statistics and univariate tests for the variables in
19 CDP uses the following response status legend: AQ: Answered the survey; AQ(L): Answered the survey late; AQ(SA): Answered the survey but the company is a subsidiary or has merged; NP: Answered the survey but the response is not publicly available; IN: Information provided; DP: Declined to participate; NR: No response; X: the company did not fall into the CDP sample that year.
20
Damodaran (2015) estimates an average risk premium of 2.62 percent over the 2008−2014 period for S&P 500 firms using the dividend discounting (DD) model, and 5.50 percent using the free cash-flows-to-equity (FCFE) approach. With an average risk-free rate of 2.60 percent over this period, this translates into a COE of 5.22 percent and 8.10 percent for the DD and FCFE approaches, respectively.
Equation (1), partitioned by whether the firms disclose or do not disclose CCR (DISC_10K = 1
and DISC_10K = 0, respectively). In general, except for FI/PI, the disclosers are significantly
different from the non-disclosers. Both the mean and median COE are significantly higher for
the disclosers than for the non-disclosers (p < 0.05 and p < 0.10, respectively). Although both the
mean BETA and BM are higher for the disclosers (p < 0.05), the median BETA is not
significantly different between disclosers and non-disclosers. The significantly higher mean
BETA and BM for the disclosers suggests that, in general, these firms are riskier on these
dimensions and therefore may have a higher COE than the non-disclosers. The mean and median
SIZE are significantly higher for the disclosers than for the non-disclosers (p = 0.00). Contrary to
expectation, the mean and median ROA are higher for the non-disclosers than for the disclosers
(p = 0.00). Taken together, our univariate results reinforce the importance of correcting for
self-selection. That is, as discussed earlier, using data from the disclosing firms to draw inferences
about the non-disclosing firms, without first correcting for these differences, will likely lead to
biased coefficients and thus, erroneous conclusions.
Panel C of Table 4 shows summary statistics for the variables in Equation (1), partitioned
by user-based (SASB) materiality judgments. The median COE is higher for firms in the material
CCR group than those of firms in the not-material CCR group, but the difference in means is not
significant. The material CCR firms also have higher BM and are larger than the not-material
CCR firms, but have lower ROA. Further, material CCR firms also have higher STRNG and
CNCRN scores.
| Insert Table 4 about here |
Table 5 presents correlation coefficients for the variables in Equation (1). The tables
is positively correlated with both DISC_10K (mandatory disclosure) and CDP (voluntary
disclosure) (p < 0.10). Further, COE is correlated with all the other variables in our regression
model (p < 0.01 or better), except FI/PI. The signs for all the correlations are as expected, except
for the positive correlation between COE and SIZE (Spearman rank = 0.243; p < 0.01). This
result is consistent with Dhaliwal et al. (2011) and may be due to our sample firms (drawn from
the S&P 500 index), which are among the largest in the world.22DISC_10K is significantly
correlated with both STRNG and CNCRN, consistent with our descriptive statistics in Panels B
and C of Table 4. Interestingly, the correlation between DISC_10K and CDP, although highly
significant, is small (0.057, p < 0.01).
| Insert Table 5 about here |
Hypothesis 1 Tests
Table 6 presents the results of Equation (1) matching the firms that disclose CCR in Form
10K (DISC_10K = 1) with those that do not (DISC_10K = 0) on various firm-level
characteristics (Panel A), and our tests of H1 to examine the COE effect of disclosing vs. not
disclosing CCR after propensity score matching (PSM) (Panel B). Panel A shows that, of the
total 2,996 firm-year observations, we are able to match 2,966 observations: 1,770 disclosers
matched with 1,196 non-disclosers. We are unable to match 30 disclosers. Before matching, the
two groups of firms were significantly different on all but one of the firm characteristics included
in Equation (1) (see Table 4, Panel B). After matching, only four firm-level variables remain
significantly different between the two groups, BM and SIZE (at p < 0.05), and STRNG and CDP
(at p < 0.01) (Table 6, Panel A, Covariate Balance).
| Insert Table 6 about here |
Panel B of Table 6 shows the t-tests of differences in the COE of matched disclosers
versus non-disclosers. The difference in COE is positive and significant (p < 0.05); that is, the
COE of the disclosers is higher than the COE of non-disclosers before matching. However, after
matching, the COE for the disclosers is lower than that of the non-disclosers, but the difference is
not statistically significant (p > 0.10).
As discussed above, even after propensity score matching, our matched sample is
significantly different on four dimensions. Further, the standard errors from the PSM may not be
unbiased. Therefore, to remove any residual misspecification that may remain after matching, we
estimate a doubly robust regression (Imbens and Wooldridge 2007), clustering the standard
errors on firm identifier (Permno). Panel C of Table 6 shows that the difference in COE between
the DISC_10K = 1andthe DISC_10K = 0firms is negative and significant (p < 0.05): the COE
of disclosers is approximately 21.3 bps lower than the COE of the non-disclosers, thus rejecting
our null hypothesis (H1) of no difference between the COE of disclosers and non-disclosers.
Hypothesis 2 Tests
Our tests of H2 examine the role of CCR materiality, as judged by users (i.e., SASB’s
panel of experts), on the association between disclosing CCR and COE. The PSM results in
Table 7, Panel A show that the matched sample for the material CCR firms has differences along
the three risk dimensions, BETA, BM, and SIZE, as well as the two environmental performance
measures, STRNG, and CNCRN. We are able to match 1,095 firm-year observations (out of the
total 1,138): 809 disclosers to 286 non-disclosers. We are unable to match 43 disclosers.
Panel B of Table 7 shows the tests of differences in COE between matched disclosers and
non-disclosers, partitioned by user-based (SASB) materiality. For the matched sample of the
DISC_10K = 0 firms, but the difference is not significant (p > 0.10). However, the doubly robust
regression results in Panel C show that, for the material CCR group, the difference in COE
between the disclosers and non-disclosers is negative and significant (p < 0.05): the COE of
disclosers is 49.1 bps lower than the COE of non-disclosers.
Next, we discuss the results for the not-material CCR firms (SASB_MTRL=0). Panel A of
Table 7 shows that the matched sample of 1,793 firms, 912 disclosers and 881 non-disclosers,
differs along three dimensions after matching: BETA, ROA, and STRNG. We are not able to find
matches for 16 disclosers. Panel B of Table 7 shows that, for the not-material CCR group of
matched firms, the COE of disclosers is higher than the COE of non-disclosers, but the
difference is not statistically significant (p > 0.10). Similarly, the doubly-robust regression
results (Panel C, Table 7) show no statistical difference in the COE of disclosers versus
non-disclosers for the not-material CCR group. Taken together, our results support H2.
| Insert Table 7 about here |
In summary, our H1 results are consistent with lower COE for firms that disclose CCR,
compared to firms that do not disclose CCR. In addition, our H2 results indicate that disclosing
CCR is associated with lower COE only for firms in industries where users judge CCR as
material. For firms where users judge CCR as not material, we find no association between
disclosing CCR and COE. Overall, our results indicate that, on average, investors impose a risk
premium on firms that do not disclose CCR in their 10-K filings. However, after partitioning the
sample on materiality of CCR from the users’ perspective, we find that this risk premium exists
Sensitivity and Robustness Tests
Prior research finds that firms with better corporate governance have higher firm value
and stock returns (Gompers, Ishii, and Metrick 2003). To control for the effects of corporate
governance on COE, we construct a variable, CGOV, to proxy for firms’ climate-change
governance measures. We obtain corporate governance data from Bloomberg on three separate
dimensions: Does the firm have: (1) a climate change policy; (2) a climate change committee;
and (3) incentives tied to climate change management? We code each dimension as equal to one
if the firm answers “yes,” and zero otherwise. We add the scores on the three questions to
construct the CGOV variable.23 Tables 8 and 9 show our results for the full sample, and broken
down by materiality, respectively. Our doubly robust regression results are consistent with our
main results. After matching on all firm-level variables, including corporate governance, we find
a negative association between disclosing CCR and COE for the full sample (Table 8, Panel C),
and for firms where users judge CCR as material (Table 9, Panel C).
We also test H1 and H2 after including industry fixed effects in our models (untabulated).
We use the Fama-French five-industry classification for industries. Although we are able to find
matches for more observations for the full sample, we are unable to match on six of the nine
firm-level variables. Our results remain unchanged. The COE coefficient for the full sample in
the doubly robust regression shows that the COE for disclosers is 18.3 bps lower than the COE
for non-disclosers (p < 0.05). Our results after partitioning on user-based materiality judgments
also remain unchanged. For firms in the CCR material group, the COE of disclosers is 73.7 bps
lower than the COE of non-disclosers, and the difference is significant (p < 0.01). In contrast, for
firms in the CCR not-material group, we find no significant difference in the COE of disclosers
versus non-disclosers.
Although our hand-collected data on firms’ CCR disclosures includes 2015, the time
period for our main analyses ends in 2014 because we do not have 2015 data on firms’
participation in the CDP climate survey. However, firms’ participation in the survey is sticky;
that is, once a firm participates in the CDP survey, it is likely to continue to do so in subsequent
years. In our sample period, less than 10 percent of the firms change their reporting status from
one year to the next. In addition, the correlation between CDP reporting status in 2013 and 2014
is 0.85 (p < 0.01). Consequently, we test H1 and H2 by extrapolating firms’ CDP reporting status
for 2015 using CDP 2014 data (untabulated). Our sample size increases to 3,395 firm-year
observations (i.e., an increase of 399 observations relative to our main results), of which we are
able to match 3,376 observations (2,045 disclosers to 1,331 non-disclosers). The results from the
doubly robust regressions are stronger relative to our main results. The COE of disclosers is 24.4
bps lower than that for non-disclosers (p < 0.01). For firms in the material CCR group, we are
able to match 927 disclosers with 316 non-disclosers. The doubly robust regression results show
that the COE for the disclosers is 54.6 bps lower than the COE for non-disclosers, and this
difference is significant (p < 0.01). For firms in the not-material CCR group, the difference in
COE between disclosers and non-disclosers is not significant.
In our next sensitivity analyses, we look at changes in whether CCR is disclosed in
10-K’s (untabulated). The results of these analyses need to be interpreted with caution since only
about 5 percent of our sample firms (i.e., about 155 observations) change their disclosure
practices. We find that firms which start disclosing CCR experience a decline in COE, but the
increase in COE for the full sample and for firms where users judge CCR as material (p < 0.05).
Our results are not significant for non-material CCR firms.
Next, instead of matching on firm performance using ROA, we match on whether a firm
suffered a loss during the year (untabulated). We include an indicator variable equal to 1 if the
firm reported negative income before extraordinary items during the year, and 0 otherwise. Our
results are inferentially similar to our main results. Finally, we calculate implied COE as the
average of the four COE measures, instead of the median of the four measures (untabulated). Our
results are inferentially similar to our main results.
VI. CONCLUSION
We examine the association between managers’ decisions whether to disclose CCR in
Form 10-K and firm risk, as measured by COE, a composite implied cost of equity measure
using the median of four measures suggested by the accounting and finance literatures. We
exploit two key institutional factors that are central to, and motivate our research question: (1)
there is little consensus on whether CCR is material to the firms; and (2) the SEC has
inconsistently enforced federal regulation to disclose CCR across firms. These factors, along with managers’ unobservable evaluations of the costs and benefits of disclosing versus not disclosing CCR create uncertainty about whether the requirement to disclose CCR is voluntary or mandatory. This hinders investors’ ability to disentangle whether managers’ failure to disclose CCR is either deliberately intended to conceal useful but adverse information, or an
acknowledgement that CCR is not a material risk.
Using a hand-collected sample of 2,996 firm-year observations of S&P 500 firms’
choices of whether to disclose CCR for years 2008 to 2014, we examine the difference in COE
voluntary participation in the CDP climate survey to control for voluntarily CCR disclosures.We
find that the COE of disclosers is significantly lower, by 21.3 bps, than the COE of
non-disclosers. This indicates that, on average, investors consider CCR to be a material risk and
impose a risk premium on non-disclosers.
Next, we examine whether the relation between disclosing CCR and COE is different for
firms where users judge CCR to be material versus firms where users do not judge CCR to be
material. We find that, for firms where users judge CCR as material, the COE is 49.1 bps lower
for disclosers relative to non-disclosers. In contrast, we find that disclosing vs. not disclosing
CCR is not associated with the COE for firms where users judge CCR as not material.
Our findings highlight the importance of incorporating both the materiality of disclosures
and the strength of the regulatory enforcement of these disclosures in studies that examine
mandatory disclosures and investors’ inferences based on the disclosures. In our setting, although
regulation unambiguously mandates disclosing material CCR, the uncertainty surrounding both
the materiality of CCR and the strength of the regulatory enforcement result in investors
appearing to interpret managers’ decisions to disclose CCR as voluntary rather than mandatory.
As either the ambiguity regarding materiality of CCR is resolved or the SEC’s enforcement of
the regulation changes, future research could exploit the changes to disentangle the effects of
enforcement from materiality on choice to disclose CCR.
Our findings also support the argument that equity investors are increasingly factoring
CCR into their investment decisions, and point to the greater impetus to disclose CCR. The
higher COE for non-disclosing firms–limited to firms where users consider CCR to be material–
also underscores the need for managers to assess the materiality of CCR more carefully because
our results suggest that investors may be able to look past managers’ efforts to “greenwash”
because we do not find any COE benefits of disclosing CCR for firms where users do not judge
REFERENCES
Basic, Inc. v. Levinson. 1988. 485 U.S. 224, 299–31.
Beyer, A., D. A. Cohen, T. Z. Lys, and B. R. Walther. 2010. The financial reporting
environment: Review of the recent literature. Journal of Accounting and Economics 50(2): 296–343.
Blacconiere, W. G., D. M. Patten. 1994. Environmental disclosures, regulatory costs, and changes in firm value. Journal of Accounting and Economics 18: 357–377.
BlackRock Investment Institute. 2016. Adapting Portfolios to Climate Change. Available at: https://www.blackrock.com/investing/literature/whitepaper/bii-climate-change-2016-us.pdf
Botosan, C. A. 1997. Disclosure level and the cost of equity capital. The Accounting Review 72(3): 323–350.
Botosan, C. A. 2000. Evidence that greater disclosure lowers the cost of equity capital. Journal of Applied Corporate Finance 12(4): 60–69.
Bozanic, Z., J. R. Dietrich, and B. Johnson. 2015. SEC comment letters and firm disclosures. Working paper, The Ohio State University.
Casey, K. 2010. Statement at Open Meeting – Interpretive Release Regarding Disclosure of Climate Change Matters (Jan. 27, 2010). Available at:
http://www.sec.gov/news/speech/2010/spch012710klc-climate.htm.
CDP. 2015. CDPClimate Change Report 2015: The Mainstreaming of Low-Carbon on Wall Street. CDP. Available for download from www.cdp.net.
Ceres. 2007. https://www.sec.gov/rules/petitions/2007/petn4-547.pdf
CFA Institute. 2015. Environmental, Social and Governance (ESG) Survey (June). Available at: https://www.cfainstitute.org/Survey/esg_survey_report.pdf.
Cheney, G. A. 2012. SEC enforcement review – The teeth of the SEC: Too sharp, or not sharp enough? Financial Executive (June): 25–29.
Cheng, L, S. Liao, and H. Zhang. 2013. The commitment effect versus information effect of disclosure – Evidence from smaller reporting companies. The Accounting Review 88 (4): 1239–1263.
Christensen, H. B., E. Floyd, L. Y. Liu, and M. G. Maffett. 2016. The real effects of mandated information on social responsibility in financial reports: Evidence from mine-safety records. Chicago Booth Research Paper No. 16-05. Available at: https://ssrn.com/abstract=2680296 or http://dx.doi.org/10.2139/ssrn.2680296.
Claus, J., and J. Thomas. 2001. Equity premia as low as three percent? Evidence from analysts’ earnings forecasts for domestic and international stock markets. The Journal of Finance 56(5): 1629–1666.
Coburn, J., and J. Cook. 2014. Cool Response: The SEC & Corporate Climate Change
Reporting. Ceres (February). Available at: http://www.ceres.org/resources/reports/cool-response-the-sec-corporate-climate-change-reporting/view.
Corwin, S., and J. Harris. 2001. The initial listing decisions of firms that go public. Journal of Financial Management 30 (1): 35–55.
Damodaran, A., 2015. Musings on Markets (January 2). Available at:
http://aswathdamodaran.blogspot.com/2015/01/an-erp-retrospective-looking-back-2014.html.
Deloitte & Touche LLP. 2016. Comment letter to the SEC regarding SEC Release No. 33-10064, Business and Financial Disclosure Required by Regulation S-K (July 15). Available at: http://www2.deloitte.com/us/en/pages/audit/articles/hu-sec-concept-release-seeks-comments-on-regulation-s-k.html.
Dhaliwal, D., O. Z. Li, A. Tsang, and Y. G. Yang. 2011. Voluntary nonfinancial disclosure and the cost of equity capital: The initiation of corporate social responsibility reporting. The Accounting Review 86 (1): 59–100.
Easley, D., and M. O’Hara. 2004. Information and the cost of capital. The Journal of Finance 59 (4): 1553–1583.
Easton, P. 2004. PE ratios, PEG ratios, and estimating the implied expected rate of return on equity capital. The Accounting Review 79: 73–96.
Easton, P. 2007. Estimating the cost of capital implied by market prices and accounting data. Foundations and Trends in Accounting 2 (4): 241–364.
Easton, P., and G. Sommers. 2007. Effect of analysts' optimism on estimates of the expected rate of return implied by earnings forecasts. Journal of Accounting Research: 983–1016.
European Parliament. 2014. Directive 2014/95/EU of the European Parliament and the Council of the European Union. Official Journal of the European Union (October 22). Available at:
