Are third-party assurances preferable to third-party comments for promoting financial accountability in environmental reporting?

Journal of Cleaner Production xxx (xxxx) xxx

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Are third-party assurances preferable to third-party comments for promoting financial accountability in environmental reporting? Kimitaka Nishitani a, *, Mohammad Badrul Haider b, Katsuhiko Kokubu c a

Research Institute for Economics and Business Administration, Kobe University, 2-1 Rokkodai Nada Kobe, 657-8501, Japan Institute of Business and Accounting, Kwansei Gakuin University, 1-155 Uegahara Ichiban-Cho Nishinomiya, 662-8501, Japan c Graduate School of Business Administration, Kobe University, 2-1 Rokkodai Nada Kobe, 657-8501, Japan b

a r t i c l e i n f o

a b s t r a c t

Article history: Received 4 June 2019 Received in revised form 19 September 2019 Accepted 6 November 2019 Available online xxx

The purpose of this paper is to provide empirical insights into whether third-party reviews such as comments and assurances promote financial accountability in environmental reporting by ensuring the credibility of reported information. This paper empirically tests the hypothesis, based on voluntary disclosure theory, that companies proactively improving their environmental performance and management enhance their shareholder value by reporting environmental information with high credibility. The main findings from a regression analysis of data from Japanese manufacturing companies selected from the Nikkei 500 Index for the period 2007e2015 are as follows. Although companies proactively improving their environmental performance and management are more likely to report environmental information voluntarily, those that do so are unlikely to have any higher shareholder value than companies that do not report this information. However, if companies report more credible information through third-party reviews, especially third-party comments, they improve their shareholder value more than companies that merely publish their own environmental information. These findings support the view that third-party reviews promote financial accountability in environmental reporting. In other words, environmental reporting fulfills the financial accountability role assumed by voluntary disclosure theory only after the credibility of reported information is ensured by third-party reviews. Note that this does not apply to third-party assurances. Therefore, our findings imply that the improvement of environmental performance and management alone is insufficient to enhance shareholder value; companies should also report credible environmental information through third-party comments. On the other hand, this does not mean that any kind of third-party review is positively evaluated by the stock market. An expectation gap in third-party assurances may exist. © 2019 Elsevier Ltd. All rights reserved.

Handling editor: Mattias Lindahl Keywords: Environmental reporting Third-party comments Third-party assurances Environmental performance and management Voluntary disclosure theory

1. Introduction Environmental reporting and other sustainability reporting became much more common in the late 1990s. Such reporting practices address the information needs of a broad range of stakeholders. However, environmental information has recently become as important as financial information for investment decisions by shareholders and investors (Said et al., 2013). This is because shareholders and investors increasingly recognize the long-term financial impacts of environmental performance and management, although environmental issues caused by business

* Corresponding author. E-mail address: [email protected] (K. Nishitani).

activities have been conventionally regarded as external diseconomies (Jensen and Berg, 2012). This is evidenced, for example, by the assertion by the International Integrated Reporting Council (IIRC) that integrated reporting of economic, social, and environmental sustainability factors is necessary as a basis for investment decisions (de Villiers et al., 2014; IIRC, 2013). In this situation, especially where integrated reporting has not yet become the main form of corporate reporting, it is expected that environmental reporting by companies proactively improving their environmental performance and management is motivated by a desire to be evaluated highly by the stock market. This motivation can be explained by voluntary disclosure theory, which focuses on financial accountability to improve decisionmaking by shareholders and investors (Nishitani et al., 2017). Because voluntary disclosure theory assumes that companies with

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better environmental performance and management are more likely to report environmental information voluntarily, demonstrating the presence or absence of such a relationship will indicate whether financial accountability motives underlie company environmental reporting practices. However, although many empirical studies in the sustainability accounting field have analyzed the role of environmental reporting, few have found this role to be consistent with voluntary disclosure theory (e.g., Al-Tuwaijri et al., 2004; Clarkson et al., 2008). If anything, a relatively large number of studies in the sustainability accounting field have found environmental reporting to be consistent with sociopolitical theories, including political economy, legitimacy, and stakeholder theories, which focus on social acceptance (e.g., Bewley and Li, 2000; Cho et al., 2012; Clarkson et al., 2011; Guidry and Patten, 2012; Hughes et al., 2001; Patten, 2002). Because voluntary disclosure theory and sociopolitical theories have conventionally been considered alternatives, there remains a lack of consensus on the role of financial accountability in environmental reporting that voluntary disclosure theory supposes. However, financial accountability only functions when shareholders and investors evaluate the environmental reports highly. This implies that the relationship between environmental performance and management and environmental reporting may not be independent of the evaluations of shareholders and investors. Accordingly, a relationship is expected between environmental performance and management, environmental reporting, and shareholders’ and investors’ evaluations, and the role of environmental reporting in financial accountability is determined by this triadic relationship (Al-Tuwaijri et al., 2004). To establish such a relationship, the credibility of environmental information reported by companies may be important, because environmental reporting is generally voluntary and frequently criticized for its lack of credibility (Adams, 2004; Adams and Evans, 2004; O’Dwyer and Owen, 2005). Specifically, shareholders’ and investors’ perceptions of the value of corporate reporting could be affected by their perceptions of its credibility (Coram et al., 2009). On this basis, including third-party reviews such as assurances and comments is one way of ensuring the credibility of environmental reporting (Haider and Kokubu, 2015). Indeed, 54% of our sample companies that had published environmental reports had also confirmed the environmental information using third-party reviews. Formal third-party assurances are the most common method of providing assurances globally. According to KPMG (2015), third-party assurances are an established standard practice in environmental reporting, especially for leading global companies. On the other hand, general third-party comments have declined in popularity, in particular among Japanese companies, which are among the most proactive environmental reporters (Haider and Kokubu, 2015). However, because the (main) role of environmental reporting is not considered to be financial accountability, relatively few credibility or third-party reviews of environmental reports have been examined in terms of their accountability motives (Haider and Kokubu, 2015; Wong and Millington, 2014). Furthermore, third-party assurances and thirdparty comments differ in quality, as detailed in Section 2.2, and the difference in their influence on evaluations of shareholders and investors also remains unclear. Therefore, the purpose of this paper is to provide empirical insights into whether third-party reviews (and the different thirdparty reviews) promote financial accountability in environmental reporting practices by ensuring the credibility of reported information. This paper empirically tests the hypothesis, based on voluntary disclosure theory, that companies proactively improving their environmental performance and management enhance their shareholder value by reporting environmental information with

high credibility. The study uses data from Japanese manufacturing companies selected from the Nikkei 500 Index between 2007 and 2015. We consider this sample selection to be appropriate, because the context of this paper is important to provide a new insight into environmental reporting practices for the following reasons. Japan is one of the world’s largest stock markets, it has long-standing traditions of corporate environmental reporting, and its companies adopt not only third-party assurances but also third-party comments. The remainder of this paper is organized as follows. Section 2 discusses a research framework for this study with a literature review and develops our hypotheses. Section 3 explains the research design. Section 4 presents the estimation results and Section 5 discusses our findings. Section 6 concludes. 2. Research framework and hypothesis development 2.1. The financial accountability role of environmental reporting Although a number of environmental accounting studies have analyzed the relationship between environmental performance and management and environmental reporting, their results are inconsistent. For example, Al-Tuwaijri et al. (2004) and Clarkson et al. (2008) found a positive relationship, whereas Bewley and Li (2000), Braam et al. (2016), Cho et al. (2012), Clarkson et al. (2011), and Patten (2002) found a negative relationship. In addition, early studies such as those by Freedman and Jaggi (1982), Hughes et al. (2001), and Wiseman (1982) found no relationship. Two alternative theoriesdvoluntary disclosure theory and sociopolitical theoriesdwere generally used to explain such conflicting findings. Voluntary disclosure theory focuses on the financial accountability role of environmental reporting, whereas sociopolitical theories focus on social acceptance. There is a lack of consensus concerning the voluntary disclosure theory or the role of environmental reporting in financial accountability. This is reasonable if shareholders and investorsdespecially institutional investorsdgenerally prefer companies with poorer environmental performance and management, as Friedman and Heinle (2016) suggest. However, the number of shareholders and investors that regard environmental performance and management as intangible assets that add value to a company (by providing future cash flow) is increasing (Jensen and Berg, 2012). In this situation, it is possible that the financial accountability role of environmental reporting (and thus the applicability of voluntary disclosure theory) has been strengthened. The voluntary disclosure theory used in environmental reporting studies has its origins in the financial reporting literature. A company only reports information above a threshold determined by the proprietary costs associated with reporting it (i.e., a reduction in future cash flows attributable to the report), and withholds it otherwise (Dye, 1985; Lang and Lundholm, 1993; Verrecchia, 1990). This characterizes the partial reporting equilibrium in which a company follows a strategy of reporting only successes. That is, the fundamental premise of voluntary disclosure theory is that companies will report information with a lower proprietary cost and withhold information with a higher proprietary cost. Thus, shareholders and investors will be uncertain about what has actually occurred within a company (i.e., uncertain whether information is withheld to avoid reporting bad news or to avoid incurring proprietary costs, despite the withheld information containing good news). In the environmental reporting literature (e.g., Al-Tuwaijri et al., 2004; Clarkson et al., 2008), the notions of voluntary disclosure theory are modified to enable empirical statistical analysis in the environmental context; the modified theory is that better (worse)

Please cite this article as: Nishitani, K et al., Are third-party assurances preferable to third-party comments for promoting financial accountability in environmental reporting?, Journal of Cleaner Production, https://doi.org/10.1016/j.jclepro.2019.119199

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environmental performance and management incur lower (higher) proprietary costs where shareholders and investors are uncertain about occurrences within a company. Therefore, the theory assumes that companies voluntarily report environmental information to signal unobservable improvements in environmental performance and management and to differentiate themselves from other companies, thus reducing the information asymmetry between the company and its shareholders and investors (Cho et al., 2012; Clarkson et al., 2008, 2011). Hence, companies that improve their environmental performance and management are believed to be more likely to report objective environmental information voluntarily, and this practice is difficult for weaker performers to mimic (Clarkson et al., 2008). Such reporting may improve evaluations of better-performing companies, because shareholders and investors infer that the expected financial benefits of environmental performance and management for these companies outweigh their costs (Al-Tuwaijri et al., 2004; Bewley and Li, 2000; Clarkson et al., 2008). Accordingly, voluntary disclosure theory predicts a positive relationship between environmental performance and management and environmental reporting. For example, Clarkson et al. (2008) conducted a Tobit analysis of 191 US companies from the five most polluting industries in 2003 and found a positive relationship between environmental performance measured by the percentage of treated, recycled, or processed toxic waste in relation to total toxic waste and the level of discretionary environmental reporting in stand-alone environmental reports and on company websites. Using data from 195 companies listed in the Bloomberg European 500 index in 2013, Hummel and Schlick (2016) found that companies with better sustainability performance reported higher-quality sustainability information, whereas companies with worse performance reported lower-quality information. They suggested that voluntary disclosure theory and sociopolitical theories simultaneously explained the quality of sustainability information reports. This paper assumes that the financial accountability motive for environmental reporting is embodied in the maintenance of equilibrium between environmental performance and management, environmental reporting, and the evaluations of shareholders and investors. In other words, a triadic relationship between them is expected to be established in practice (Al-Tuwaijri et al., 2004; Clarkson et al., 2013). This is because the financial accountability motive for environmental reporting would only function when shareholders and investors evaluated it highly. Environmental reporting that reduces the information asymmetry between a company and its shareholders and investors enables them to estimate more precisely the long-term financial impacts of direct synergy between environmental performance and management, economic performance, and possible exposure to future environmental risk (Baas, 2007; Bachoo et al., 2013; Cormier and Magnan, 2007; Kokubu and Kitada, 2015; Nakano and Hirao, 2011; Nishitani and Itoh, 2016; Nishitani et al., 2011). On this basis, if shareholders and investors consider environmental reporting to be important in enhancing corporate value, they should react by estimating the present value of discounted future cash flows, which would be reflected in shareholder value (Konar and Cohen, 2001). Indeed, an increasing number of studies have reported a positive relationship between environmental reporting and shareholder value (e.g., Aerts et al., 2008; Bachoo et al., 2013; Clarkson, 2013; Cormier and Magnan, 2007; Dhaliwal et al., 2011, 2014; Griffin and Sun, 2013; Plumlee et al., 2015), although they independently analyzed the relationship between environmental performance, management and environmental reporting. However, because shareholder value has several aspects, different studies have used different terminology and proxies such as market value, firm value, and the cost of equity capital. For example, Plumlee et al. (2015)

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focused on specific aspects of firm value, namely the expected future cash flows and cost of equity. They empirically analyzed US companies across five industries from 2000 to 2005 and found that the quality of a company’s voluntary environmental reporting was associated with firm value through both cash flow and the cost of equity. According to the original voluntary disclosure theory, if anything, shareholder value (from the viewpoint of environmental reporting) has a strong association with cash flow. Friedman and Heinle (2016) argued that the market reaction to sustainability performance and related corporate reporting was driven by investors’ preferences and the related shareholder base effect. Although all shareholders valued cash flow equally, sustainability performance was valued only by a fraction of shareholders and investors, including long-term institutional investors and socially responsible investors. It was the trades of the latter group that caused sustainability to influence prices. The market would respond positively only when a significant portion of a company’s investors valued sustainability. 2.2. Third-party reviews of reported environmental information If environmental information reported by a company is assured, its credibility and quality are enhanced, so such information further reduces the information asymmetry between a company and its stakeholders, including shareholders and investors (Wallace, 1987; Watts and Zimmerman, 1986). In fact, the role of environmental reporting in reducing information asymmetry can be amplified by adding assurance provisions to enhance user confidence in reported information (Casey and Grenier, 2015). Some studies, such as those of Moroney et al. (2012) and Pflugrath et al. (2011), found that assurances affect the credibility of nonfinancial reporting. Velte and Stawinoga (2017) suggested that environmental reporting assurance may enhance the credibility of the information, especially from the point of view of shareholders and investors. Assurances of reported environmental information can take different forms. Current methods used by companies, especially in Japan, include internal audits (implemented by the companies themselves) and third-party reviews, including third-party (general) comments and third-party (formal) assurances. Therefore, in addition to methods implemented by companies internally, other third-party methods are being introduced. This suggests that to increase the credibility of reported environmental information, its objectivity should be assured to a certain extent via evaluation by third parties. Among the various alternatives, third-party assurances are the most common method globally. Third-party assurances are defined as “an engagement in which a practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria” (International Federation of Accountants, 2012, p.16). Specifically, third-party assurances in environmental reporting are intended to add credibility to environmental information in the same way as a financial audit adds credibility to financial information, by examining data and claims from an independent position (Park and Brorson, 2005). The number of large companies seeking assurances of sustainability reports has increased significantly in recent years (KPMG, 2015). In 2015, 63% of the top 250 companies listed on the Fortune Global 500 independently assured their sustainability information. This figure was more than double that just 10 years previously. As for practical business trends regarding environmental reporting, companies are increasingly focusing on environmental information that has high materiality for their own company, partly because the G3 Sustainability Reporting Guidelines of the Global

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Reporting Initiative (GRI) introduced the materiality principle in 2006. Because materiality is the standard by which information to be reported is selected, the process by which a company determines it is also important information for stakeholders (AccountAbility, 2008). Accordingly, the foci of third-party assurances have come to include not only the veracity, accuracy, and completeness of reported (quantitative) data and claims, but also the materiality determination process (AccountAbility, 2006). Given these issues, studies have reported a wide variation in terms of demand for assurances (Jones and Solomon, 2010; Kolk and Perego, 2010; Sierra et al., 2013; Simnett et al., 2009; Zorio et al., 2013), quality of assurance statements (Ball et al., 2000; Deegan et al., 2006; O’Dwyer and Owen, 2005, 2007), and providers of assurance services (Edgley et al., 2010; O’Dwyer, 2011; O’Dwyer et al., 2011; Perego, 2009; Simnett et al., 2009). For example, regarding demand for assurances, while KPMG’s surveys (e.g., KPMG, 2015) show that European countries such as Denmark, Spain, Italy, and France are in general more likely to provide assurances, empirical studies such as those of Kolk and Perego (2010) and Simnett et al. (2009) found that demand for assurances was higher in stakeholder-oriented countries and in those with weaker legal systems. In addition, Casey and Grenier (2015) found that the sustainability assurance market in the US was fundamentally different from international markets. Unlike their international counterparts, finance and utilities industries in the US market were no more likely than other industries to obtain assurances of sustainability information. Regarding quality of assurance statements and providers of assurance services, unlike financial audits, a variety of organizations and individuals are engaged to provide assurance of environmental reports (KPMG, 2008). Assurances are usually provided by certification bodies, specialist consultancies, and accounting firms (Corporate Register, 2008; KPMG, 2008; O’Dwyer et al., 2011). Major accounting firms, in particular, have dominated the market over the years, and in 2015, 65% of the leading global companies that assured sustainability information used assurance services from such firms (KPMG, 2015). A number of studies have focused on whether third-party assurance is used by accounting firms and whether it follows standards such as the AA1000 Assurance Standard (Casey and Grenier, 2015; Junior et al., 2014; Kolk and Perego, 2010; O’Dwyer et al., 2011; Perego, 2009; Simnett et al., 2009). For example, AlHamadeen (2007) suggested that the majority (63%) of UK FTSE100 companies engaged consultancy firms to provide assurance of their sustainability reports. Perego (2009) found that companies in countries with weaker governance systems were more likely to use accounting firms as assurance providers. In an analysis of companies in Australia, the US, and the UK in 2007, Pflugrath et al. (2011) found that the credibility of sustainability information was greater when it was assured and when the assurer was a professional accountant. Casey and Grenier (2015) empirically analyzed US companies that issued sustainability reports from 1993 to 2010 and found that sustainability reports with assurance reduced the cost of capital, and this reduction was significantly greater when the assurance was provided by an accounting firm. However, Cho et al. (2014) examined the association between sustainability report assurance and firm value in US companies and failed to find any relationship between assurance practices and shareholder value. Fazzini and Dal Maso (2016) investigated the value relevance of environmental reporting and assurance in the Italian market during the period 2008e2013. Although environmental reporting was found to be significantly related to companies’ market value, there was no incremental increase in value relevance when such information was assured. In contrast, Birkey et al. (2016) considered the

benefits of assurance from a different perspective. Based on a sample of 351 company-year observations, they examined the relationship between assurance and the corporate environmental reputation scores of the greenest companies in the US. The study found that the assurance of sustainability reports significantly influenced stakeholders’ perceptions of companies’ environmental reputations. This positive relationship held for assurance provided by both accounting firms and other players, which suggests that “it is the presence of assurance, as opposed to assurer type, that impacts assessments of corporate environmental reputation” (p. 144). Based on an international sample of 1466 companies, Dal Maso et al. (2017) found that reporting on stakeholder engagement was positively perceived by investors in countries characterized by low embeddedness, low hierarchy, and high mastery. This suggested that national culture played a mediatory role in the relationship between market value and sustainability reporting. On the other hand, third-party comments are a unique method especially used by Japanese companies (Haider and Kokubu, 2015). Third-party comments involve declarations (including evaluations and recommendations) regarding reported environmental information as well as comments regarding the company’s activities covered in the information from an independent position, from parties such as institutions or experts rather than certification bodies, specialist consultancies, or accounting firms. Although third-party assurances are a stricter form of review than third-party comments according to the above definitions, few Japanese companies appreciate this difference. For example, although all the large companies now regularly publish sustainability reports, demand for assurance services is relatively low. Indeed, Haider and Kokubu (2015) reported that although the number of Japanese companies listed on the Nikkei 225 publishing environmental reports with third-party comments increased between 2006 and 2010, the number publishing environmental reports with thirdparty assurances decreased. KPMG (2008) noted that only onequarter of the top 100 Japanese companies attached assurance statements in 2008, and that instead of using “formal assurances,” a large number of Japanese companies preferred to attach general comments or views by external parties, including academics, individual experts, and stakeholder panels. Whereas only 18% of the top 100 companies in 22 countries adopted third-party comment practices in 2008, 54% of the leading Japanese companies conducted these practices using the services of nonprofessional assurance providers. However, previous studies on sustainability assurances have largely ignored this practice, for which there are several possible reasons. For example, in his study on UK sustainability assurance practices, Al-Hamadeen (2007) expressed concern about the limitations of such evaluation statements, including inadequately systematic approaches, an absence of a specific set of standards, and unclear opinions/conclusions. Citing the examples of a number of environmental (sustainability) reports of Japanese companies, Haider and Kokubu (2015) found that third-party comments were based merely on reading the sustainability reports without collecting substantive evidence or following guidelines or standards; if anything, these third-party comments mainly applauded the performance of companies and identified areas for future improvements without drawing any specific conclusions. Observing a similar lack of quality in assurance engagement, Wilson (2003) considered this type of third-party comment or celebrity endorsement of a report to be unsubstantiated assurances. Accordingly, because third-party comments are viewed as no more than a general statement (not a systematic, documented, and evidence-based process), and consequently such practices have not been considered the same as third-party assurances, the literature focusing on third-party comments is limited (Cheng et al., 2015;

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Haider and Kokubu, 2015). Thus, practices concerning third-party reviews of Japanese companies contrast with those in other countries. However, such unique practices should be considered when analyzing the link between assurances of environmental information and the decision-making of shareholders and investors, especially in the Japanese context. Although third-party reviews, including assurances and comments, do not directly evaluate actual environmental performance and/or management, a review assures a certain degree of objectivity and credibility regarding the reported information through evaluation by third parties. Accordingly, it is expected that shareholder value will be enhanced when environmental information is voluntarily reported and increased further when the credibility of the reported environmental information is enhanced by the inclusion of third-party reviews of the information. Furthermore, because third-party assurances and third-party comments differ in quality, the difference in influence between them is another issue to be analyzed. 2.3. Hypothesis development From the above discussion, it is possible to derive a hypothesis regarding the relationship between environmental performance and management, environmental reporting, and the evaluation of companies by shareholders and investors; that is, companies proactively improving environmental performance and management enhance their shareholder value via reporting environmental information with high credibility. This paper will test the following three hypotheses to verify this claim. Hypothesis 1. Companies that proactively improve their environmental performance and management are more likely to report environmental information voluntarily. Hypothesis 2. Companies that voluntarily report environmental information are more likely to have higher shareholder value than those that do not report this information. Hypothesis 3. Among companies that voluntarily report environmental information, those that include third-party reviews (third-party comments and/or third-party assurances) are more likely to have higher shareholder value. Hypotheses 1 and 2 propose the following relationship: (1) better environmental performance and management / (2) voluntary environmental reporting / (3) higher shareholder value. Hypothesis 3 proposes that the relationship (2) / (3) strengthens when the credibility of the disclosed environmental information is enhanced. These relationships are described in Fig. 1. 3. Research design 3.1. Empirical models We use a treatment effects model to test our hypotheses. This is because if the environmental report publication dummy used as a proxy for environmental reporting is endogenous, an ordinary least squares (OLS) estimation captures the reverse causality whereby companies with higher shareholder value are more likely to report environmental information proactively.1 Thus, the estimation results from a treatment effects model are more reliable than those from OLS if the environmental report publication dummy is endogenous, although OLS is more reliable otherwise. As shown in

1 If a proxy for environmental reporting is a continuous variable, the two-stage least squares and three-stage least squares methods should be used.

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Section 4, the environmental report publication dummy is actually endogenous. In contrast, the ISO 14001 years variable used as a proxy for environmental performance and management is regarded as exogenous, because ISO 14001 years are predetermined when a company initially adopts the certification (Nishitani, 2009; Nishitani et al., 2016).2 The general formulation of the treatment effects model is as follows:

ER*it ¼ a0 þ a1 EPMit þ a2 GCit þ a3 Controlit þ εit

(1)

SVit ¼ b0 þ b1 EPMit þ b2 ERit þ b3 Controlit þ dit

(2)

SVit ¼ g0 þ g1 EPMit þ g2 ERit þ g3 ERit  TPRit þ g4 Controlit þ uit (3) where ER* is the latent variable of environmental reporting; EPM is environmental performance and management; GC is the United Nations Global Compact (UNGC) signature, which is an instrumental variable3 that directly influences ER* but not SV; SV is shareholder value; ER is environmental reporting (¼ 1 if ER* > 0 and 0 otherwise); TPR is the inclusion of third-party reviews; Control is the control variable(s); a, b, and g represent estimation parameters; ε, d, and u are error terms; and i and t, respectively, represent the company and time. Equation (1) shows the relationship between environmental performance and management and environmental reporting and will be used to test Hypothesis 1. Equation (2) shows the relationship between environmental reporting (and environmental performance and management) and shareholder value and will be used to test Hypothesis 2. Equations (1) and (2) are estimated simultaneously. Equation (3) shows the relationship between the credibility of environmental reporting (and environmental performance and management) and shareholder value and will be used to test Hypothesis 3. Equations (1) and (3) are also estimated simultaneously. Note that the difference between Equations (2) and (3) is the inclusion of interaction terms for environmental reporting and third-party reviews. By including the additional interaction terms in Equation (3), the influence of environmental reporting with third-party reviews (relative to environmental reporting without them) can be estimated. 3.2. Sample selection The data used for empirical analyses are pooled data from 2007 to 2015 for 174 Japanese manufacturing companies listed in the Nikkei 500 Index. Holding companies and companies with missing values are excluded from the sample. Consequently, the total number of observations for the analyses is 1533 company-years. 3.3. Variable measurements The variable for measuring shareholder value is Tobin’s q. The variable for environmental reporting is the ER (environmental report) publication dummy. The three dummy variables used for measuring the effect of third-party reviews of environmental reporting by interacting with the ER publication dummy

2 Three companies in our sample initially adopted ISO 14001 during the estimation period. However, there is hardly any difference between the estimation results with or without these companies in the sample. 3 For statistical estimations of the simultaneous equations, the instrumental variable(s) that directly influence the endogenous variable but not the dependent variable must usually be included in the regression.

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Fig. 1. Research framework of the relationship between environmental performance, management, environmental reporting, and third-party reviews.

respectively denote the following: a comment (¼ 1 if a comment is included, 0 otherwise); an assurance (¼ 1 if an assurance is included, 0 otherwise); and both a comment and assurance (¼ 1 if both a comment and an assurance are included, 0 otherwise). Thus, the interaction terms of the ER publication dummy and third-party reviews are ER with a comment, ER with an assurance and ER with both a comment and an assurance.4 The variable for environmental performance and management is ISO 14001 years. The instrumental variable that influences environmental reporting but does not directly influence shareholder value is the UNGC signature. The control variables are the natural logarithm of the number of employees (ln(employees)), advertising expenditure ratio, return on assets (ROA), debt ratio, proportion of shares held by foreign investors, proportion of shares held by financial institutions, industry sector dummies, and year dummies. The selection of these control variables is based on previous research on environmental reporting and shareholder value (Table 1). The definitions of these variables are given in Table 1, the descriptive statistics are listed in Table 2, and the correlation matrix is shown in Table 3. There is no multicollinearity among independent variables because the strongest correlation is 0.497. 3.4. Databases To create the aforementioned variables, Tobin’s q data were obtained from the NEEDS-Cges database. Environmental report publication data were obtained from the websites of sample companies. Environmental reports without or with third-party reviews (comments and assurances) were classified by checking each environmental report downloaded from these websites. ISO 14001 data were obtained from the Japanese Standards Association, Japan Accreditation Board for Conformity Assessment, and company websites. Other data were obtained from the Nikkei NEEDS FinancialQUEST database.

4 Note that we employ the interaction terms of the ER publication dummy and different types of third-party reviews to resolve the endogeneity issue of the ER publication dummy. It is not necessary to create an interaction term if the ER publication dummy is exogeneous.

4. Estimation results Table 4 summarizes the estimation results used to test our hypotheses. According to the results of a Wald test, the estimation results from the treatment effects model are more reliable than those from OLS in both Models 1 and 2. Panel A shows estimation results for Equation (1), and Panel B shows those for Equations (2) and (3). Thus, Model 1 in Panels A and B is one set of simultaneous estimations, and Model 2 in these panels is another. Although all regressions include the industry sector and year dummies, these are omitted from the table owing to space limitations. First, we examine the estimation results in Models 1 and 2 of Panel A. These models show the same results. The ISO 14001 years coefficient is significantly positive at the 1% level. This suggests that companies that proactively improve environmental performance and management are more likely to report environmental information voluntarily, which supports Hypothesis 1. The results for instrumental and control variables show that UNGC signature, ln(employees), and the proportion of shares held by financial institutions are significantly positive at the 1% level, and the ROA and proportion of shares held by foreign investors are significantly negative, at least at the 5% level. This suggests that companies that sign the UNGC, are large, have large proportions of shares held by financial institutions, have low profitability, or have small proportions of shares held by foreign investors are more likely to report environmental information voluntarily. The proportion of shares held by foreign investors has a negative influence. This implies that environmental reporting is determined not by direct pressure from shareholders and investors but by financial accountability to shareholders and investors, at least when the environmental report publication dummy is used as a proxy for environmental reporting. Second, we examine the estimation results in Model 1 of Panel B. The ER publication dummy does not have a significant influence. This suggests that companies voluntarily reporting environmental information are unlikely to have any higher shareholder value than companies that do not report this information, which does not support Hypothesis 2. On the other hand, the influence of the ISO 14001 years variable is significantly negative at the 1% level. This

Please cite this article as: Nishitani, K et al., Are third-party assurances preferable to third-party comments for promoting financial accountability in environmental reporting?, Journal of Cleaner Production, https://doi.org/10.1016/j.jclepro.2019.119199

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Table 1 Definitions of variables. ⁃ Tobin’s q: the aggregate market price of stock plus debt divided by total assets. Because Tobin’s q indicates the ratio of a company’s market value to the replacement value of its assets, a high value implies that shareholders and investors evaluate the present value of a company’s expected future net cash flows positively (Konar and Cohen, 2001; Nakao et al., 2007; Nishitani and Kokubu, 2012). ⁃ ER (environmental report) publication dummy: a dummy variable that takes a value of 1 if a company publishes an environmental report, and 0 otherwise. Because environmental reports are the main global medium for reporting environmental information voluntarily, especially in Japan, this paper focuses on the publication of stand-alone environmental reports as a proxy for environmental reporting (de Villiers et al., 2014; Haider and Kokubu, 2015). Environmental reports strive for accountability concerning the state of environmental management and performance in the company. They reveal environmental information about a company’s business activities, regardless of the report’s name (e.g., “CSR report” or “sustainability report”), whether it includes information on other topics, or the medium through which it is published. Environmental reports provide useful information that influences stakeholder decisions and facilitates environmental communication (Japanese Ministry of the Environment, 2007). Their content is generally in accordance with the environmental reporting guidelines of the Japanese Ministry of the Environment and the GRI, but the choice of information to include is fundamentally at the discretion of each company. The ER publication dummy is expected to influence shareholder value positively. ⁃ A comment: a dummy variable that takes a value of 1 if a third-party comment is included, and 0 otherwise. ⁃ An assurance: a dummy variable that takes a value of 1 if a third-party assurance is included, and 0 otherwise. ⁃ A comment and assurance: a dummy that takes a value of 1 if both a third-party comment and a third-party assurance are included, and 0 otherwise. ⁃ ER with a comment: the interaction term of ER publication dummy and a comment. This variable is expected to influence shareholder value positively. ⁃ ER with an assurance: the interaction term of ER publication dummy and an assurance. This variable is expected to influence shareholder value positively. ⁃ ER with both a comment and an assurance: the interaction term of ER publication dummy and both a comment and an assurance. This variable is expected to influence shareholder value positively. ⁃ ISO 14001 years: the number of years since the company initially adopted the ISO 14001 certification, which is the most widely recognized international standard for environmental management systems, certified by the International Organization for Standardization. Because an environmental management system provides an environmental management framework based on the principles of continuous improvement using a series of Plan, Do, Check, and Act cycles, companies following the framework for years are more likely to improve environmental performance and management proactively. The ISO 14001 years variable is expected to influence the ER publication dummy and shareholder value positively. ⁃ United Nations Global Compact (UNGC) signature: a dummy variable that takes a value of 1 if a company has signed the UNGC, and 0 otherwise. The UNGC is the world’s largest corporate sustainability initiative, and it was proposed by the UN Secretary General Kofi Annan in 1999. Companies that sign the UNGC implement various activities following the senior management’s own commitment to satisfy the 10 principles of the UNGC on human rights, labor, the environment, and anticorruption measures. Because the UNGC is an initiative to encourage innovation based on accountability and transparency, companies that sign the UNGC are expected to report environmental information. On the other hand, because shareholders and investors evaluate not the UNGC signature but rather the environmental information that is thereby encouraged, it is unlikely that signing the UNGC directly influences shareholder value. Signing the UNGC is expected to influence the ER publication dummy positively. ⁃ Ln(employees): natural logarithm of the number of employees. This measures the influence of company size (e.g., Al-Tuwaijri et al., 2004; Bewley and Li, 2000; Cho and Patten, 2007; Cho et al., 2010, 2012; Clarkson et al., 2008, 2011; Nishitani and Kokubu, 2012; Patten, 2000, 2002). ln(employees) is expected to influence the ER publication dummy and shareholder value positively. ⁃ Advertising expenditure ratio: advertising expenditure divided by total sales. It is thought that business-to-consumer (B-to-C) companies have higher ratios of advertising expenditure to total sales, so this variable controls for the influence of the company’s position in supply chains (e.g., Konar and Cohen, 2001; Nishitani and Kokubu, 2012). However, companies are not obligated to disclose advertising expenditure if this does not exceed 5% of their selling, general, and administrative expenses (SG&A). Accordingly, if advertising expenditure values are missing, they are calculated as 5% of SG&A to supplement the data. The advertising expenditure ratio is expected to influence the ER publication dummy positively and to influence shareholder value either positively or negatively. ⁃ Return on assets (ROA): net earnings before taxes divided by total assets. The ROA measures the influence of profitability (e.g., Al-Tuwaijri et al., 2004; Bewley and Li, 2000; Cho et al., 2010, 2012; Clarkson et al., 2008, 2011). The ROA is expected to influence the ER publication dummy either positively or negatively, and to influence shareholder value positively. ⁃ Debt ratio: total liabilities divided by equity capital. The debt ratio measures the degree of financial leverage (e.g., Cho et al., 2012; Clarkson et al., 2008, 2011). The debt ratio is expected to influence the ER publication dummy either positively or negatively, and to influence shareholder value positively. ⁃ Proportion of shares held by foreign investors: shares held by foreign investors divided by total shares outstanding. Most foreign investors in the Japanese stock market are institutional investors (Ahmadjian, 2007), so this variable measures the influence of institutional investors (i.e., Anglo-American-style corporate governance) (e.g., Nishitani and Kokubu, 2012). This variable is expected to influence the ER publication dummy and shareholder value positively. ⁃ Proportion of shares held by financial institutions: shares held by financial institutions divided by total shares outstanding. This indicates the influence of financial institutions, including major banks (i.e., Japanese-style corporate governance) (e.g., Nishitani and Kokubu, 2012). Japanese-style corporate governance emphasizes stakeholders rather than shareholders as the primary beneficiaries of corporate activity (Yonekura et al., 2012). This variable is expected to influence the ER publication dummy and shareholder value positively. ⁃ Industry sector dummies: dummy variables that take a value of 1 for companies that belong to the corresponding industry, and 0 otherwise. In this study, the industries are: foods, textiles and apparel; pulp and paper; chemicals; pharmaceuticals; oil and coal products; glass and ceramics products; iron and steel; nonferrous metals; metal products; machinery; electrical appliances; transportation equipment; precision instruments; and other products. These are based on the Tokyo Stock Exchange classifications. These variables control for the influence of each industry (e.g., Bewley and Li, 2000; Cho et al., 2010, 2012; Clarkson et al., 2008, 2011; Konar and Cohen, 2001; Nishitani and Kokubu, 2012; Patten, 2002). ⁃ Year dummies (2007e2015): the dummy variable for year 2007 equals 1 if the year is 2007, and 0 otherwise, etc. These variables control for the influence of macroeconomic shocks.

suggests that companies proactively improving environmental performance and management are more likely to have lower shareholder value, which is consistent with Friedman and Heinle’s (2016) suggestion that institutional investors generally prefer companies with weaker environmental performance and management. Thus, against our expectations, environmental performance and management do not improve shareholder value directly or indirectly through environmental reporting, at least when environmental reporting is proxied by the environmental report publication dummy. Concerning the control variables, the ROA and proportion of shares held by foreign investors are significantly positive at the 1% level, and ln(employees) and the proportion of shares held by

financial institutions are significantly negative, at least at the 5% level. This suggests that companies that have high profitability, have large proportions of shares held by foreign investors, are small, or have a small proportion of shares held by financial institutions are more likely to have higher shareholder value. Third, we examine the estimation results in Model 2 of Panel B. This model includes additional interaction terms for combinations of the ER publication dummy with different types of third-party review dummy variables to analyze the credibility of environmental information. For that reason, the coefficient of the ER publication dummy in this model indicates the influence of environmental reporting without third-party comments and assurances, and the coefficients of the interaction terms indicate

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Table 2 Descriptive statistics. Observations Tobin’s q ISO 14001 years ER publication dummy ER with a comment ER with an assurance ER with both a comment and an assurance Ln(employees) Advertising expenditure ratio ROA Debt ratio Proportion of shares held by foreign investors Proportion of shares held by financial institutions UNGC signature Industry sector dummy foods textiles & apparels pulp & paper chemicals pharmaceutical oil & coal products glass & ceramics products iron & steel nonferrous metals metal products Machinery electric appliances transportation equipment precision instruments other products Year dummy y2007 y2008 y2009 y2010 y2011 y2012 y2013 y2014 y2015

Mean

S.D.

Min

Max

1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533

1.236 12.751 0.887 0.297 0.111 0.067 8.094 0.012 0.040 1.286 0.266 0.337 0.199

0.479 4.185 0.317 0.457 0.314 0.250 1.105 0.015 0.071 1.369 0.113 0.104 0.399

0.619 0 0 0 0 0 3.332 0.000 1.047 0.036 0.035 0.064 0

5.907 20 1 1 1 1 11.210 0.147 0.606 24.966 0.742 0.613 1

1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533 1533

0.035 0.023 0.012 0.141 0.073 0.007 0.033 0.043 0.047 0.012 0.127 0.249 0.128 0.047 0.023

0.184 0.151 0.108 0.348 0.260 0.084 0.178 0.203 0.212 0.108 0.333 0.433 0.334 0.212 0.151

0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

1533 1533 1533 1533 1533 1533 1533 1533 1533

0.108 0.111 0.111 0.112 0.112 0.112 0.111 0.110 0.114

0.311 0.314 0.314 0.316 0.315 0.315 0.314 0.312 0.318

0 0 0 0 0 0 0 0 0

1 1 1 1 1 1 1 1 1

Table 3 Correlation matrix. [1] [1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13]

Tobin’s q ISO 14001 years ER publication dummy ER with a comment ER with an assurance ER with both a comment and an assurance Ln(employees) Advertising expenditure ratio ROA Debt ratio Proportion of shares held by foreign investors Proportion of shares held by financial institutions UNGC signature

[2]

[3]

[4]

[5]

[6]

[7]

[8]

[9]

[10]

[11]

[12]

[13]

1.000 0.046 1.000 0.133 0.497 1.000 0.013 0.153 0.232 1.000 0.064 0.135 0.126 0.230 1.000 0.075 0.108 0.096 0.175 0.095 1.000 0.079 0.400 0.356 0.119 0.187 0.050 1.000 0.179 0.224 0.136 0.008 0.043 0.032 0.209 1.000 0.417 0.000 0.171 0.112 0.001 0.013 0.072 0.085 1.000 0.195 0.092 0.141 0.059 0.012 0.030 0.147 0.081 0.341 1.000 0.337 0.245 0.004 0.035 0.108 0.056 0.183 0.068 0.274 0.251 1.000 0.103 0.071 0.262 0.009 0.035 0.129 0.064 0.001 0.080 0.036 0.069 1.000 0.020 0.293 0.178 0.126 0.157 0.114 0.150 0.056 0.027 0.051 0.260 0.097 1.000

differences in the degree of influence of environmental reporting with third-party reviews of environmental reporting without them. The ER publication dummy does not have a significant influence. On the other hand, the coefficient for ER with a comment is significantly positive at the 5% level, and those for ER with an assurance and ER with both a comment and an assurance are significantly negative, at least at the 5% level. These results suggest that although companies voluntarily reporting environmental information without third-party comments and third-party assurances are unlikely to have higher shareholder value than companies that do not report this information, companies whose

voluntary environmental reports are accompanied by third-party comments are likely to have higher shareholder value than those who publish reports without comments and assurances. In contrast, companies voluntarily reporting environmental information with third-party assurances and those with both comments and assurances are more likely to have lower shareholder value than those without (however, this does not mean that these companies have lower shareholder value than companies not voluntarily reporting environmental information). Furthermore, linear restriction tests suggest that the coefficient of ER with a comment is statistically (positively) greater than those of ER with an assurance

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Table 4 Estimation results. Panel A (ER publication dummy)

(1) Coefficient

ISO 14001 years Ln(employees) Advertising expenditure ratio ROA Debt ratio Proportion of shares held by foreign investors Proportion of shares held by financial institutions UNGC signature Constant

0.199 0.930 0.194 2.681 0.020 3.645 4.603 6.262 8.309

Panel B (Tobin’s q)

Coefficient

0.028*** 0.094*** 3.572 1.331** 0.076 0.685*** 0.840*** 0.333*** 0.899***

0.135 e e e 0.018 0.024 1.245 2.283 0.007 0.912 0.465 1.566

Observations Log pseudolikelihood Wald test (p-value) Linear restriction test ER with a commentary ¼ ER with an assurance (p-value) ER with a commentary ¼ ER with both a commentary and an assurance (p-value) ER with an assurance ¼ ER with both a commentary and an assurance (p-value)

S.E.

0.199 0.926 0.010 2.609 0.014 3.670 4.651 6.024 8.341

(1) Coefficient

ER publication dummy ER with a comment ER with an assurance ER with both a comment and an assurance ISO 14001 years Ln(employees) Advertising expenditure ratio ROA Debt ratio Proportion of shares held by foreign investors Proportion of shares held by financial institutions Constant

(2) S.E.

0.028*** 0.094*** 3.593 1.330** 0.076 0.681*** 0.834*** 0.422*** 0.898*** (2)

S.E.

Coefficient

0.097 e e e 0.006*** 0.012** 0.938 0.482*** 0.008 0.121*** 0.126*** 0.133***

0.092 0.064 0.099 0.089 0.018 0.015 0.955 2.279 0.005 0.938 0.437 1.504

S.E. 0.092 0.027** 0.030*** 0.038** 0.006*** 0.012 0.934 0.484*** 0.008 0.124*** 0.123*** 0.137***

1533 888.030 0.033

1533 875.974 0.046

e e e

0.000 0.000 0.786

Panel A estimates ER*it ¼ a0 þ a1 EPMit þ a2 GCit þ a3 Controlit þ εit (Eq. (1)), and Panel B estimates SVit ¼ b0 þ b1 EPMit þ b2 ERit þ b3 Controlit þ dit (Eq. (2)) and SVit ¼ g0 þ g1 EPMit þ g2 ERit þ g3 ERit  TPRit þ g4 Controlit þ uit (Eq. (3)). Although all regressions include the industry sector and year dummies, these are omitted from the table. ***, ** and * imply that the coefficient is significantly different from 0 at the 1%, 5%, and 10% levels, respectively.

and ER with both a comment and an assurance. These results only support Hypothesis 3 for companies voluntarily reporting environmental information with third-party comments. The ISO 14001 years coefficient is significantly negative at the 1% level. This suggests that companies proactively improving their environmental performance and management are more likely to have lower shareholder value. Therefore, companies reporting environmental information can mitigate the negative influence of environmental performance and management by including thirdparty comments. Concerning the control variables, the estimation results are the same as those in Model 1, except that ln(employees), which has a significantly negative coefficient at the 5% level, becomes insignificant in this model. The variable for environmental performance and management used in the above regressions is ISO 14001 years. However, if anything, the ISO 14001 years variable seems to capture environmental management more accurately than that of environmental performance. Therefore, we conducted an additional robustness check of the above regressions by using the alternative environmental score in the Asset4 database provided by Thomson Reuters. According to the definitions of the Asset4 database, the environmental score measures a company’s impact on living and nonliving natural systems, including air, land, and water, as well as complete ecosystems. It reflects the extent to which a company uses best management practices to avoid environmental risks and capitalize on environmental opportunities to generate long-term shareholder value. Although we did not use the environmental performance scores calculated by a third-party organization in the main analyses

to avoid the possibility that the score already took environmental reporting and its credibility into account, the likelihood of this is low for the environmental score in the Asset4 database because of its definition. Because the result of the Wald test suggested that the estimation results using a treatment effects model are not reliable, we independently estimated Equation (1) using a probit model, and Equations (2) and (3) using OLS (the estimation results are not shown owing to space limitations). The estimation results using environmental score as a proxy for environmental performance and management are almost the same as those derived using the ISO 14001 years variable. The only exception is that environmental score does not have a significant influence on shareholder value. Although this does not suggest that companies proactively improving environmental performance and management are more likely to have lower shareholder value, the fact remains that environmental performance and management do not improve shareholder value directly. Accordingly, the relationship between environmental performance and management and environmental reporting, and that between environmental reporting with and without third-party reviews and shareholder value are robust. 5. Discussion The purpose of this paper was to provide empirical insights into whether third-party reviews such as comments and assurances promote financial accountability in environmental reporting by ensuring the credibility of reported information. Using data from

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Japanese manufacturing companies selected from the Nikkei 500 Index for the period 2007e2015, this study empirically tested the voluntary disclosure theory-based hypothesis that companies proactively improving their environmental performance and management enhance their shareholder value via reporting environmental information with high credibility. The main findings from the simultaneous regression analysis are as follows. First, companies proactively improving their environmental performance and management are more likely to report environmental information voluntarily, which supports voluntary disclosure theory. This is consistent with the findings of Al-Tuwaijri et al. (2004) and Clarkson et al. (2008), whose results also supported voluntary disclosure theory. Thus, it is proved that companies have financial accountability motives for environmental reporting. This is consistent with the current situation where the number of Japanese companies publishing integrated reporting (of investment decisions) is gradually increasing (Nishitani et al., 2017). On the other hand, companies facing strong pressure from shareholders and investors (institutional investors) are less likely to report environmental information voluntarily. Because shareholders and investors generally prefer companies not to improve their environmental performance and management, as Friedman and Heinle (2016) suggested, companies facing strong pressure from shareholders and investors have no incentive to report environmental information. These results imply that environmental reporting is driven not by direct pressure from shareholders and investors but by financial accountability to shareholders and investors; if there is any pressure, it is from environmentally conscious shareholders and investors such as environmental, social, and governance (ESG) investment funds. Second, against our expectations, companies voluntarily reporting environmental information are unlikely to have higher shareholder value than companies that do not report this information. This is inconsistent with the findings of numerous studies such as Aerts et al. (2008), Bachoo et al., 2013, Clarkson (2013), Cormier and Magnan (2007), Dhaliwal et al. (2011, 2014), Griffin and Sun (2013), and Plumlee et al. (2015). That is, environmental reporting does not produce satisfactory results in terms of the financial accountability assumed by voluntary disclosure theory. This may be because we used an environmental report publication dummy as a proxy for environmental reporting. It is difficult for Japanese companies to differentiate themselves only by publishing environmental reports when most companies already do so. In contrast, except for Dhaliwal et al. (2011, 2014), most previous studies that found a positive relationship between environmental reporting and shareholder value focused on the comprehensiveness of the content (as one quality measure) of environmental reporting framed by guidelines and frameworks. However, because the function of third-party reviews (which also have a quality aspect) is not always to assure the comprehensiveness of the content of environmental reporting, it was not appropriate for this paper to follow these studies directly to select a proxy for environmental reporting, given that we also analyzed the influence of environmental reporting with third-party reviews on shareholder value. That said, the role of third-party reviews on reporting quality is an important issue that should be clarified, and future research will address this limitation of this paper. Moreover, environmental performance and management have a direct negative influence on shareholder value, which is consistent with Friedman and Heinle’s (2016) suggestion. Although environmental reporting is expected to offset the negative influence of environmental performance and management by highlighting such performance to environmentally conscious shareholders and investors, merely reporting environmental information is not sufficient to fulfill the financial accountability role.

Third, if companies report more credible information through third-party reviews, especially third-party comments, they will have higher shareholder value than companies that merely report environmental information, which at least partially offsets the negative influence of environmental performance and management on shareholder value. Because shareholders and investors react positively to environmental information with third-party reviews, which enhance confidence in the reported information, it is (generally) proved that third-party reviews promote the financial accountability of environmental reporting (Casey and Grenier, 2015). In other words, environmental reporting performs the financial accountability role assumed by voluntary disclosure theory only when its credibility is ensured by third-party reviews. For example, it is expected that third-party reviews contribute to resolving the “greenwashing” issue (whereby companies that do not sufficiently improve their environmental performance and management disclose exaggerated information) for shareholders and investors (Mahoney et al., 2013). However, unlike environmental reporting with third-party comments, environmental reporting with third-party assurances and with both third-party comments and assurances has no greater influence on shareholder value than environmental reporting without them. If anything, these approaches to environmental reporting actually have a less positive influence than environmental reporting without any third-party reviews, which is contrary to our expectations of increased credibility from assured reporting. As Cho et al. (2014) and Fazzini and Dal Maso (2016) found, there was no incremental increase in value relevance even if companies included third-party assurances. Moreover, although Lee et al. (2017) found that Japanese companies enhanced shareholder value by including third-party assurances and internal audits simultaneously, third-party assurances alone are insufficient to enhance shareholder value. This could be because an expectation gap of third-party assurances between the actual and expected performance of an assurance exists, as no consensus regarding the criteria for third-party assurances of environmental reporting has been reached in Japanese companies (Boolaky and Quick, 2016; Mori Junior, 2014; Porter, 1993). In the first place, environmental reporting for investment decisions has a relatively short history. The original role of third-party assurances in environmental reporting may not have shifted from an assurance of legitimacy to one of financial accountability where environmental reporting was originally regarded as a legitimacy tool (Alrazi et al., 2015). Moreover, third-party assurances of environmental reporting are not strictly regulated, unlike those of mandatory financial reporting. It may be inadequate to assure the qualitative dimensions of environmental performance with thirdparty assurances framed by financial assurance models (Dando and Swift, 2003). Indeed, there are no assurance guidelines that adequately cover all aspects of environmental reporting (Adams and Evans, 2004; Mori Junior, 2014). In addition, not even international standards, including the AA1000 Assurance Standard, have become widespread in Japanese companies. Accordingly, the thirdparty assurances currently used in most Japanese companies follow their or their assurers’ own criteria. Furthermore, third-party assurances of environmental reporting in Japanese companies do not cover all aspects in the reported information; they only cover the aspect of quantitative accuracy in the reported information and the selection of the aspect is left to the company’s discretion. This is because the financial assurance models can be applied only to the quantitative dimensions of environmental reporting. These viewpoints imply that the details of credibility of environmental reporting with third-party assurances differ between companies. In addition, the aspects covered by third parties do not always meet the information needs of shareholders and investors.

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For example, shareholders and investors seek risk information derived from the environmental aspects, but such information is rarely reported in environmental reports even with third-party assurances (Sullivan and Gouldson, 2012). Because the effectiveness of third-party assurances is vague in these circumstances, shareholders and investors cannot comprehensively and accurately evaluate a company’s environmental reporting. For example, shareholders and investors can be misled in terms of the credibility of reported information in third-party assurances if the greenwashed aspect is hidden in the reported information (that aspect is not covered by third-party assurances). Thus, the more shareholders and investors consider that the current criteria for third-party assurances do not adequately cover all aspects of environmental reporting, the more the expectation gap regarding the credibility of reported information will widen. If anything, the current form of environmental reporting with thirdparty assurances could convey the opposite impression, contrary to its intention. For that reason, it seems that shareholders and investors place a relatively low value on the current specifications of third-party assurances. In addition, the actual value of environmental reporting with third-party assurances is 0.007 (0.092e0.099) (Model 2 in Panel B in Table 4), although this value is not statistically significant. Even if we understand that this does not mean that these companies have lower shareholder value than companies that do not voluntarily report environmental information, it may suggest that the expectation gap cannot be overestimated. Accordingly, Japanese companies have not yet benefitted from the greater credibility of reported information (fundamentally obtainable from third-party assurances), although the possibility that the impact of assurance practices is contextspecific, as Coram et al. (2009) and Pflugrath et al. (2011) suggested, cannot be ruled out. On the other hand, the origins of the expectation gap could be rooted in shareholders’ and investors’ recognition of the financial assurance practices of Japanese companies, although even the latter may not be sufficiently mature to be evaluated highly by shareholders and investors. Indeed, Haider and Kokubu (2015) suggest that the long-standing financial auditing and assurance practices in Japanese companies could be related to their low demand for third-party assurances in environmental reporting. Traditionally, there has been low demand for independent external auditing in Japan (Nakajima, 1973). The Anglo-American style of independent auditing was first introduced into Japan after the Second World War as part of the reform policies led by the General Headquarters of the Allied Occupying Forces (McKinnon, 1984). Enacted in 1947, the Securities and Exchange Law mandated the requirement for Certified Public Accountant (CPA) auditing for publicly listed companies (Matsumoto and Previts, 2010). Since then, the Japanese government has taken numerous initiatives to improve the quality of auditors and the auditing profession, including the formation of the Japanese Institute of Certified Public Accountants (JICPA). However, auditing and auditors still play an insignificant role in the Japanese economy (Yoshimi, 2002). As of 31 March 2017, the total number of qualified CPAs in Japan was only 29,369, which is significantly low by Anglo-American standards (JICPA, 2017). Previous research explains that the traditional Japanese corporate governance system (i.e., with its main banks, crossshareholding, and employee sovereignty) is a plausible explanation for the weakness of the auditing and assurance system in Japanese companies because of its underlying characteristics (e.g., Komori, 2012; McKinnon, 1984; Sakagami et al., 1999). For example, the Japanese corporate governance system is based on the Japanese culture of interdependence and group consciousness. Japan is considered to be more group-oriented than Anglo-American

11

society. Japanese society emphasizes the maintenance of harmonious interpersonal and intergroup relationships, and these social values are reflected in the financial system. Historically, the main banks and insurance companies have played a significant role in corporate financing in Japan (Jackson and Miyajima, 2007). In addition, the strong presence of affiliated corporations is also seen in corporate ownership through cross-shareholding or intercorporate shareholding. In this situation, the main banks and other institutional investors (who are generally the insurance companies) have direct access to the private accounting information of their clients, which effectively reduces the demand for external reporting and auditing (Gordon, 1999). Furthermore, such a financing system enables the formation of company boards of directors that are almost exclusively composed of internally promoted managers and representatives from the main banks and affiliated companies (Jackson and Miyajima, 2007). These internally oriented boards are seen to cooperate with management to fulfill its internal objectives rather than serve the interests of shareholders and investors. In fact, the Anglo-American style of corporate governance based on external surveillance has not developed very far in Japan (Buchanan, 2007; Gordon, 1999). Thus, even after the introduction of external auditing, managers are expected to protect the interests of management rather than those of investors (McKinnon, 1984). Because the reported information does not meet the information needs of shareholders and investors, the demand for auditing and assurances may be low. Accordingly, the fundamentals of the Japanese corporate governance system may have made the third-party assurances of environmental reporting as well as financial reporting less important. The nonpositive influence of third-party assurances has important implications for the practice of third-party reviews in Japanese companies because the reviews on which many Japanese companies rely are intended to assure others of the partial quantitative accuracy of reported information and environmental performance indices. If such partial quantitative accuracy affects the investment decisions of shareholders and investors, the inclusion of third-party assurances in environmental reporting must be evaluated more favorably than the inclusion of third-party (qualitative) comments by outside experts. The finding that the inclusion of third-party comments enhances the credibility of reported information implies that the willingness of a company to solicit reviews from third parties and the possible future reaction to the comments (without the expectation gap), rather than adding additional information as part of a formal assurance service, may be evaluated highly. This is because third-party comments cover all reported information, and a good third-party comment explicitly points out the advantages and disadvantages of the company’s current environmental performance and management, which can identify areas for improvement that the company has not yet identified. Hence, the inclusion of third-party comments is expected to enhance readers’ understanding of not only the company’s current environmental performance and management but also its future direction (Kokubu, 2008). This implies that third-party comments could play an additional and informal role in securing the materiality determination process. Because third-party comments are more popular than third-party assurances for ensuring the credibility of reported information from Japanese companies, shareholders, investors, and companies may realize their implicit advantages. Although AlHamadeen (2007) and Wilson (2003) expressed concerns about the inadequacy of third-party comments to assure environmental reporting, such comments are actually evaluated highly in Japan.

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6. Conclusion This paper provides new insights into corporate environmental reporting, showing that improving environmental performance and management alone is insufficient to enhance shareholder value. Rather, companies should also report more credible environmental information with third-party comments. However, this does not mean that any kind of third-party review is positively evaluated by the stock market because of the expectation gap of third-party assurances. Because third-party assurances are less popular than third-party comments in Japanese companies, we did not focus on the details of third-party assurances such as assurers’ attributes (e.g., whether they are accounting firms). This may be a limitation of this paper. However, as suggested in Section 2.2, companies are moving toward the focused reporting of information that has high materiality for them. In such cases, stronger assurances of the validity of the processes of environmental reporting and indications of the company’s future direction will be required. If companies expect thirdparty assurances (as well as third-party comments) to promote the financial accountability of environmental reporting, assurances of the materiality determination process may be more important than assurances of the veracity, accuracy, and completeness of (partial) reported data and claims. It is hoped that this paper will encourage further research to address these issues. Acknowledgments This paper forms part of the results of research supported by Grant-in-Aid for Scientific Research (B) 19H01549 from the Ministry of Education, Culture, Sports, Science and Technology, Japan, and the Environment Research and Technology Development Fund (S-16) from the Environmental Restoration and Conservation Agency, Japan. References AccountAbility, 2006. The Materiality Report: Aligning Strategy, Performance and Reporting. AccountAbility, 2008. AA1000 Assurance Standard 2008. Adams, C.A., 2004. The ethical, social and environmental reporting-performance portrayal gap. Account. Audit. Account. 17 (5), 731e757. Adams, C.A., Evans, R., 2004. Accountability, completeness, credibility and the audit expectations gap. J. Corp. Citizensh. 14, 97e115. Aerts, W., Cormier, D., Magnan, M., 2008. Corporate environmental disclosure, financial markets and the media: an international perspective. Ecol. Econ. 64 (3), 643e659. Ahmadjian, C., 2007. Foreign investors and corporate governance in Japan. In: Aoki, M., Jackson, G., Miyajima, H. (Eds.), Corporate Governance in Japan: Institutional Change and Organizational Diversity. Oxford University Press, Oxford, pp. 125e150. Al-Hamadeen, R.H., 2007. Assurance of Corporate Stand-Alone Reporting: Evidence from the UK. PhD thesis. School of Management, University of St-Andrews, UK. Al-Tuwaijri, S.A., Christensen, T.E., Hughes, K.E., 2004. The relations among environmental disclosure, environmental performance, and economic performance: a simultaneous equations approach. Account. Org. Soc. 29 (5e6), 447e471. Alrazi, B., de Villiers, C., van Staden, C.J., 2015. A comprehensive literature review on, and the construction of a framework for, environmental legitimacy, accountability and proactivity. J. Clean. Prod. 102, 44e57. Baas, L., 2007. To make zero emissions technologies and strategies become a reality, the lessons learned of cleaner production dissemination have to be known. J. Clean. Prod. 15 (13e14), 1205e1216. Bachoo, K., Tan, R., Wilson, M., 2013. Firm value and the quality of sustainability reporting in Australia. Aust. Account. Rev. 23 (1), 67e87. Ball, A., Owen, D.L., Gray, R.H., 2000. External transparency or internal capture? The role of third party statements in adding value to corporate environmental reports. Bus. Strateg. Environ. 9 (1), 1e23. Bewley, K., Li, Y., 2000. Disclosure of environmental information by Canadian manufacturing companies: a voluntary disclosure perspective. In: Jaggi, B., Freedman, M. (Eds.), Advances in Environmental Accounting & Management. Emerald Group Publishing Limited, Bingley, pp. 201e226. Birkey, R., Michelon, G., Patten, D.M., Sankara, J., 2016. Does assurance on CSR reporting enhance environmental reputation? An examination in the US

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