Factors associated with the level of superfund liability disclosure in 10K reports: 1991-1997

Academy of Accounting and Financial Studies Journal, Sept, 2008 by Carol A. Cox

ABSTRACT

This study examines factors associated with the level of Superfund disclosure in 10K reports. Sample firms consist of Fortune 500 companies identified by the Environmental Protection Agency as Potentially Responsible Parties. The study utilizes a comprehensive environmental disclosure index based on Generally Accepted Accounting Principles, to measure the extent to which sample firms disclose environmental liability information. Empirical tests demonstrate that the extent of environmental disclosure is associated with size, profitability, industry classification and regulatory influence.

The study uses data from COMPUSTAT, EDGAR, and the Superfund Public Information System for years 1991-1997. The environmental disclosure index is compiled based on relevant authoritative guidance contained in Regulation S-K, SAB 92, and SFAS 5. Policy implications indicate that the Securities and Exchange Commission must improve monitoring and enforcement efforts designed to promote adequate recognition and disclosure related to environmental liabilities.

INTRODUCTION

Over the past fifteen years, there has been increased attention on the environment and how companies measure and report environmental exposure (Cox, 2001). Compliance with environmental regulations has a significant impact on corporate earnings, particularly for certain industries. Fitzgerald (1996) estimates that in excess of $7 billion a year is spent for U.S. Superfund site remediation. The term "Superfund" refers to the federal trust fund established to pay for environmental cleanup and enforcement. Furthermore, between $500 and $750 billion will be required to remediate all sites identified by the Environmental Protection Agency (EPA) under the Comprehensive Environmental Response, Compensation and Liability Act (the Superfund Act) (Lavelle, 1992; Committee on Commerce 1995). Probst et al. (1995) estimate that $6 billion is spent each year pursuant to the Superfund Act and $135 billion is required annually to comply with all federal environmental regulations. In light of the magnitude of estimated costs, the reporting of environmental costs and obligations has become a prominent issue with accounting regulatory and professional bodies, such as the Securities Exchange Commission (SEC), Financial Accounting Standards Board (FASB), American Accounting Association (AAA) and American Institute of Certified Public Accountants (AICPA) (Sack et al, 1995). Of specific concern are the recognition of environmental liabilities and the adequacy of related environmental disclosures (ED).

Recent accounting scandals have resulted in increased public scrutiny of corporate governance and disclosures, and have further heightened the attention on ED (Bibler, 2003). The new regulatory requirements promulgated by the Sarbanes-Oxley Act of 2002 have implications for companies with environmental obligations. United States Senators have asked the Government Accounting Office to examine whether SEC requirements for ED are adequate (Sissell, 2002). Moreover, philanthropic foundations and investment mangers are appealing to the SEC to improve enforcement activities related to ED (Bank, 2002).

Early studies suggest that ED are self-serving and inaccurate, although much of the evidence is anecdotal [Beams and Fertig, 1971; Estes, 1976; Churchill, 1978; Nader, 1978]. A later stream of empirical research, resulting from growing public scrutiny of ED, examines both the content and quality of environmental disclosure (Gamble et al., 1995; Freedman and Wasley, 1990; Rockness, 1985; Wiseman, 1982, Ingram and Frazier, 1980). This research suggests that ED quality is generally low because the disclosures do not adequately reflect the firm's actual environmental liability exposure. In addition, firms generally do not record material environmental liabilities. The public scrutiny of ED as well as the findings of early research led to additional reporting requirements with respect to environmental liabilities, as well as increased oversight of environmental matters by the SEC. Two later studies suggest that firms have increased the extent of ED in response to Staff Accounting Bulletin No. 92 (SAB 92, issued in 1993); however, they have not increased disclosure of accrued amounts for environmental remediation (Stanny, 1998; Barth et al., 1997). Thus, like previous studies, Stanny and Barth et al. conclude that accounting guidance is not successful in promoting the recognition of environmental liabilities.

The current study maintains that while much discretion exists under Generally Accepted Accounting Principles (GAAP), firms are subject to specific, mandatory recognition and disclosure requirements with respect to environmental liabilities. Thus, the current study compiles a comprehensive index of GAAP disclosures related to environmental liabilities, based on relevant authoritative guidance provided by the FASB and SEC. The index is used to measure the extent of ED in the 10K filings of 182 Fortune 500 companies with known potential environmental liabilities, for years 1991-1997. The research question is: Are firm characteristics associated with the amount of ED included in 10K reports? The study examines whether size, industry classification, profitability, and regulatory influence affects the extent of ED provided in 10K reports. Prior research finds the level of social disclosure to be associated with industry and size, but not profitability (Trotman and Bradley, 1981; Cowen et al., 1987; Patten, 1991). Stanny (1998) and Barth et al. (1997) suggest that increased regulation is associated with the level of ED. The current study finds that size, industry classification, profitability, and regulatory influence are significantly associated with the level of ED in 10K reports.