Scott Marshall 6 21 10 45 am Eco Innovation

Voluntary Environmental Disclosures and Cost of Equity Capital: 

Voluntary Environmental Disclosures and Cost of Equity Capital MSWG Eco-Innovation 2005 Grand Rapids, Michigan Darrell Brown Scott Marshall (Today’s presenter) Marlene Plumlee

In Context : 

In Context What’s happening… KPMG—occasional surveys Global Fortune 250—45% in 2002, 35% in 1999 Deloitte, E&Y, PwC…all prepare and verify CERs GRI —standardization, transparency, coverage, structure Why are we doing this particular work… Marlene – cost of equity capital and disclosures Darrell –metrics, measurement and AIS Scott – environmental practices and performance And, who provided the support for this work… KPMG grant for research advancing the “state of the art” in business measures

In Practice: 

In Practice Volkswagen’s 2001/2002 Mobility and Sustainability Report Illustrates methods for applying life-cycle analysis to 4 vehicles. Potential competitive costs - Provides insights into the process technologies. Potential competitive benefits – Advanced product design, supply chain and manufacturing. Konica Group - 2001 Environmental Report Explicitly committed to reducing global emissions by 6% below fiscal 1990 levels by fiscal 2010 and achieving zero waste at 15 manufacturing facilities by 2003. Potential reputational costs – commitments made to stakeholder groups. Potential reputational benefits – reduced regulatory oversight, positive NGO engagement, enhanced consumer loyalty

In Theory: 

In Theory Voluntary disclosures impact… The equity cost of capital. The ability of investors to be certain about their estimates of future cash flows. Information risk—the risk that the information used to predict future cash flows is insufficient. Environmental disclosures… Are a representation and a component of corporate environmental strategy. Present information related to strategic issues. Value impact –consequences of investments into (1) reducing environmental-related risks and (2) communicating these investments.

Our Question: 

Our Question Is higher quality voluntary environmental disclosure associated with a lower firm risk premium? Prior theoretical and empirical research suggests yes. Clarification: Quality of disclosure NOT quality of performance Considering Information Risk, not Business Risk

Our Approach: 

Our Approach Build a detailed ‘quality’ index that can be used to collect data regarding environmental disclosures. Examine the quality of environmental disclosures across several industries and 3 years. Document whether the quality of disclosure, which provide investors with information for predicting long-term cash flows, reduces the market’s perception of firm risk.

What we have achieved…: 

What we have achieved… Completed Literature Reviews. Created Disclosure Index and Coding Scheme. Selected Sample. Collected CERs, Annual Reports, & 10-Ks for 2000, 2001, and 2002. Completed data collection. Run preliminary analysis.

Steps to Creating the Quality of Disclosure Index: 

Steps to Creating the Quality of Disclosure Index Searched academic and practitioner literature for possible methods. Drafted a matrix of commonalities and differences across methods. Using matrix, drafted coding scheme and conducted independent pre-tests using actually firm data. Identified discrepancies across two coders (two co-authors) and finalize the index. Using ‘final’ index conducted additional pre-tests, using two independent coders, until able to reach consensus across outcomes. Final Index consists of 62 items and 351 ‘possible’ items disclosed.

The Statistical Methods in Brief: 

The Statistical Methods in Brief Regress estimate of cost of capital less risk premium (risk premium) on risk proxies and rank of the quality of environmental disclosures. 2 most crucial proxies Risk premium and quality of environmental disclosures Control variables from prior research

What did we learn?: 

What did we learn? Quality of environmental disclosures Is difficult, but not impossible to capture Is increasing during this period Number of firms issuing CER’s Voluntary disclosures, in and out of CER’s Is associated with an INCREASE in perceived risk.

Explanations?: 

Explanations? New type of disclosure may fail to reduce information asymmetry. Issuers - Lack of comparability. Users - Lack of knowledge. Certain aspects of disclosure may impact perceived risk more than others. Need to categorize the disclosure data.

Additional Information – Control Variables: 

Additional Information – Control Variables (+) BETA = market model beta based on 60 months data, minimum 12 months. (+) LTG = long range expected growth in earnings, 3-5 year forecasted earnings (Value Line). 2 measures of firm size (-) SIZE = log of market value (price *shares outstanding). (+) BP = book-to-price. (-) ALL_DIS = difference between VL high and low target price, scaled by the mean (target price range)