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Changes in environmental regulation and reporting: The case of the petroleum industry from 1989 to 1998
Journal of Accounting and Public Policy 23 (2004) 295–304 www.elsevier.com/locate/jaccpubpol
Changes in environmental regulation and reporting: The case of the petroleum industry from 1989 to 1998 Mimi Alciatore a, Carol Callaway Dee b, Peter Easton
c,*
a
University of Houston, USA Florida State University, USA Department of Accounting, Mendoza College of Business, University of Notre Dame, 305A Mendoza, Notre Dame, IN 46556, USA b
c
Available online Abstract We present a detailed description of changes in environmental disclosures by petroleum companies from 1989 to 1998, a period of significant promulgation of environmental reporting regulations. We extend prior research by (a) examining a richer, more comprehensive set of environmental data, (b) reporting the dollar amounts disclosed, (c) describing the availability of those disclosures in annual reports and Forms 10K, and (d) documenting the change in environmental reporting patterns and amounts over 1989–1998. This description provides a broad basis for the development of hypotheses for future research, and makes it clear that data used in extant research on environmental disclosures is only a small subset of reported data. Ó 2004 Elsevier Inc. All rights reserved. Keywords: Financial reporting; Disclosure; Environmental accounting; SEC; Regulation; Oil and gas
1. Introduction We present an in-depth description of environmental disclosures in order to call attention to the opportunities available to expand the breadth and depth of
*
Corresponding author. Tel.: +574-631-6096; fax: +574-631-5544. E-mail address: [email protected] (P. Easton).
0278-4254/$ - see front matter Ó 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.jaccpubpol.2004.06.002
296
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environmental research. Prior environmental studies often focused on potentially responsible party (PRP) obligations, or more generally, remediation liabilities. Our findings reveal that these amounts are just the tip of the iceberg when it comes to the total environmental costs a firm may face. We extend prior research by (a) examining a richer, more comprehensive set of environmental data, (b) reporting the dollar amounts disclosed, (c) describing the availability of those disclosures in annual reports and Forms 10K, and (d) documenting the change in environmental reporting patterns and amounts over 1989–1998. This description provides a broad basis for the development of hypotheses for future research, and makes it clear that data used in extant research on environmental disclosures is only a small subset of reported data. The Securities and Exchange Commission (SEC) is concerned with the adequacy of firms’ disclosures of environmental costs. With regard to the SEC’s examination of registrants’ environmental reporting, Roberts (former SEC commissioner) and Hohl write (Roberts and Hohl, 1994, p. 2). This scrutiny is expected to continue in the foreseeable future and may become even more intense with respect to registrants in industries significantly affected by environmental risks. When the Staff finds material omissions or deficiencies relating to environmental matters, it will continue to request corrective disclosure and, in egregious cases, to refer the matter to the Commissions Division of Enforcement for appropriate enforcement consideration. Despite these ominous words, there is little documentation regarding firms’ disclosure levels relative to the extensive environmental reporting rules promulgated during the 1990s. To bridge this gap in the literature, we describe shifts in environmental disclosures from 1989 to 1998 for a sample of firms in the petroleum industry. This period was a time of increased environmental disclosure regulation and public and governmental pressure regarding environmental obligations of public companies. Specifically, we examine the Forms 10-K (10Ks) and annual reports for environmental disclosures relating to: (1) PRP information under the 1980 Comprehensive Environmental Response and Liability Act and the 1986 Superfund Amendments and Reauthorization Act, (2) remediation liabilities, (3) environmental exit costs (‘‘dismantlement liabilities’’), (4) environmental capital expenditures, and (5) environmental operating expenditures. Each of these items is either required or recommended to be disclosed by either the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), or the SEC. Our paper contributes to the literature in the following ways. First, we examine a more complete set of environmental disclosures than those examined
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in the literature to date. Many prior studies focus on environmental disclosures related to a firm’s PRP obligations, which allows the researcher to use data provided by the Environmental Protection Agency (EPA). However, for our sample, PRP obligations represented only 5.1–9.8% of total remediation liabilities in 1998. If one includes exit costs, the percentage of total environmental liabilities represented by PRP sites drops to a range of 0.6–3.6%. Thus, our findings suggest that PRP obligations may represent a small percentage of the environmental liabilities a firm may face. Moreover, these amounts relate only to environmental liabilities, and do not consider the financial implications of environmental capital and operating expenditures. Overall, our paper highlights the fact that remediation liabilities, the central focus of many prior studies, are just one subset of total reported environmental costs. 1 Second, we examine environmental exit costs. These costs can be much larger than remediation liabilities, yet relatively few studies include them in their analyses. 2 For example, in our sample, mean (median) dismantlement liabilities are $475 million ($303 million), over twice the mean remediation liabilities of $217 million and more than four times the median remediation liabilities of $75 million. Third, few studies have reported dollar amounts of environmental costs, possibly due to the limited number of firms actually disclosing amounts and/or the difficulty in obtaining the numbers. Consequently, to date, research has provided little information as to the effects of environmental costs on firms’ net assets, profitability, and cash flows. Some exceptions are Bewley (2000) and Stanny (1998) who report dollar amounts of remediation liabilities and Clarkson et al. (2004) who provide amounts relating to environmental capital expenditures. We present dollar amounts not only for remediation liabilities and environmental capital expenditures, but also for dismantlement liabilities and environmental operating costs. Finally, we review disclosures during a period of increasing governmental regulation and financial reporting requirements. Most prior studies use data before the increase in regulation that occurred with the implementation of the Staff Accounting Bulletin (SAB) No. 92, issued in 1993. 3 We find that, in spite of the increased regulatory pressure, the percentage of firms reporting the dollar amount of a given environmental item (such as remediation liabilities) in 1998 was generally 50% or less.
1 Examples of studies focusing on remediation liabilities and/or PRP obligations include Ely and Stanny (1999); Barth et al. (1997); Li et al. (1997); Stanny (1998); Freedman and Stagliano (1995). 2 An exception is D’Souza et al. (2000), who examine decommissioning costs for nuclear power plants. 3 Exceptions are Clarkson et al. (2004), Bewley (2000), and Stanny (1998).
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2. Environmental disclosure requirements This section provides an overview of major categories of environmental information that are required, or suggested, to be reported according to various accounting standards. We review the relevant accounting standards in chronological order. Fig. 1 presents a timeline of these standards. The first standard that applied to environmental reporting was SFAS No. 5, issued in 1975. It provided guidance on reporting contingent liabilities, including environmental obligations. The statement requires firms to record a liability for a contingent loss if the amount of the loss can be ‘‘reasonably estimated’’ and the likelihood of the loss is ‘‘probable’’. Footnote disclosure of the contingent loss is appropriate if the likelihood of the loss is at least ‘‘reasonably possible’’. During our sample period, oil and gas companies were required to account for exit costs according to SFAS No. 19 (for successful efforts firms) or the SEC’s Reg. SX 4-10 (for full cost firms), which both state ‘‘Estimated dismantlement, restoration, and abandonment costs and estimated residual salvage values shall be taken into account in determining amortization and depreciation rates.’’ 4 Most oil companies implemented those regulations by using a form of the unit-of-production method in which the proportion of total estimated dismantlement costs expensed in a given period was equal to the proportion of the firms’ proved reserves produced that period. The amount accrued was credited to either an accumulated depreciation, depletion, and amortization account, or to a dismantlement liability account (see Jennings et al., 2000, pp. 485–488). The SEC requires publicly traded firms to disclose in the Management’s Discussion and Analysis (MD&A) section of the 10K and annual report any uncertain event that may materially affect the financial condition of the firm, which could include environmental costs and liabilities. In 1988, the SEC started its MD&A project, ‘‘a special review of the adequacy of MD&A disclosures provided by registrants’’ (Herz et al., 1997, p. 1055). Note that Crude Petroleum and Natural Gas was one of the industries specifically evaluated by the SEC in its third phase of the MD&A project for l0Ks ‘‘filed for the fiscal year ended November 30, 1988 or later’’ (Financial Reporting Release (FRR) No. 36). Later, the SEC’s staff indicated that it would focus particularly on the adequacy of MD&A disclosures regarding environmental liabilities in their review of filings made in 1993 (Jennings, 1993, p. 7). Another change that occurred during our test period is that the EPA now provides the SEC with EPA-obtained, corporate environmental information. The SEC can use this
4
These requirements were superceded by SFAS No. 143, Accounting for Asset Retirement Obligations, which became effective for fiscal years beginning after June 15, 2002.
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Fig. 1. Timeline of environmental reporting standards.
additional information to better determine whether individual firms are providing adequate disclosure relating to their environmental exposure (Johnson, 1993, p. 121). Based on the initial results of the MD&A Project, the SEC issued FRR No. 36 in 1989 to provide registrants with additional guidance relating to MD&A disclosure requirements. The SEC discussed PRP disclosures in FRR No. 36 and provided the following hypothetical case: A registrant has been correctly designated a PRP by the EPA with respect to cleanup of hazardous waste at three sites. . . Management is unable to determine that a material effect on future financial condition or results of operations is not reasonably likely to occur. . . MD&A disclosure of the effects of the PRP status, quantified to the extent reasonably practicable, would be required (FRR 36, IIIB). The SEC also addressed several environmental issues in SAB No. 92, issued in June 1993. It states that ‘‘material liabilities for site restoration. . . or other exit costs. . . should be disclosed in the notes to the financial statements. Appropriate disclosures generally would include. . . the total anticipated cost, the total costs accrued to date, the balance sheet classification of accrued amounts.’’ SAB No. 92 also provides guidance as to information that registrants should report in MD&A and/or Item 1 of the 10K, such as a description of material recurring costs associated with managing pollution, and capital expenditures to limit or monitor pollutants. In addition, in Regulation S-K, the SEC requires firms to report estimated capital expenditures related to environmental control facilities for the current year, and for future years if material (Herz et al., 1997, p. 1008). Finally, the AICPA’s SOP 96-1, Environmental Remediation Liabilities, requires companies to disclose the nature and total amount of their recorded remediation liabilities if it is necessary for the financial statements not to be misleading. For loss contingencies that are reasonably possible, firms must disclose an estimate of the amount of exposure, or the fact that an estimate cannot be made. 3. Description of environmental disclosures The petroleum industry, which is subject to costly environmental regulation, is the focus of our study. The American Petroleum Institute (API) estimates
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that the US petroleum industry had environmental expenditures in 1999 of $7.5 billion (API, 2001). This amount represents one-third of the net income of the top 200 oil and gas producers in the US (API, 2001). Our sample is comprised of 34 firms from the Oil and Gas Journal’s 1994 Energy Database that had (1) oil and gas exploration and production activities, and (2) l0Ks and annual reports available for 1998 and 1989. 5 It includes all of the ‘‘major’’ US oil companies that existed in 1998, large independent oil and gas firms, as well as smaller firms. In 1998, the market value of the sample had a mean (median) of $13.2 billion ($2.7 billion) and ranged from $187 million to $178 billion. For 1989 and 1998, we read the firms’ 10K Items 1 and 14, MD&A, financial statements, and footnotes for information relating to the following categories of environmental disclosures: (1) PRP status, (2) remediation liabilities, (3) dismantlement liabilities, (4) environmental capital expenditures, and (5) environmental operating expenses and/or expenditures. 6 These categories were identified based on the environmental reporting rules issued by the SEC, FASB, and the AICPA as discussed in Section 2. That is, the items listed in these categories (such as the accrued remediation liability) are either required or recommended to be disclosed. We first present what quantitative information our sample firms disclosed relating to environmental liabilities, and then examine the dollar amounts they reported for environmental capital and operating expenditures. 3.1. Disclosures of environmental liabilities Table 1 shows that, overall, disclosure of numerical amounts increased from 1989 to 1998. For example, in 1989 only four firms (12%) disclosed the number of sites on which they were a PRP, while 12 (35%) firms disclosed this information in 1998. The number of PRP sites disclosed increased from a mean
5
The firms must have existed in both 1989 and 1998 so that we can examine changes in environmental disclosures over the period during which the new environmental regulations were issued. As discussed in Section 2, the MD&A project began in 1988, while SOP 96-1 was effective for years beginning after December 15, 1996. We examine disclosures in 1989 and 1998 to allow firms a one-year learning period relative to the MD&A Project and SOP 96-1, respectively. As shown in Fig. 1, four different sets of regulations (the MD&A Project, FRR No. 36, SAB No. 92, and SOP No. 96-1) relating to environmental reporting were issued during the test period. There were no environmental standards issued for a decade before this, so our test period covers a time of substantial change in environmental reporting regulations. The sample size is consistent with numerous prior studies on environmental disclosure such as Blacconiere and Patten (1994), and Neu et al. (1998). 6 Note that category five refers to operating expenses and/or expenditures because some firms report operating expenses, some report operating expenditures (which presumably represent cash outflows), and some report a combination of both.
Variable
1989 N
Number of PRP sites Remediation liabilities Scaled by total liabilities Est. total remed. costs Scaled by total liabilities Dismantlement liabilities Scaled by total liabilities Est. total dismantle costs Scaled by total liabilities Capital expenditures Scaled by total Capex Est. capital expend. Yr + 1 Scaled by total Capex Est. capital expend. Yr + 2 Scaled by total Capex Oper. expense/expend. Scaled by total revenues Current expense/expend. Scaled by total revenues Estimated future expend. Scaled by total revenues Net income/total revenue a
4 4
1998 % 12 12
Mean
Med.
Max
N
9 381 0.036
2 355 0.044
31 792 0.052
12 17
35 50
2
6
12
35
5
15
18
53
16
47
8
24
3
38
2
6
5
15
34
100
0 7
21
455 0.043
346 0.035
1,460 0.100
0 10
29
10
29
7
21
7
21
2
6
5
15
34
100
101 0.057 97 0.066 104 0.094 195 0.008 612 0.013 721 0.028 0.068
68 0.058 70 0.061 40 0.067 185 0.009 612 0.013 98 0.032 0.060
310 0.091 235 0.128 220 0.248 470 0.012 1,185 0.014 2,810 0.049 0.266
%
Mean
Med.
Max
85 217 0.024 94 0.049 475 0.053 384 0.075 87 0.040 114 0.047 180 0.052 267 0.014 80 0.056 79 0.041 )0.058
34 75 0.011 94 0.049 303 0.055 106 0.102 25 0.045 42 0.045 152 0.059 175 0.009 80 0.056 24 0.016 0.020
282 870 0.099 171 0.096 1,400 0.130 1,109 0.118 432 0.100 600 0.113 600 0.072 889 0.040 142 0.102 230 0.165 0.171
Amounts are in millions of dollars (except for the number of PRP sites); N (%) is the number (percentage) of sample firms disclosing the item in that year; the variable ‘‘Capital Expenditures’’ represents Environmental capital expenditures whereas ‘‘Capex’’ are firms’ total capital expenditures for the year; Yr + 1 and Yr + 2 are the fiscal years that are one and two years after the current year.
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Table 1 Environmental items firms disclosed in 1989 and 1998a
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(median) of 9 (2) in 1989 to 85 (34) in 1998, a dramatic increase over the period. The mean (median) amounts disclosed for remediation liabilities decreased from $381 ($355) million in 1989 to $217 ($75) million in 1998. 7 This is consistent with Stanny (1998) who found a decline in the size of reported remediation liabilities over 1991–1993, and Bewley (2000) for the period 1989– 1996. Table 1 also shows that the remediation amounts scaled by total liabilities decreased from a mean (median) of 3.6% (4.4%) in 1989 to 2.4% (1.1%) in 1998. However, the scaled remediation liabilities for three of the four firms that provided remediation amounts in 1989 were actually larger in 1998. Thus, our data indicates that the decrease in the size of the scaled remediation liabilities in 1998 is due to an increased number of firms reporting remediation liabilities, with the new firms tending to report smaller liabilities. Note that the SEC requires separate disclosure of any liability in excess of 5% of total liabilities. The remediation liabilities were approximately greater than or equal to 5% of total liabilities for two of the four firms reporting in 1989 but for only three of the 17 firms reporting in 1998. Thus, it appears that firms may have lowered their threshold for disclosing remediation liabilities over the period. Regarding dismantlement liabilities, Table 1 shows that the number of firms disclosing dollar amounts increased from seven (21%) in 1989 to 12 (35%) in 1998. Table 1 also indicates that the average scaled dismantlement liability in 1998 was more than twice the average remediation liability, and the median dismantlement amount was five times that for remediation obligations. Thus, for our sample, the reported dismantlement obligations represent a much larger environmental liability than reported remediation liabilities. While our sample includes only petroleum firms, firms in all industries are required to report environmental exit costs under SAB No. 92 (and now under SFAS No. 143, Accounting for Asset Retirement Obligations). Our findings suggest that these liabilities may represent a significant part of environmental costs that should be considered in future research on environmental reporting. A final major issue relating to environmental liabilities is that the PRP liability is a relatively small part of the remediation obligation for the firms that provided that information. Superfund and similar sites account for between 5.1% and 9.8% of 1998 remediation liabilities for the four firms that reported the data. Further, if one includes the firms’ dismantlement liabilities, the percentages decrease to a range of 0.6–3.6%. Moreover, these small percentages relate to some of the largest oil companies, which one might expect to be particularly likely to be named a PRP given their ‘‘deep pockets.’’ Much of the prior literature has focused on Superfund and other PRP obligations. Our findings suggest that these PRP obligations may be just the tip of the iceberg,
7
Numbers are as reported (not adjusted for inflation).
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and that there are extensive environmental costs beyond these for future research to examine. 3.2. Disclosures of environmental capital and operating expenditures Table 1 shows that 53% of the firms disclosed environmental capital expenditures in 1998, versus 29% in 1989. It also reports that mean environmental capital expenditures (scaled by total capital expenditures) were 5.7% in 1989 and 4.0% in 1998. Thus, as with remediation liabilities, more firms are disclosing in 1998 but the average amounts disclosed are smaller. The amounts disclosed for environmental operating expenses/expenditures went from a mean of $195 million in 1989 to $267 million in 1998. Note that the average amounts for the operating costs in 1998 were more than triple the size of the average environmental capital expenditures. Moreover, as a proportion of total revenues, average environmental operating costs increased 75% from 0.8% of revenues in 1989 to 1.4% in 1998. To put these amounts into perspective, return on sales (net income divided by total revenue) for our firms for 1993–1997 averaged 5.2%. 8 If, on average, environmental expenses decreased the firms’ return on sales from 6.6% (5.2% + 1.4% environmental costs) to 5.2%, their bottom line profitability would be cut by more than 21%.
4. Conclusion We examine a broad set of environmental disclosures that are based on rules promulgated by the SEC, FASB, and AICPA. We find that the number of firms disclosing dollar amounts of remediation liabilities quadrupled over the test period. Our data suggests that the decrease in the mean and median size of these liabilities from 1989 to 1998 is due to an increased number of firms reporting them, with the new firms tending to report smaller liabilities. Moreover, the median dismantlement liability for 1998, as a percentage of total liabilities, was 5.5%, compared to the median remediation liability of 1.1%. We find that the percentage of total environmental liabilities (remediation and exit obligations) represented by Superfund and other sites in 1998 ranges from only 0.6% to 3.6%. While much of the prior literature has focused on Superfund and other PRP obligations and/or remediation liabilities, our findings suggest that remediation liabilities and especially PRP obligations represent a small proportion of environmental costs. That is, there are extensive environmental costs beyond these for future research to explore.
8
We excluded 1998 since earnings were unusually low that year due to a plunge in oil prices.
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References American Petroleum Institute, 2001. US Petroleum Industry’s Environmental Expenditures. Available from. Barth, M., McNichols, M., Wilson, G.P., 1997. Factors influencing firms’ disclosures about environmental liabilities. Review of Accounting Studies 2, 35–64. Bewley, K., 2000. The impact of SAB No. 92 on the value relevance of reported environmental liabilities. Working Paper, York University. Blacconiere, W., Patten, D., 1994. Environmental disclosures, regulatory costs, and changes in firm value. Journal of Accounting and Economics 18, 357–377. Clarkson, P., Li, Y., Richardson, G., 2004. The market valuation of environmental capital expenditures by pulp and paper companies. The Accounting Review 79, 329–353. D’Souza, J., Jacob, J., Soderstrom, N., 2000. Nuclear decommissioning costs: The impact of recoverability risk on valuation. Journal of Accounting and Economics 29, 207–230. Ely, K., Stanny, E., 1999. User sophistication and the specificity of disclosure as reflected in disclosure of a firm’s status as a potentially responsible party. Working Paper, Emory University. Freedman, M., Stagliano, A.J., 1995. Disclosure of environmental cleanup costs: The impact of the Superfund act. Advances in Public Interest Accounting 6, 163–176. Herz, R., Dittmar, N., Lis, S., Decker, W., Murray, R., 1997. The Coopers and Lybrand SEC Manual, 7th ed. John Wiley and Sons, New York. Jennings, D., 1993. Current developments in financial accounting and reporting. Petroleum Accounting and Financial Management Journal (Spring), 1–7. Jennings, D., Feiten, J., Brock, H., 2000. Petroleum Accounting: Principles, Procedures, and Issues, 5th ed. Professional Development Institute, Denton, TX. Johnson, L.T., 1993. Research on Environmental Reporting. Accounting Horizons 7 (September), 118–123. Li, Y., Richardson, G., Thornton, D., 1997. Corporate disclosure of environmental liability information: Theory and evidence. Contemporary Accounting Research 14 (2), 435–474. Neu, D., Warsame, H., Pedwell, K., 1998. Managing public impressions: Environmental disclosures in annual reports. Accounting, Organizations, and Society 23 (3), 265–282. Roberts, R., Hohl, K., 1994. Environmental liability disclosure and Staff Accounting Bulletin No. 92. The Business Lawyer 50 (November), 1–17. Stanny, E., 1998. Effect of regulation on changes in disclosure of and reserved amounts for environmental liabilities. The Journal of Financial Statement Analysis (Summer), 34–49.
Changes in environmental regulation and reporting: The case of the petroleum industry from 1989 to 1998 Mimi Alciatore a, Carol Callaway Dee b, Peter Easton
c,*
a
University of Houston, USA Florida State University, USA Department of Accounting, Mendoza College of Business, University of Notre Dame, 305A Mendoza, Notre Dame, IN 46556, USA b
c
Available online Abstract We present a detailed description of changes in environmental disclosures by petroleum companies from 1989 to 1998, a period of significant promulgation of environmental reporting regulations. We extend prior research by (a) examining a richer, more comprehensive set of environmental data, (b) reporting the dollar amounts disclosed, (c) describing the availability of those disclosures in annual reports and Forms 10K, and (d) documenting the change in environmental reporting patterns and amounts over 1989–1998. This description provides a broad basis for the development of hypotheses for future research, and makes it clear that data used in extant research on environmental disclosures is only a small subset of reported data. Ó 2004 Elsevier Inc. All rights reserved. Keywords: Financial reporting; Disclosure; Environmental accounting; SEC; Regulation; Oil and gas
1. Introduction We present an in-depth description of environmental disclosures in order to call attention to the opportunities available to expand the breadth and depth of
*
Corresponding author. Tel.: +574-631-6096; fax: +574-631-5544. E-mail address: [email protected] (P. Easton).
0278-4254/$ - see front matter Ó 2004 Elsevier Inc. All rights reserved. doi:10.1016/j.jaccpubpol.2004.06.002
296
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environmental research. Prior environmental studies often focused on potentially responsible party (PRP) obligations, or more generally, remediation liabilities. Our findings reveal that these amounts are just the tip of the iceberg when it comes to the total environmental costs a firm may face. We extend prior research by (a) examining a richer, more comprehensive set of environmental data, (b) reporting the dollar amounts disclosed, (c) describing the availability of those disclosures in annual reports and Forms 10K, and (d) documenting the change in environmental reporting patterns and amounts over 1989–1998. This description provides a broad basis for the development of hypotheses for future research, and makes it clear that data used in extant research on environmental disclosures is only a small subset of reported data. The Securities and Exchange Commission (SEC) is concerned with the adequacy of firms’ disclosures of environmental costs. With regard to the SEC’s examination of registrants’ environmental reporting, Roberts (former SEC commissioner) and Hohl write (Roberts and Hohl, 1994, p. 2). This scrutiny is expected to continue in the foreseeable future and may become even more intense with respect to registrants in industries significantly affected by environmental risks. When the Staff finds material omissions or deficiencies relating to environmental matters, it will continue to request corrective disclosure and, in egregious cases, to refer the matter to the Commissions Division of Enforcement for appropriate enforcement consideration. Despite these ominous words, there is little documentation regarding firms’ disclosure levels relative to the extensive environmental reporting rules promulgated during the 1990s. To bridge this gap in the literature, we describe shifts in environmental disclosures from 1989 to 1998 for a sample of firms in the petroleum industry. This period was a time of increased environmental disclosure regulation and public and governmental pressure regarding environmental obligations of public companies. Specifically, we examine the Forms 10-K (10Ks) and annual reports for environmental disclosures relating to: (1) PRP information under the 1980 Comprehensive Environmental Response and Liability Act and the 1986 Superfund Amendments and Reauthorization Act, (2) remediation liabilities, (3) environmental exit costs (‘‘dismantlement liabilities’’), (4) environmental capital expenditures, and (5) environmental operating expenditures. Each of these items is either required or recommended to be disclosed by either the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), or the SEC. Our paper contributes to the literature in the following ways. First, we examine a more complete set of environmental disclosures than those examined
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in the literature to date. Many prior studies focus on environmental disclosures related to a firm’s PRP obligations, which allows the researcher to use data provided by the Environmental Protection Agency (EPA). However, for our sample, PRP obligations represented only 5.1–9.8% of total remediation liabilities in 1998. If one includes exit costs, the percentage of total environmental liabilities represented by PRP sites drops to a range of 0.6–3.6%. Thus, our findings suggest that PRP obligations may represent a small percentage of the environmental liabilities a firm may face. Moreover, these amounts relate only to environmental liabilities, and do not consider the financial implications of environmental capital and operating expenditures. Overall, our paper highlights the fact that remediation liabilities, the central focus of many prior studies, are just one subset of total reported environmental costs. 1 Second, we examine environmental exit costs. These costs can be much larger than remediation liabilities, yet relatively few studies include them in their analyses. 2 For example, in our sample, mean (median) dismantlement liabilities are $475 million ($303 million), over twice the mean remediation liabilities of $217 million and more than four times the median remediation liabilities of $75 million. Third, few studies have reported dollar amounts of environmental costs, possibly due to the limited number of firms actually disclosing amounts and/or the difficulty in obtaining the numbers. Consequently, to date, research has provided little information as to the effects of environmental costs on firms’ net assets, profitability, and cash flows. Some exceptions are Bewley (2000) and Stanny (1998) who report dollar amounts of remediation liabilities and Clarkson et al. (2004) who provide amounts relating to environmental capital expenditures. We present dollar amounts not only for remediation liabilities and environmental capital expenditures, but also for dismantlement liabilities and environmental operating costs. Finally, we review disclosures during a period of increasing governmental regulation and financial reporting requirements. Most prior studies use data before the increase in regulation that occurred with the implementation of the Staff Accounting Bulletin (SAB) No. 92, issued in 1993. 3 We find that, in spite of the increased regulatory pressure, the percentage of firms reporting the dollar amount of a given environmental item (such as remediation liabilities) in 1998 was generally 50% or less.
1 Examples of studies focusing on remediation liabilities and/or PRP obligations include Ely and Stanny (1999); Barth et al. (1997); Li et al. (1997); Stanny (1998); Freedman and Stagliano (1995). 2 An exception is D’Souza et al. (2000), who examine decommissioning costs for nuclear power plants. 3 Exceptions are Clarkson et al. (2004), Bewley (2000), and Stanny (1998).
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2. Environmental disclosure requirements This section provides an overview of major categories of environmental information that are required, or suggested, to be reported according to various accounting standards. We review the relevant accounting standards in chronological order. Fig. 1 presents a timeline of these standards. The first standard that applied to environmental reporting was SFAS No. 5, issued in 1975. It provided guidance on reporting contingent liabilities, including environmental obligations. The statement requires firms to record a liability for a contingent loss if the amount of the loss can be ‘‘reasonably estimated’’ and the likelihood of the loss is ‘‘probable’’. Footnote disclosure of the contingent loss is appropriate if the likelihood of the loss is at least ‘‘reasonably possible’’. During our sample period, oil and gas companies were required to account for exit costs according to SFAS No. 19 (for successful efforts firms) or the SEC’s Reg. SX 4-10 (for full cost firms), which both state ‘‘Estimated dismantlement, restoration, and abandonment costs and estimated residual salvage values shall be taken into account in determining amortization and depreciation rates.’’ 4 Most oil companies implemented those regulations by using a form of the unit-of-production method in which the proportion of total estimated dismantlement costs expensed in a given period was equal to the proportion of the firms’ proved reserves produced that period. The amount accrued was credited to either an accumulated depreciation, depletion, and amortization account, or to a dismantlement liability account (see Jennings et al., 2000, pp. 485–488). The SEC requires publicly traded firms to disclose in the Management’s Discussion and Analysis (MD&A) section of the 10K and annual report any uncertain event that may materially affect the financial condition of the firm, which could include environmental costs and liabilities. In 1988, the SEC started its MD&A project, ‘‘a special review of the adequacy of MD&A disclosures provided by registrants’’ (Herz et al., 1997, p. 1055). Note that Crude Petroleum and Natural Gas was one of the industries specifically evaluated by the SEC in its third phase of the MD&A project for l0Ks ‘‘filed for the fiscal year ended November 30, 1988 or later’’ (Financial Reporting Release (FRR) No. 36). Later, the SEC’s staff indicated that it would focus particularly on the adequacy of MD&A disclosures regarding environmental liabilities in their review of filings made in 1993 (Jennings, 1993, p. 7). Another change that occurred during our test period is that the EPA now provides the SEC with EPA-obtained, corporate environmental information. The SEC can use this
4
These requirements were superceded by SFAS No. 143, Accounting for Asset Retirement Obligations, which became effective for fiscal years beginning after June 15, 2002.
M. Alciatore et al. / Journal of Accounting and Public Policy 23 (2004) 295–304
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Fig. 1. Timeline of environmental reporting standards.
additional information to better determine whether individual firms are providing adequate disclosure relating to their environmental exposure (Johnson, 1993, p. 121). Based on the initial results of the MD&A Project, the SEC issued FRR No. 36 in 1989 to provide registrants with additional guidance relating to MD&A disclosure requirements. The SEC discussed PRP disclosures in FRR No. 36 and provided the following hypothetical case: A registrant has been correctly designated a PRP by the EPA with respect to cleanup of hazardous waste at three sites. . . Management is unable to determine that a material effect on future financial condition or results of operations is not reasonably likely to occur. . . MD&A disclosure of the effects of the PRP status, quantified to the extent reasonably practicable, would be required (FRR 36, IIIB). The SEC also addressed several environmental issues in SAB No. 92, issued in June 1993. It states that ‘‘material liabilities for site restoration. . . or other exit costs. . . should be disclosed in the notes to the financial statements. Appropriate disclosures generally would include. . . the total anticipated cost, the total costs accrued to date, the balance sheet classification of accrued amounts.’’ SAB No. 92 also provides guidance as to information that registrants should report in MD&A and/or Item 1 of the 10K, such as a description of material recurring costs associated with managing pollution, and capital expenditures to limit or monitor pollutants. In addition, in Regulation S-K, the SEC requires firms to report estimated capital expenditures related to environmental control facilities for the current year, and for future years if material (Herz et al., 1997, p. 1008). Finally, the AICPA’s SOP 96-1, Environmental Remediation Liabilities, requires companies to disclose the nature and total amount of their recorded remediation liabilities if it is necessary for the financial statements not to be misleading. For loss contingencies that are reasonably possible, firms must disclose an estimate of the amount of exposure, or the fact that an estimate cannot be made. 3. Description of environmental disclosures The petroleum industry, which is subject to costly environmental regulation, is the focus of our study. The American Petroleum Institute (API) estimates
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that the US petroleum industry had environmental expenditures in 1999 of $7.5 billion (API, 2001). This amount represents one-third of the net income of the top 200 oil and gas producers in the US (API, 2001). Our sample is comprised of 34 firms from the Oil and Gas Journal’s 1994 Energy Database that had (1) oil and gas exploration and production activities, and (2) l0Ks and annual reports available for 1998 and 1989. 5 It includes all of the ‘‘major’’ US oil companies that existed in 1998, large independent oil and gas firms, as well as smaller firms. In 1998, the market value of the sample had a mean (median) of $13.2 billion ($2.7 billion) and ranged from $187 million to $178 billion. For 1989 and 1998, we read the firms’ 10K Items 1 and 14, MD&A, financial statements, and footnotes for information relating to the following categories of environmental disclosures: (1) PRP status, (2) remediation liabilities, (3) dismantlement liabilities, (4) environmental capital expenditures, and (5) environmental operating expenses and/or expenditures. 6 These categories were identified based on the environmental reporting rules issued by the SEC, FASB, and the AICPA as discussed in Section 2. That is, the items listed in these categories (such as the accrued remediation liability) are either required or recommended to be disclosed. We first present what quantitative information our sample firms disclosed relating to environmental liabilities, and then examine the dollar amounts they reported for environmental capital and operating expenditures. 3.1. Disclosures of environmental liabilities Table 1 shows that, overall, disclosure of numerical amounts increased from 1989 to 1998. For example, in 1989 only four firms (12%) disclosed the number of sites on which they were a PRP, while 12 (35%) firms disclosed this information in 1998. The number of PRP sites disclosed increased from a mean
5
The firms must have existed in both 1989 and 1998 so that we can examine changes in environmental disclosures over the period during which the new environmental regulations were issued. As discussed in Section 2, the MD&A project began in 1988, while SOP 96-1 was effective for years beginning after December 15, 1996. We examine disclosures in 1989 and 1998 to allow firms a one-year learning period relative to the MD&A Project and SOP 96-1, respectively. As shown in Fig. 1, four different sets of regulations (the MD&A Project, FRR No. 36, SAB No. 92, and SOP No. 96-1) relating to environmental reporting were issued during the test period. There were no environmental standards issued for a decade before this, so our test period covers a time of substantial change in environmental reporting regulations. The sample size is consistent with numerous prior studies on environmental disclosure such as Blacconiere and Patten (1994), and Neu et al. (1998). 6 Note that category five refers to operating expenses and/or expenditures because some firms report operating expenses, some report operating expenditures (which presumably represent cash outflows), and some report a combination of both.
Variable
1989 N
Number of PRP sites Remediation liabilities Scaled by total liabilities Est. total remed. costs Scaled by total liabilities Dismantlement liabilities Scaled by total liabilities Est. total dismantle costs Scaled by total liabilities Capital expenditures Scaled by total Capex Est. capital expend. Yr + 1 Scaled by total Capex Est. capital expend. Yr + 2 Scaled by total Capex Oper. expense/expend. Scaled by total revenues Current expense/expend. Scaled by total revenues Estimated future expend. Scaled by total revenues Net income/total revenue a
4 4
1998 % 12 12
Mean
Med.
Max
N
9 381 0.036
2 355 0.044
31 792 0.052
12 17
35 50
2
6
12
35
5
15
18
53
16
47
8
24
3
38
2
6
5
15
34
100
0 7
21
455 0.043
346 0.035
1,460 0.100
0 10
29
10
29
7
21
7
21
2
6
5
15
34
100
101 0.057 97 0.066 104 0.094 195 0.008 612 0.013 721 0.028 0.068
68 0.058 70 0.061 40 0.067 185 0.009 612 0.013 98 0.032 0.060
310 0.091 235 0.128 220 0.248 470 0.012 1,185 0.014 2,810 0.049 0.266
%
Mean
Med.
Max
85 217 0.024 94 0.049 475 0.053 384 0.075 87 0.040 114 0.047 180 0.052 267 0.014 80 0.056 79 0.041 )0.058
34 75 0.011 94 0.049 303 0.055 106 0.102 25 0.045 42 0.045 152 0.059 175 0.009 80 0.056 24 0.016 0.020
282 870 0.099 171 0.096 1,400 0.130 1,109 0.118 432 0.100 600 0.113 600 0.072 889 0.040 142 0.102 230 0.165 0.171
Amounts are in millions of dollars (except for the number of PRP sites); N (%) is the number (percentage) of sample firms disclosing the item in that year; the variable ‘‘Capital Expenditures’’ represents Environmental capital expenditures whereas ‘‘Capex’’ are firms’ total capital expenditures for the year; Yr + 1 and Yr + 2 are the fiscal years that are one and two years after the current year.
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Table 1 Environmental items firms disclosed in 1989 and 1998a
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(median) of 9 (2) in 1989 to 85 (34) in 1998, a dramatic increase over the period. The mean (median) amounts disclosed for remediation liabilities decreased from $381 ($355) million in 1989 to $217 ($75) million in 1998. 7 This is consistent with Stanny (1998) who found a decline in the size of reported remediation liabilities over 1991–1993, and Bewley (2000) for the period 1989– 1996. Table 1 also shows that the remediation amounts scaled by total liabilities decreased from a mean (median) of 3.6% (4.4%) in 1989 to 2.4% (1.1%) in 1998. However, the scaled remediation liabilities for three of the four firms that provided remediation amounts in 1989 were actually larger in 1998. Thus, our data indicates that the decrease in the size of the scaled remediation liabilities in 1998 is due to an increased number of firms reporting remediation liabilities, with the new firms tending to report smaller liabilities. Note that the SEC requires separate disclosure of any liability in excess of 5% of total liabilities. The remediation liabilities were approximately greater than or equal to 5% of total liabilities for two of the four firms reporting in 1989 but for only three of the 17 firms reporting in 1998. Thus, it appears that firms may have lowered their threshold for disclosing remediation liabilities over the period. Regarding dismantlement liabilities, Table 1 shows that the number of firms disclosing dollar amounts increased from seven (21%) in 1989 to 12 (35%) in 1998. Table 1 also indicates that the average scaled dismantlement liability in 1998 was more than twice the average remediation liability, and the median dismantlement amount was five times that for remediation obligations. Thus, for our sample, the reported dismantlement obligations represent a much larger environmental liability than reported remediation liabilities. While our sample includes only petroleum firms, firms in all industries are required to report environmental exit costs under SAB No. 92 (and now under SFAS No. 143, Accounting for Asset Retirement Obligations). Our findings suggest that these liabilities may represent a significant part of environmental costs that should be considered in future research on environmental reporting. A final major issue relating to environmental liabilities is that the PRP liability is a relatively small part of the remediation obligation for the firms that provided that information. Superfund and similar sites account for between 5.1% and 9.8% of 1998 remediation liabilities for the four firms that reported the data. Further, if one includes the firms’ dismantlement liabilities, the percentages decrease to a range of 0.6–3.6%. Moreover, these small percentages relate to some of the largest oil companies, which one might expect to be particularly likely to be named a PRP given their ‘‘deep pockets.’’ Much of the prior literature has focused on Superfund and other PRP obligations. Our findings suggest that these PRP obligations may be just the tip of the iceberg,
7
Numbers are as reported (not adjusted for inflation).
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and that there are extensive environmental costs beyond these for future research to examine. 3.2. Disclosures of environmental capital and operating expenditures Table 1 shows that 53% of the firms disclosed environmental capital expenditures in 1998, versus 29% in 1989. It also reports that mean environmental capital expenditures (scaled by total capital expenditures) were 5.7% in 1989 and 4.0% in 1998. Thus, as with remediation liabilities, more firms are disclosing in 1998 but the average amounts disclosed are smaller. The amounts disclosed for environmental operating expenses/expenditures went from a mean of $195 million in 1989 to $267 million in 1998. Note that the average amounts for the operating costs in 1998 were more than triple the size of the average environmental capital expenditures. Moreover, as a proportion of total revenues, average environmental operating costs increased 75% from 0.8% of revenues in 1989 to 1.4% in 1998. To put these amounts into perspective, return on sales (net income divided by total revenue) for our firms for 1993–1997 averaged 5.2%. 8 If, on average, environmental expenses decreased the firms’ return on sales from 6.6% (5.2% + 1.4% environmental costs) to 5.2%, their bottom line profitability would be cut by more than 21%.
4. Conclusion We examine a broad set of environmental disclosures that are based on rules promulgated by the SEC, FASB, and AICPA. We find that the number of firms disclosing dollar amounts of remediation liabilities quadrupled over the test period. Our data suggests that the decrease in the mean and median size of these liabilities from 1989 to 1998 is due to an increased number of firms reporting them, with the new firms tending to report smaller liabilities. Moreover, the median dismantlement liability for 1998, as a percentage of total liabilities, was 5.5%, compared to the median remediation liability of 1.1%. We find that the percentage of total environmental liabilities (remediation and exit obligations) represented by Superfund and other sites in 1998 ranges from only 0.6% to 3.6%. While much of the prior literature has focused on Superfund and other PRP obligations and/or remediation liabilities, our findings suggest that remediation liabilities and especially PRP obligations represent a small proportion of environmental costs. That is, there are extensive environmental costs beyond these for future research to explore.
8
We excluded 1998 since earnings were unusually low that year due to a plunge in oil prices.
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References American Petroleum Institute, 2001. US Petroleum Industry’s Environmental Expenditures. Available from