Environmental disclosure quality: Evidence on environmental performance, corporate governance and value relevance

Environmental disclosure quality: Evidence on environmental performance, corporate governance and value relevance

Emerging Markets Review 14 (2013) 55–75 Contents lists available at SciVerse ScienceDirect Emerging Markets Review journal homepage: www.elsevier.co...

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Emerging Markets Review 14 (2013) 55–75

Contents lists available at SciVerse ScienceDirect

Emerging Markets Review journal homepage: www.elsevier.com/locate/emr

Environmental disclosure quality: Evidence on environmental performance, corporate governance and value relevance George Emmanuel Iatridis University of Thessaly, Department of Economics, Volos, Greece Accounting and Auditing Oversight Board, Ministry of Economics, Athens, Greece

a r t i c l e

i n f o

Article history: Received 17 September 2012 Received in revised form 29 October 2012 Accepted 27 November 2012 Available online 5 December 2012 JEL classification: M41 Keywords: Emerging markets Environmental disclosure Environmental performance Corporate governance Value relevance Investor perceptions

a b s t r a c t This study focuses on common-law Malaysia, which is classified as an advanced emerging market. It assesses the association between environmental disclosure and environmental performance and examines the financial attributes of companies with different environmental disclosure scores. It investigates the relation between environmental disclosure quality and corporate governance, and also examines the extent to which effective environmental disclosures are value relevant and how they influence investor perceptions. The findings of the study show that environmental disclosure is positively linked to environmental performance. Company attributes, such as large size, the need for capital, profitability and capital spending, are positively associated with environmental disclosure quality. High quality environmental disclosers display effective corporate governance and would tend to face less difficulties in accessing capital markets. They generally are audited by a big 4 auditor or cross-listed on foreign stock exchanges and display significant levels of managerial and institutional ownership. High quality environmental disclosures are value relevant and improve investor perceptions. High quality disclosers overall belong to beverages, chemicals, food producers, forestry and paper, and industrial metals and mining. © 2012 Elsevier B.V. All rights reserved.

1. Introduction This study examines the quality of reported information about company environmental performance and the association between company practices and the environment. Sustainability is a central issue for business and society. Scarcity and the cost and financial value of natural resources are crucial to business activity. More important however is the protection of environment. Although the initiatives that may be undertaken vary, the costs involved limit the motivation to undertake them. Financial reporting is important for disclosing E-mail address: [email protected]. 1566-0141/$ – see front matter © 2012 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.ememar.2012.11.003

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crucial information about the options that are available for adopting environment-friendly industrial practices and the related costs. The disclosure of company environmental policies in annual reports would allow investors and other interested parties to make informed judgements about the efficiency and impact of managers' sustainability decisions and actions (Deegan, 2004). High quality disclosures would provide a signal of transparency and would enhance managers' reputation and social profile (Deegan et al., 2006; Patel et al., 2002; Simnett et al., 2009). For example, information about the management policy on spending relating to significant environmental actions would reduce uncertainty and would earn the company a competitive advantage. Investors would require the disclosure of useful narrative and numerical information about environmental risks and choices and risk management policies (Solomon and Solomon, 2006). Disclosures to be of high quality, they will need to provide explicit information about managerial judgements, assumptions and estimations relating to relevant valuation and projection models. Of particular interest are the disclosures that relate to changes of environmental policies, environmental liabilities, environmental costs and environmental impairment. The provision of detailed disclosures would reduce the potential for earnings manipulation. In addition, the International Corporate Governance Network has pointed that informative disclosures about the environment are important for investors when evaluating a company's value and future prospects as well as opportunities and risks. Environmental disclosures should include key environmental matters and their impact on companies' future performance and position, risks and uncertainties, material items of income or expense, policies on significant environmental issues, such as emissions trading, etc. They should report on emissions trading schemes and include reporting greenhouse gas emissions, calculating direct emissions, e.g. fuel combustion in boilers, and indirect emissions, e.g. waste disposal, disclosing expenditure on energy, reporting on direct energy, e.g. oil and coal, and indirect energy, e.g. electricity purchases, reporting quantities of water abstracted, reporting quantities of waste, reporting on policies on water use, etc. They should also explain how their tangible and intangible assets may be affected by environmental impairment. Hazardous items would require special treatment. Additional disclosures should include fines or penalties for non-regulatory compliance, environmental friendly capital investments, compliance with internal and external environmental reporting quality benchmarks, and contribution to sustainability projects. Companies should also disclose information about their environmental plan of action and strategy leading to environment-friendly products. Overall, the reported information should be in line with accounting principles and meet the reporting requirements as prescribed by accounting regulation. Hence, it should be relevant, understandable and accessible to users, provided on a timely basis, and possess confirmatory value. It should also be comparable, reliable and free of error or bias. Socially and environmentally sensitive disclosures would tend to be highly valued by financial analysts, investors and market authorities to the extent that they are meaningful and value relevant (Throop et al., 1993). The presentation of numerical environmental information would contribute to reducing environmental costs and costs of capital, and increasing productivity and regulatory compliance. Lack of sufficient information about material environmental areas might give rise to significant political costs and concerns at local or national level. This would tend to be more evident in the case of large companies, since large size would attract political and regulatory attention and would motivate managers to provide higher quality sustainability disclosures. Agency theory deals with conflicts in the association between shareholders and managers (Jensen and Meckling, 1976). Graves and Waddock (1994) argue that managers, driven by self-interest, may be more willing than shareholders to spend more on environmental protection policies as it is shareholders' money and not their own. An annual report should communicate easy-to-verify and difficult-to-verify financial information (Fields et al., 2001; Meek et al., 1995). A focal issue is whether an annual report presents the true and fair view of a company's financial performance and position or serves managers' personal financial objectives and bonus pursuits (Lambert, 2001; Roberts, 1992). According to agency theory, shareholders would need to establish mechanisms to monitor managers, reduce opportunism and information asymmetry, and ensure that shareholders' wealth is maximised (Cormier and Magnan, 2003; Healy and Palepu, 2001). If effective monitoring devices were in place, managers would be more careful and would tend to better look after shareholders' objectives (Eisenhardt, 1989). A number of corporate governance mechanisms, such as material managerial ownership, the

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existence of non-executive or independent directors on the board of directors, and the presence of internal control, compensation and nomination committees, would monitor managers' decisions and actions and would limit the potential for earnings manipulation (Greeno, 1993; Halme and Huse, 1997; Mitton, 2004). The quality of investor protection mechanisms and environmental care as well as the magnitude of environmental problems and the means of solving them would vary from country to country (Silberhorn and Warren, 2007; van der Laan Smith et al., 2005). For example, it is documented that the Nordic countries have been more environmental cautious than southern European countries (Bernes, 1993). This is also evidenced by the requirements for reporting specific information about environmental impact and by the level of the presentation of voluntary disclosures (Choi and Mueller, 1992). Moreover, common-law countries, which are shareholder/investor oriented and have strong investor protection mechanisms and effective corporate governance structures in place, would tend to promote shareholder values, including the disclosure of environmental risks exposure, risk management and problems, to a greater extent than code-law countries that are government-driven, tax-dominated and lender/creditor oriented (Ball et al., 2000; Jaggi and Low, 2000). In the absence of a strong and effective regulatory framework or effective governance structures to evaluate the quality and added value of environmental disclosures, the reported information may be misleading and not reflective of firm environmental performance (Patten, 2005). This study focuses on Malaysia and uses the agency theory as the theoretical background. Malaysia is classified as an advanced emerging market based on the 2011 FTSE Global Equity Index. The legal system of Malaysia is based on English Common Law. According to 2011 World Bank national accounts data, the Malaysian GDP at purchasing power parity was $15,568 per capita and $447.279 billion in total. The literature on Malaysian environmental practice is limited. Nik Ahmad and Sulaiman (2004) and Yusoff et al. (2005) show that environmental disclosures that are reported by Malaysian companies have overall been general and narrative in their nature. Numerical or difficult-to-verify information has been reported less frequently. An early survey carried out by ACCA (2002) has shown that only 7.7% of the sample companies provided environmental information on a voluntary basis. However, this percentage is reported to grow over time in terms of quality and quantity (ACCA, 2004; Yusoff and Lehman, 2009). More Malaysian companies report key performance indicators, material environmental issues, environmental costs, and stakeholder feeds. Yusoff and Lehman (2009) explain that the reporting of environmental disclosures in Malaysia has also increased by significant local efforts, such as the issue of the Malaysia Code on Corporate Governance and the joint development of environmental reporting guidance by the government and ACCA Malaysia. Also, although environmental reporting is voluntary in Malaysia, the Malaysian Financial Reporting Standard 101 ‘Presentation of Financial Statements’ encourages the reporting of environmental disclosures. In addition, national regulation supports environment protection, penalises pollution and evaluates companies' environment impact. Jaffar and Buniamin (2004) argue that Malaysian companies generally use environmental reporting to improve their business profile and influence investor perceptions. Yusoff et al. (2007) have found that Malaysian companies tend to report environmental disclosures mainly to obtain ISO 14001 certification. Corbett et al. (2003) report that companies may seek to obtain ISO 14001 certification in order to improve their relations with market authorities, suppliers, the local community and other accounting users. It is therefore important to study the extent to which Malaysia, which is an emerging country and depends on international capital and money markets, would disclose environmental information to gain international investor confidence and reap trade and economic benefits. Effective corporate governance structures that would follow from privatisations would also call for higher quality environmental disclosures. This study examines the association between environmental disclosure and environmental performance and the financial attributes of companies with different environmental disclosure scores. It also seeks to investigate the association between environmental disclosure quality and corporate governance. Companies with effective environmental and corporate governance structures would be expected to face less capital constraints and experience easier access to capital markets. Further, this study assesses the extent to which environmental disclosures are value relevant and also the association between effective environmental disclosures and investor perceptions. Overall, this study predicts that companies that operate in strict regulatory environments, in terms of corporate governance and capital market structures, should display higher quality and value relevance of environmental disclosures. The findings of the study show that environmental disclosure is positively linked to environmental performance. Company attributes, such as large size, the need for capital, profitability and capital spending,

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are positively associated with environmental disclosure quality. High quality environmental disclosers display effective corporate governance and would tend to face less difficulties in accessing capital markets. They generally are audited by a big 4 auditor or cross-listed on foreign stock exchanges and display significant levels of managerial and institutional ownership. High quality environmental disclosures are value relevant and improve investor perceptions. High quality disclosers overall belong to beverages, chemicals, food producers, forestry and paper, and industrial metals and mining. The remaining sections of the study are as follows. Section 2 presents background considerations. Section 3 shows the research hypotheses. Section 4 describes the datasets and the environmental disclosure index. Section 5 discusses the empirical findings, and Section 6 presents the conclusions of the study. 2. Background considerations Informative environmental disclosures would carry significant value since alternative sources of company-related environmental information may be limited (Cormier et al., 2005). Shareholders would require environmental disclosures to be audited in order to ensure their reliability and hold managers accountable for the environmental impact of their decisions (de Villiers and van Staden, 2010; Sutton and Arnold, 1998). Companies would be inclined to provide accurate and reliable disclosures to avoid negative audit reports and disappointing investors or attracting authorities' attention. Also, the use of environmental performance ratings would reinforce the value relevance of the reported financial statements (Hassel et al., 2005). The reporting of meaningful environmental disclosures would also assist investors in effectively evaluating the risk exposure and level of a company and would therefore enable them to revise their investment strategy and portfolio accordingly (Cormier et al., 2005). The increase in the reporting of environmental disclosures is closely related to the institutional background, the regulatory environment, risk exposure, environmental pressure groups, media and political costs. Τhe existence of effective corporate governance mechanisms is significantly associated with the quality of environmental reporting since managers decide on the level of detail and relevance of reported financial information (Claessens and Yurtoglu, in press; Gibbins et al., 1990). The existence of non-executive directors is positively related to environmental reporting. Non-executive directors would ensure that managers act in the best interest of shareholders and adopt environmental friendly policies, and thus positively influence societal perceptions (Zahra and Stanton, 1988). Likewise, environmental disclosures are positively related to board members holding multiple directorships. Their participation in other companies' boards would imply that their shareholder and company wealth-maximising abilities and qualities are widely valued and appreciated. In a similar vein, foreign share ownership is positively related to environmental reporting, since foreign investors are likely to appreciate or require high quality and advanced disclosures (Craswell and Taylor, 1992; Haniffa and Cooke, 2005). Similar considerations would hold for companies that are cross-listed on foreign stock exchanges, which would need to comply with national market regulations and meet the needs of various interested parties (Andrew et al., 1989). The association between shareholders and managers would determine the company attention on environmental care. Higher ownership dispersion would indicate that the shareholders would be more focused on company values as well as on environmental protection (Haniffa and Cooke, 2002; Wang and Coffey, 1992). On the other hand, lower ownership dispersion is likely to lead to a situation, which fosters managerial opportunism and where managerial objectives prevail over shareholder objectives (Halme and Huse, 1997; Rahman et al., 2002). It is noteworthy that shareholder objectives may vary from shareholders to shareholders. For example, large shareholders with long-term strategic financial goals would be likely to consider environmental protection more seriously (Blair, 1995). Likewise, the existence of non-executive and independent directors on the board of directors as well as a large board of directors would tend to adopt socially acceptable policies and to better serve shareholder objectives, including environmental protection (Halme and Huse, 1997). Voluntary environmental disclosures would include reporting information about financial ability, environmentally-sensitive operations, shareholder ownership, previous legal environmental engagements, media exposure, environmental problems and risks, and previous engagements with environmental groups (Berthelot et al., 2003; Clarkson et al., 2008; Marshall et al., 2007). Firms that provide voluntary environmental disclosures would tend to employ less environment-harmful practices (Al-Tuwaijri et al., 2004; Clarkson et al., 2008). The provision of voluntary disclosures would not

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necessarily reflect stewardship of higher quality. Nevertheless, the voluntary disclosure of more information than is required by law would signal superior environmental and managerial ability. Media, investor and market authority scrutiny of these disclosures would subsequently make firms behave more responsibly. Similarly, mandatory environmental disclosures would force companies that present poor disclosures to provide more information about material events that must be reported as required by the regulation (Wiseman, 1982). Users would therefore be able to obtain at least the minimum required information. Companies may be motivated to disclose voluntary environmental disclosures in order to impress stakeholders and reduce uncertainty and scepticism. To this end, companies may provide disclosures that meet financial analysts' forecasts and investors' expectations in order to reap financial and reputational benefits. It is notable that managers may adopt the Sustainability Balanced Scorecard in order to provide sound and meaningful information about company environmental performance and economic performance (Dias-Sardinha et al., 2007). Companies are also encouraged to establish certain procedures, such as utilising and reviewing appropriate internal control systems, monitoring compliance with legal requirements and adopting widely accepted practices regarding material environmental issues, e.g. disposal of waste, in order to ensure compliance with environmental regulations and avoid litigation risks, fines or penalties or damaging their reputation. Seeking to satisfy users' needs and influence their perceptions and expectations, may, however, lead to managerial opportunism, whereby managers manipulate key environmental performance indicators or superficially reduce the adverse impact of certain environmental decisions and actions (Milne and Patten, 2002; Suchman, 1995). Managers may be inclined to creatively influence key environmental measures in order to show that they abide by regulation and standards, avoid negative publicity and manage compliance costs. For example, companies with high air emissions, e.g. sulphur dioxide and nitrogen oxides, or water pollution, e.g. nitrogen, phosphorus and heavy metals, would be inclined to provide higher levels of environmental disclosure in order to mitigate concerns associated with material negative environmental performance (Cho and Patten, 2007). Given their large size, exposure and visibility, large firms would be inclined to report more relevant and informative disclosures in order to avoid market's scrutiny and investigation (Elsayed and Hoque, 2010; Naser et al., 2006). Profitable firms would also be likely to provide good quality disclosures in their effort to show their superior managerial ability and contribution to environmental protection and stakeholders' informational welfare (Mangos and Lewis, 1995). Companies with high levels of debt would also tend to report disclosures of higher quality in order to provide capital providers with assurance that they respect and honour their financial obligations and debt covenants (Cooke, 1996). Additional factors that would increase the level and the quality of accounting disclosure include the following. Spathis and Georgakopoulou (2007) indicate that the current economic environment would determine the information that is necessary to be reported. High quality environmental reporting would reflect an open economy and would subsequently attract foreign investors (Mashayekhi and Mashayekh, 2008). In a similar vein, Ding et al. (2007) argue that countries with different growth rates would display different levels of reporting quality. The existence of well-established political systems and political stability would also strengthen the financial reporting structures (Roberts et al., 2005). Companies with serious environmental problems would tend to attract significant environmental attention (Rikhardsson et al., 1994). It stems that certain industries would be less exposed to environmental risks than others. It has been identified by the World Commission on Environment and Development that, due to the nature of their operations and their implications for the environment, the most polluting industries are chemicals, utilities, pulp and paper, and metals. Therefore, these industries would be expected to display more material impact on the environment (Willums and Goltike, 1992). In a similar manner, consumer industries would tend to report more environmental disclosures in order to improve their business picture and influence consumers' perceptions (Cowen et al., 1987). The costs relating to certain environmental activities and investments may be easier to identify and measure. In contrast, the benefits of positive environmental initiatives, such as recycling instead of disposing or emitting lower levels of greenhouse gasses, would be harder and would require further judgement. In this case, it would be useful to disclose environmental compliance costs, i.e. prevention and appraisal, and noncompliance costs, i.e. internal and external failure, in order to indicate the benefits from cost reductions and reflect managers' cost strategy (Bebbington, 2007).

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Environmental costs may be aggregated with other costs, preventing users from identifying key components of long-term environmental risk, and may drive users' attention to short-term financial performance illustrations. For example, certain environmental operations, such as the removal of toxic chemicals, are not required to be separately reported, so they are presented together with other financial information (Raiborn et al., 2011). The environmental costs and benefits need to be quantifiable so that managers can record them in the financial statements and make efficient decisions about spending and resourcing. In addition, certain environmental costs, such as those that relate to determining the impact of emitting acidic pollutants, are more difficult to capture (Raiborn et al., 2011). The reported variation in reporting environmental information may lead to different company reporting practices or opportunistic behaviours. Given the considerable visibility of such disclosures, it stems that misleading disclosures or low quality reported information on environmental performance, policies and implications on the environment would be expected to be heavily penalised by the stock market, since public scrutiny calls for accurate and unbiased disclosures (Gamble et al., 1995; Monks and Minow, 1995). This would depend on the efficiency of the stock market and on how sensitive the society is to environmental issues (Demb and Neubauer, 1992). The lack of sufficient environmental reporting is also evidenced by Dawkins and Lewis (2003) and Campbell and Slack (2008), who have found that the majority of investors consider that the reported environmental and social disclosures are generally of lower quality. Holm and Rikhardsson (2008), Ragothaman and Carr (2008) and Rikhardsson and Holm (2008) have shown that stock returns react positively to good environmental performance and news, while they respond negatively to negative environmental news. 3. Research hypotheses 3.1. Environmental disclosures and environmental performance The voluntary disclosure literature indicates that companies are inclined to report good news, while they are discouraged to disclose bad news. Companies might resort to earnings management or earnings smoothing to mitigate the adverse impact of bad news (Dye, 1985; Li et al., 1997; Verrecchia, 1983). It follows that companies that are environmentally sensitive and adopt sound environmental policies would be motivated to provide voluntary environmental disclosures to inform investors of their superior environmental strategy. Good environmental performers would tend to disclose ‘hard’, verifiable and difficult to mimic environmental information (see Al-Tuwaijri et al., 2004). Unlike good environmental performers, poor environmental performers may be inclined to report ‘soft’, general and not easy to verify environmental information (Clarkson et al., 2011a). The provision of voluntary environmental disclosures would tend to favourably affect investor perceptions and reduce uncertainty, thereby increasing firm valuation (Clarkson et al., 2008). The impact on firm valuation would be influenced by the quality and the value relevance of the reported environmental information. Here, the hypothesis tests the extent of discretionary disclosures of environmental performance and also examines the financial attributes of companies with different environmental disclosure scores.

H1. Environmental disclosure is positively associated with environmental performance. EDSi;t ¼ a0 þ a1 HW i;t þ a2 TCSi;t þ a3 NF i;t þ a4 TQ i;t þ a5 SVOLi;t þ a6 ROAi;t þa7 GEARi;t þ a8 lnAi;t þ a9 AAi;t þ a10 CAPSP i;t þ a11 JF i;t þ a12 INDi;t þ ei;t

ð1Þ

where EDSi,t is the Global Reporting Initiative (GRI)-based environmental disclosure score and proxies for environmental disclosure quality. The environmental disclosure index is presented in Section 4.2. HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. A lower value for HWi,t would reflect better environmental performance. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. TCSi,t = 1 for firms that adopt such environmental initiatives and reflect environmental awareness and TCSi,t = 0 otherwise.

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NFi,t is the amount of debt or equity capital raised by the firm. NFi,t is equal to common and preferred shares, less any stock repurchase, plus long-term debt, less any debt reduction, scaled by total assets at the end of the year. TQi,t is Tobin's Q. Tobin's Q is equal to market value of common equity plus book value of preferred stock, plus book value of long-term debt and current liabilities, scaled by book value of total assets. SVOLi,t is stock price volatility. SVOLi,t is measured as standard deviation of monthly stock returns. ROAi,t is the return on assets. ROAi,t is income before extraordinary items scaled by total assets at the end of the year. GEARi,t is the leverage ratio. GEARi,t is total debt scaled by total assets at the end of the year. lnAi,t is a proxy for size. lnAi,t is the natural logarithm of total assets at the end of the year. AAi,t is a proxy for asset age. AAi,t is equal to net property, plant and equipment scaled by the gross property, plant and equipment at the end of the year. CAPSPi,t is equal to capital spending scaled by total revenues at the end of the year. JFi,t is the Janis–Fadner coefficient. JFi,t measures the favourability of media coverage regarding companies' environmental activities (Aerts and Cormier, 2009; Janis and Fadner, 1965). JFi,t takes values from − 1 to +1. − 1 reflects unfavourable perceptions. + 1 reflects favourable perceptions. 0 would imply neutral perceptions. This study has used the Factiva database to search for news stories. JFi,t is computed as follows (see Clarkson et al., 2010; Janis and Fadner, 1965, p. 15):   2 2 JF ¼ f −f u =ðf þ uÞ ; if f > u;

ð2Þ

  2 2 JF ¼ f u−u =ðf þ uÞ ; if u > f

ð3Þ

where f is the number of favourable environmental articles obtained from Factiva. u is the number of unfavourable environmental articles obtained from Factiva. INDi,t is a dummy variable that proxies for industry classification. ei,t is the error term. 3.2. Environmental disclosures and corporate governance Effective environmental disclosures would tend to close the information gap between managers, shareholders and other stakeholders. The existence of independent and non-executive directors on the board of directors, and the existence of an audit committee would reinforce the quality of reported environmental disclosures (Haniffa and Cooke, 2005; Xie et al., 2003). Effective corporate governance mechanisms would improve the social picture of a company and would reduce uncertainty. Therefore, they could achieve an efficient alignment of company financial goals and societal values and priorities (Zahra and Stanton, 1988). Managerial ownership would align managers' interests with shareholders' interests. Further, institutional ownership would serve as a monitoring device of managers' decisions and would subsequently promote shareholders' interests (McKnight and Weir, 2009). Similar considerations would hold for leverage, implying that lenders monitor managers' actions and financial reporting quality (McConnell and Servaes, 1990). Large and visible firms would tend to establish effective corporate governance structures and report high quality environmental disclosures in order to avoid attention and negative publicity (Francis, 2001). Thus, companies with effective corporate governance mechanisms in place would be expected to provide environmental information of higher quality. The hypothesis that is tested is as follows. H2. Firms that report higher environmental disclosure quality are likely to display effective corporate governance. EDSi;t ¼ a0 þ a1 IDBi;t þ a2 IDACi;t þ a3 BIGAUi;t þ a4 AC i;t þ a5 MOi;t þ a6 IOi;t þa7 MC i;t þ a8 CLi;t þ a9 ROAi;t þ a10 GEARi;t þ a11 lnAi;t þ ei;t

ð4Þ

where EDSi,t is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. IDBi,t is the percentage of independent directors sitting on the board of directors.

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IDACi,t is the percentage of independent directors sitting on the audit committee of the board. BIGAUi,t BIGAUi,t = 1 for firms that are audited by a big 4 auditor and BIGAUi,t = 0 otherwise. ACi,t ACi,t = 1 if an audit committee exists and ACi,t = 0 otherwise. MOi,t is the proportion of ordinary shares held by managers. IOi,t is the proportion of ordinary shares held by institutional investors. MCi,t MCi,t = 1 when changes in the management have occurred in the year and MCi,t = 0 otherwise. CLi,t CLi,t = 1 when a company is cross-listed and CLi,t = 0 otherwise. ROAi,t is the return on assets. ROAi,t is income before extraordinary items scaled by total assets at the end of the year. GEARi,t is the leverage ratio. GEARi,t is total debt scaled by total assets at the end of the year. lnAi,t is a proxy for size. lnAi,t is the natural logarithm of total assets at the end of the year. ei,t is the error term. 3.3. Environmental disclosures, corporate governance and capital constraints Cheng et al. (2012) argue that companies that display effective corporate governance and report informative environmental disclosures would be expected to exhibit lower levels of investor uncertainty. The disclosure of effective sustainability reports that promote transparency, credibility would tend to reduce information asymmetry and capital constraints (Benabou and Tirole, 2010; Dhaliwal et al., 2011; Hubbard, 1998). Hence, the risk involved would tend to be lower, subsequently leading to better chances of obtaining financing on favourable terms. The smooth communication between managers, shareholders and lenders would reduce agency costs, such as monitoring costs and bonding costs, and would result in efficient contracting and more flexible financing (Foo, 2007; Jones, 2010; Karolyi, 2012). Here, this study tests the hypothesis that firms that display high environmental disclosure scores and superior corporate governance would be expected to experience less financing barriers. The hypothesis and the model to test this hypothesis are presented below.

H3. Firms with effective environmental and corporate governance structures are likely to face less capital constraints. KZ i;t ¼ α 0 þ α 1 EDSi;t þ a2 HW i;t þ a3 TCSi;t þ a4 IDBi;t þ a5 IDAC i;t þ a6 BIGAU i;t þa7 AC i;t þ a8 MOi;t þ a9 IOi;t þ a10 CLi;t þ ei;t

ð5Þ

where KZi,t is the Kaplan and Zingales (KZ) index. The construction of the KZ index is presented in Eq. (6) below. Higher values would indicate that a company faces more capital constraints. EDSi,t is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. A lower value for HWi,t would reflect better environmental performance. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. TCSi,t = 1 for firms that adopt such environmental initiatives and reflect environmental awareness and TCSi,t = 0 otherwise. IDBi,t is the percentage of independent directors sitting on the board of directors. IDACi,t is the percentage of independent directors sitting on the audit committee of the board. BIGAUi,t BIGAUi,t = 1 for firms that are audited by a big 4 auditor and BIGAUi,t = 0 otherwise. ACi,t ACi,t = 1 if an audit committee exists and ACi,t = 0 otherwise. MOi,t is the proportion of ordinary shares held by managers. IOi,t is the proportion of ordinary shares held by institutional investors. CLi,t CLi,t = 1 when a company is cross-listed and CLi,t = 0 otherwise. ei,t is the error term.

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The construction of the KZ index has been based on regression coefficient results obtained by Kaplan and Zingales (1997). Based on Baker et al. (2003, p. 983) and Cheng et al. (2012, p.13), the KZ index is computed as follows: KZ i;t ¼ −1:002 CF i;t =Ai;t−1 −39:368 DV i;t =Ai;t−1 −1:315 C i;t =Ai;t−1 þ 3:139 LEV i;t þ 0:283 Q i;t

ð6Þ

where CFi,t/Ai,t-1 is cash flow from operating activities scaled by lagged assets. DVi,t/Ai,t-1 is dividends scaled by lagged assets. Ci,t/Ai,t-1 is cash scaled by lagged assets. LEVi,t is total debt scaled by total assets at the end of the year. Qi,t is the market value of equity plus assets minus the book value of equity scaled by assets. 3.4. Environmental disclosures and value relevance Companies that provide effective environmental disclosures would enjoy investors' confidence and appreciation, which might also take the form of ‘green goodwill’ and of easier access to capital markets (Clarkson et al., 2004). This would reduce future compliance costs and positively influence companies' future financial prospects and firm value (Dhaliwal et al., 2011; Plumlee et al., 2009). In contrast, poor environmental disclosers that report the minimum required by the regulation might incur higher future environmental expenditures and might display limited abnormal returns for shareholders due to their lower disclosure and reporting quality (Hughes, 2000). Companies with low environmental performance would also be likely to face higher litigation risks and pollution fines, which would in turn influence the riskiness of future cash flows. Clarkson et al. (2008) argue that rich environmental disclosers provide investors with positive signals of high quality reporting assurance, which would be difficult to be mimicked by poor disclosers. Richardson and Welker (2001) argue that informative environmental disclosures relating, for example, to environmental strategies and liabilities or costs would increase stock returns through lower information asymmetry and investment risk. The hypothesis that is tested is as follows. H4. Environmental disclosures are value relevant. To test this hypothesis, this study uses the Ohlson (1995) valuation equation as adopted by Clarkson et al. (2010, p. 10): P i;t ¼ a0 þ a1 BV i;t−1 þ a2 AEPSi;t−1 þ a3 EDSi;t þ a4 HW i;t þ a5 TCSi;t þ ei;t

ð7Þ

where Pi,t is the stock price at the end of the year. BVi,t-1 is lagged book value per share at year-end. AEPSi,t-1 is lagged abnormal earnings per share. AEPSi,t is earnings per share at the end of the year, minus the cost of equity capital multiplied by book value of equity at the beginning of the year. To estimate the cost of equity capital (CEQ), this study employs the price to earnings growth ratio based on Easton (2004) as adopted by Clarkson et al. (2010, p. 13): CEQ ¼ √½ðf 2 –f 1 Þ=p0 

ð8Þ

where f2 is a two-year median forecast of earnings per share. f1 is a one-year median forecast of earnings per share. p0 is share price at t0. EDSi,t is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. A lower value for HWi,t would reflect better environmental performance.

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TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. TCSi,t = 1 for firms that adopt such environmental initiatives and reflect environmental awareness and TCSi,t = 0 otherwise. ei,t is the error term. To test the value relevance of environmental disclosures, this study also uses the model below, which is based on Cormier and Magnan (2007, p. 617). MBV i;t ¼ a0 þ a1 1=BV i;t þ a2 EAR=BV i;t þ a3 EAR=BVx EDSi;t þ a4 EDSi;t þ a5 HW i;t þa6 TCSi;t þ ei;t

ð9Þ

where MBVi,t is market value of equity scaled by book value of equity. BVi,t is the book value per share at the end of the year. EAR/BVi,t is net income before extraordinary items scaled by book value of equity. EDSi,t is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. A lower value for HWi,t would reflect better environmental performance. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. TCSi,t = 1 for firms that adopt such environmental initiatives and reflect environmental awareness and TCSi,t = 0 otherwise. ei,t is the error term. 3.5. Environmental disclosures and investor perceptions Investors would need further socially responsible information to verify reported environmental performance. It is noteworthy that high quality environmental disclosures would show that certain environmental information and exposures may not be fully reflected on environmental liabilities (Clarkson et al., 2008). The content of certain environmental disclosures may depict crucial legal information, such as litigations, lawsuits or media revelations, which may affect investor perceptions (Cormier and Magnan, 2007). Thus, the provision of additional and/or voluntary information would shed light on potentially uncertain or questionable situations and would reduce investors' scepticism. It follows that superior environmental reporting, regardless of whether the reported information is positive or negative, would enhance company stock market value (Cormier and Magnan, 2007). Hence, firms would be inclined to improve the quality of environmental disclosures in order to influence investors' sentiment of environmental performance (Clarkson et al., 2008). The hypothesis that is tested is presented below. H5. Environmental disclosures are positively associated with investor perceptions. To test this hypothesis, this study uses the model presented below (see Clarkson et al., 2010, p. 14). JF i;t ¼ a0 þ a1 EDSi;t þ a2 lnAi;t þ a3 HW i;t þ a4 TCSi;t þ ei;t

ð10Þ

where JFi,t is the Janis–Fadner coefficient. JFi,t measures the favourability of media coverage regarding companies' environmental activities (Aerts and Cormier, 2009; Janis and Fadner, 1965). JFi,t takes values from − 1 to + 1. –1 reflects unfavourable perceptions. + 1 reflects favourable perceptions. 0 would imply neutral perceptions. This study has used the Factiva database to search for news stories. The computation of JFi,t is presented in Eq. (1). EDSi,t is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. lnAi,t is the natural logarithm of total assets at the end of the year. HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. A lower value for HWi,t would reflect better environmental performance.

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TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. TCSi,t = 1 for firms that adopt such environmental initiatives and reflect environmental awareness and TCSi,t = 0 otherwise. ei,t is the error term. 4. Datasets and environmental disclosure index 4.1. Datasets This study focuses on companies that are listed on Bursa Malaysia, formerly known as Kuala Lumpur Stock Exchange. Malaysia requires listed firms to use International Financial Reporting Standards (IFRSs) as from 1 January 2012. The period of investigation is 2005 to 2011. Information on environmental performance has been collected from company annual reports and company websites. Accounting and financial data were collected from DataStream. Based on Cormier and Magnan (2007), this study has examined 529 Malaysian listed companies that belong to industries that are environmentally sensitive, including aerospace and defense, automobiles and parts, beverages, chemicals, electricity, electronic and electrical equipment, food producers, forestry and paper, gas, water and multiutilities, general industrials, household goods and home construction, industrial engineering, industrial metals and mining, mining, oil and gas producers, oil equipment and services, technology hardware and equipment, and tobacco. The research hypotheses are tested using the OLS regression analysis. The study has accounted for heteroscedasticity, autocorrelation, departure from normality and multicollinearity, where appropriate. The tests that have been performed to check the OLS assumptions are the White test and the Autoregressive Conditional Heteroscedasticity (ARCH) test for heteroscedasticity; the Durbin-Watson test and the Breusch-Godfrey test for autocorrelation; the Jarque–Bera test for the departure from normality of residuals; and the correlation coefficients among the test variables for multicollinearity. 4.2. Environmental disclosure index This study has designed an environmental disclosure index in order to compute an environmental score for each sample company. The scoring index has been based on the GRI Guidelines as adopted by Clarkson et al. (2008, pp. 311–313) and Clarkson et al. (2011a, pp. 58–60). The use of GRI has obtained wide recognition as an increasing number of firms implement this framework for the provision of voluntary disclosures (Raiborn et al., 2011). GRI was formed in 1997 as a joint initiative of the US Coalition for Environmentally Responsible Economics and the United Nations Environment Program. It provides internationally recognised guidance for sustainability reporting and aims at the disclosure of standardised environmental and social information in annual reports. The scoring index includes 95 equally weighted line items and consists of the following categories: (1) governance structure and management systems (maximum score is 6), (2) credibility (maximum score is 10), (3) environmental performance indicators (maximum score is 60), (4) environmental spending (maximum score is 3), (5) vision and strategy claims (maximum score is 6), (6) environmental profile (maximum score is 4), and (7) environmental initiatives (maximum score is 6). For each one of the checklist questions of categories (1), (2), (4), (5), (6) and (7), the score is 1 if the disclosure is present or 0 otherwise. For category (3), the checklist questions amount to 10 and the scoring scale per question is from 0 to 6. The scoring index includes hard disclosure and soft disclosure items. Hard disclosures comprise categories (1), (2), (3) and (4). Soft disclosures consist of categories (5), (6) and (7). The points obtained for each company of the sample are summed and subsequently divided by the maximum points available to determine a percentage score for each company. The score for all companies ranges between 0% and 100%. 5. Empirical findings 5.1. Descriptive statistics Table 1 presents the descriptive statistics for the (in)dependent variables used in the empirical analysis. The mean environmental disclosure score is 54% (EDS). The mean hazardous waste produced

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Table 1 Descriptive statistics. Variables

Mean

Std Deviation

EDSi,t HWi,t TQi,t ROAi,t GEARi,t lnAi,t AAi,t CAPSPi,t JFi,t KZi,t MBVi,t

0.54 0.978 1.35 0.0563 0.061 10.1 0.60 0.058 −0.045 0.10 1.98

0.33 1.88 0.67 0.27 0.22 1.40 0.18 0.14 0.74 1.89 1.64

The sample period is 2005 to 2011. The sample consists of 3703 firm-years. EDSi,t is the GRI-based environmental disclosure score. HWi,t is total amount of hazardous waste produced in tonnes divided by net sales. TQi,t is Tobin's Q and is equal to market value of common equity plus book value of preferred stock, plus book value of long-term debt and current liabilities, scaled by book value of total assets. ROAi,t is income before extraordinary items scaled by total assets at the end of the year. GEARi,t is total debt scaled by total assets at the end of the year. lnAi,t is the natural logarithm of total assets at the end of the year. AAi,t is equal to net property, plant and equipment scaled by the gross property, plant and equipment at the end of the year. CAPSPi,t is equal to capital spending scaled by total revenues at the end of the year. JFi,t is the Janis–Fadner coefficient that measures the favourability of media coverage regarding companies' environmental activities. KZi,t is the Kaplan and Zingales index that proxies for capital constraints. MBVi,t is market value of equity scaled by book value of equity.

(HW) is 0.978 tonnes per thousand dollars of net sales. The mean Tobin's Q (TQ) is 1.35. The mean return on assets (ROA) is 5.63%. The mean leverage (GEAR) is high and amounts to 61%. The mean firm size (lnA) is 10.1. The mean asset age (AA) is 0.60. The mean capital spending scaled by revenues (CAPSP) amounts to 0.058. The mean JF coefficient (JF), which proxies for the un/favourability of media coverage regarding companies' environmental activities, is − 0.045. The mean value of the KZ index (KZ) is 0.10 and the standard deviation is 1.89. This shows that there exists significant variability in the capital constraints that companies experience. The mean market to book value of equity (MBV) is 1.98. 5.2. Environmental disclosures and environmental performance Table 2 supports H1 and shows that environmental disclosure is positively associated with environmental performance. As predicted, companies that display smaller amounts of hazardous waste (HW) and take on initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances (TCS) exhibit higher environmental disclosure scores (EDS). The positive coefficient of the amount of debt or equity capital raised by a firm (NF) indicates that firms that seek capital in money and stock markets have a higher propensity for informative and meaningful disclosures in order to positively influence the terms of financing. Similar considerations would hold for companies with higher leverage (GEAR), which would reflect a more intensive monitoring of managers' behaviour by lenders and would lead to more effective financial and environmental disclosures. Healy and Palepu (2001) claim that companies would seek to reduce information asymmetry, and subsequently the cost of capital, by reporting difficult-to-verify information of high quality. Here, the proxies of information asymmetry are Tobin's Q (TQ) and stock price volatility (SVOL). Table 2 shows that TQ is positive and SVOL is negative, implying a negative association between informative environmental disclosures, uncertainty and agency costs. As shown by the positive return on assets (ROA), companies that display higher profitability would be inclined to report higher environmental disclosure scores in order to provide a signal of their effective decisions and actions (Lang and Lundholm, 1993). The positive coefficient of size (lnA) shows that companies that are visible in the marketplace, and subsequently are followed by financial analysts, market authorities and investors because of their large size, would tend to disclose significant environmental information. Likewise, companies with high capital spending (CAPSP) would be expected to possess environment-friendly machinery and equipment and to reflect higher environmental performance, which would be communicated through informative environmental disclosures in the annual reports. Also, the findings provide evidence of a positive association between environmental disclosure

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Table 2 Environmental performance. Variables

Coefficients

HWi,t

−2.6253* (1.4551) 1.9427*** (0.7263) 0.0921* (0.0550) 0.3694* (0.2101) −1.464*** (0.6124) 0.4533*** (0.1086) 1.1270*** (0.3244) 0.1924*** (0.0648) 0.0091 (0.0269) 0.6362** (0.3281) 0.0503*** (0.0190) 0.0299*** (0.0063) 0.0997*** (0.0221) 0.0194* (0.0109) 1.1625* (0.6551) 0.01662** (0.0080) 0.9317 (1.1045) 0.419 N = 3703

TCSi,t NFi,t TQi,t SVOLi,t ROAi,t GEARi,t lnAi,t AAi,t CAPSPi,t JFi,t BEVi,t CHEi,t FOOPi,t FORPAPi,t MEMIi,t Constant R2 adj. Sample size

***, ** and * indicate statistical significance at the 1%, 5% and 10% level (two-tailed) respectively. The standard error is in parentheses. In Tables 2 and 3, the dependent variable is EDSi,t, which is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. In Table 4, the dependent variable is KZi,t, which is the Kaplan and Zingales (KZ) index. The construction of the KZ index is presented in Eq. (6). HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. NFi,t is the amount of debt or equity capital raised by the firm. TQi,t is Tobin's Q and is equal to market value of common equity plus book value of preferred stock, plus book value of long-term debt and current liabilities, scaled by book value of total assets. SVOLi,t is the standard deviation of monthly stock returns. ROAi,t is income before extraordinary items scaled by total assets at the end of the year. GEARi,t is total debt scaled by total assets at the end of the year. lnAi,t is the natural logarithm of total assets at the end of the year. AAi,t is equal to net property, plant and equipment scaled by the gross property, plant and equipment at the end of the year. CAPSPi,t is capital spending scaled by total revenues at the end of the year. JFi,t is the Janis–Fadner coefficient, which measures the favourability of media coverage regarding companies' environmental activities. The computation of JFi,t is presented in Eq. (1). BEVi,t is a dummy variable that takes 1 for companies that belong to beverages and 0 otherwise. CHEi,t is a dummy variable that takes 1 for companies that belong to chemicals and 0 otherwise. FOOPi,t is a dummy variable that takes 1 for companies that belong to food producers and 0 otherwise. FORPAPi,t is a dummy variable that takes 1 for companies that belong to forestry and paper and 0 otherwise. MEMIi,t is a dummy variable that takes 1 for companies that belong to industrial metals and mining and 0 otherwise. IDBi,t is the percentage of independent directors sitting on the board of directors. IDACi,t is the percentage of independent directors sitting on the audit committee of the board. BIGAUi,t takes 1 for firms that are audited by a big 4 auditor and 0 otherwise. ACi,t takes 1 if an audit committee exists and 0 otherwise. MOi,t is the proportion of ordinary shares held by managers. IOi,t is the proportion of ordinary shares held by institutional investors. MCi,t takes 1 when changes in the management have occurred in the year and 0 otherwise. CLi,t takes 1 when a company is cross-listed and 0 otherwise.

quality and the Janis–Fadner coefficient (JF), which is a proxy for investor perceptions relating to companies' environmental activities. As predicted, companies with high environmental disclosure scores influence investor perceptions in a positive manner. Table 2 also indicates that companies that belong to beverages

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(BEV), chemicals (CHE), food producers (FOOP), forestry and paper (FORPAP), and industrial metals and mining (MEMI) tend to display higher environmental disclosure scores (EDS). 1 5.3. Environmental disclosures and corporate governance Table 3 shows that firms that report higher quality of environmental disclosure are likely to display effective corporate governance, suggesting that H2 holds. The findings show that the environmental disclosure score (EDS) is positively associated with the percentage of independent directors sitting on the board of directors (IDB), the percentage of independent directors sitting on the audit committee of the board (IDAC) and the presence of an audit committee (AC). This would imply that the former as well as the latter would serve as monitoring devices exercising pressure on managers to improve the quality of reported environmental information. Similar considerations would hold for companies audited by a big 4 auditor (BIGAU) that would directly or indirectly motivate their clients to disclose relevant and meaningful information. Also, managerial ownership (MO) and institutional ownership (IO) are positively associated with EDS. This shows that the intensive participation of managers in the equity capital and the monitoring role of institutional investors would motivate companies to report disclosures of higher quality in order to increase their value. A change in company management (MC) appears to be positively related to EDS, implying that the new management would be inclined to report high quality environmental information in order to favourably affect investors' perceptions and provide a positive signal of their superior managerial ability. Similarly, companies that are cross-listed (CL) would tend to report a higher environmental disclosure score as they would need to impress foreign investors and comply with listing and other financial reporting requirements of foreign stock exchanges. 5.4. Environmental disclosures, corporate governance and capital constraints Table 4 supports H3 and shows that firms with effective environmental and corporate governance structures are likely to face less capital constraints (see also Baker et al., 2003; Cheng et al., 2012). The findings show that firms that display higher environmental disclosure scores (EDS) and take initiatives to reduce toxic chemicals or substances (TCS) would provide assurance of superior reporting quality and would be expected to face less difficulties in obtaining capital. In contrast, companies with significant amounts of hazardous waste (HW) would give rise to concerns and would adversely affect investors' perceptions and subsequently companies' access to capital markets. Further, companies with effective corporate governance monitoring mechanisms, such as the presence of an audit committee (AC) and high percentages of independent directors sitting on the board of directors (IDB) and independent directors sitting on the audit committee of the board (IDAC), would tend to reduce information asymmetry and experience less capital constraints. Similar considerations would hold for companies that are audited by a big 4 auditor (BIGAU) or exhibit a significant proportion of ordinary shares held by institutional investors (IO), implying that their reporting practices are watched and scrutinised, and providing positive signals of transparency and quality. Companies that are cross-listed (CL) should comply with the disclosure requirements of foreign stock markets, which would vary in terms of demand from market to market. Hence, they would be expected to be able to reduce uncertainty and convince capital providers about their managerial skills and reporting quality, and obtain better terms of financing. 5.5. Environmental disclosures and value relevance According to Table 5, environmental disclosures provide incremental information that is value relevant and positively related to stock valuation, implying that H4 holds. Panel A shows that the coefficient of environmental disclosure score (EDS) is positive, signifying that superior environmental performers that display higher environmental disclosure scores would present meaningful information about company environmental performance beyond the minimum required (see Clarkson et al., 2011b). This incremental information would be positively valued by investors (see Clarkson et al., 2008). The coefficient of the total

1

Here, Table 2 presents only the industries that are found to be statistically significant.

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Table 3 Corporate governance. Variables

Coefficients

IDBi,t

0.0416* (0.0239) 0.2235** (0.1105) 2.0016** (0.9272) 0.1824*** (0.053) 0.0755*** (0.0276) 1.9570** (0.952) 0.02101*** (0.0056) 0.1692* (0.0934) 0.0024*** (0.0010) 0.0013 (0.0012) 0.0098** (0.0043) 0.1210 (0.1295) 0.656 N = 3703

IDACi,t BIGAUi,t ACi,t MOi,t IOi,t MCi,t CLi,t ROAi,t GEARi,t lnAi,t Constant R2 adj. Sample size

***, ** and * indicate statistical significance at the 1%, 5% and 10% level (two-tailed) respectively. The standard error is in parentheses. In Tables 2 and 3, the dependent variable is EDSi,t, which is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. In Table 4, the dependent variable is KZi,t, which is the Kaplan and Zingales (KZ) index. The construction of the KZ index is presented in Eq. (6). HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. NFi,t is the amount of debt or equity capital raised by the firm. TQi,t is Tobin's Q and is equal to market value of common equity plus book value of preferred stock, plus book value of long-term debt and current liabilities, scaled by book value of total assets. SVOLi,t is the standard deviation of monthly stock returns. ROAi,t is income before extraordinary items scaled by total assets at the end of the year. GEARi,t is total debt scaled by total assets at the end of the year. lnAi,t is the natural logarithm of total assets at the end of the year. AAi,t is equal to net property, plant and equipment scaled by the gross property, plant and equipment at the end of the year. CAPSPi,t is capital spending scaled by total revenues at the end of the year. JFi,t is the Janis–Fadner coefficient, which measures the favourability of media coverage regarding companies' environmental activities. The computation of JFi,t is presented in Eq. (1). BEVi,t is a dummy variable that takes 1 for companies that belong to beverages and 0 otherwise. CHEi,t is a dummy variable that takes 1 for companies that belong to chemicals and 0 otherwise. FOOPi,t is a dummy variable that takes 1 for companies that belong to food producers and 0 otherwise. FORPAPi,t is a dummy variable that takes 1 for companies that belong to forestry and paper and 0 otherwise. MEMIi,t is a dummy variable that takes 1 for companies that belong to industrial metals and mining and 0 otherwise. IDBi,t is the percentage of independent directors sitting on the board of directors. IDACi,t is the percentage of independent directors sitting on the audit committee of the board. BIGAUi,t takes 1 for firms that are audited by a big 4 auditor and 0 otherwise. ACi,t takes 1 if an audit committee exists and 0 otherwise. MOi,t is the proportion of ordinary shares held by managers. IOi,t is the proportion of ordinary shares held by institutional investors. MCi,t takes 1 when changes in the management have occurred in the year and 0 otherwise. CLi,t takes 1 when a company is cross-listed and 0 otherwise.

amount of hazardous waste produced (HW) is negative, suggesting that the stock market would respond negatively to situations of environmental neglect. In contrast, TCS is positive, showing that investors appreciate companies that seek to reduce or eliminate toxic chemicals and other substances. Lagged abnormal earnings (AEPS) also display a positive coefficient, indicating that abnormal earnings and positive future prospects would affect stock valuation in a positive manner. Panel B shows that the coefficient of the inverse of book value of equity (1/BV) is positive. Likewise, the multiplication of earnings by the environmental disclosure score (EAR/BV × EDS) carries a positive coefficient, implying that companies that report valid environmental information would present a positive association between earnings and firm value (see Cormier and Magnan, 2007). In a similar manner, the coefficient of environmental disclosure score (EDS) is also positive, reflecting the positive relationship

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Table 4 Capital constraints. Variables

Coefficients

EDSi,t

−0.1082** (0.0471) 0.0223* (0.0117) −0.0889*** (0.0378) −0.8992*** (0.3417) −0.0684*** (0.0185) −0.5613*** (0.1351) −0.1237*** (0.0389) 0.5215 (0.9890) −0.2770*** (0.1046) −0.7364*** (0.2570) 0.1873 (0.4764) 0.375 N = 3703

HWi,t TCSi,t IDBi,t IDACi,t BIGAUi,t ACi,t MOi,t IOi,t CLi,t Constant R2 adj. Sample size

***, ** and * indicate statistical significance at the 1%, 5% and 10% level (two-tailed) respectively. The standard error is in parentheses. In Tables 2 and 3, the dependent variable is EDSi,t, which is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. In Table 4, the dependent variable is KZi,t, which is the Kaplan and Zingales (KZ) index. The construction of the KZ index is presented in Eq. (6). HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. NFi,t is the amount of debt or equity capital raised by the firm. TQi,t is Tobin's Q and is equal to market value of common equity plus book value of preferred stock, plus book value of long-term debt and current liabilities, scaled by book value of total assets. SVOLi,t is the standard deviation of monthly stock returns. ROAi,t is income before extraordinary items scaled by total assets at the end of the year. GEARi,t is total debt scaled by total assets at the end of the year. lnAi,t is the natural logarithm of total assets at the end of the year. AAi,t is equal to net property, plant and equipment scaled by the gross property, plant and equipment at the end of the year. CAPSPi,t is capital spending scaled by total revenues at the end of the year. JFi,t is the Janis–Fadner coefficient, which measures the favourability of media coverage regarding companies' environmental activities. The computation of JFi,t is presented in Eq. (1). BEVi,t is a dummy variable that takes 1 for companies that belong to beverages and 0 otherwise. CHEi,t is a dummy variable that takes 1 for companies that belong to chemicals and 0 otherwise. FOOPi,t is a dummy variable that takes 1 for companies that belong to food producers and 0 otherwise. FORPAPi,t is a dummy variable that takes 1 for companies that belong to forestry and paper and 0 otherwise. MEMIi,t is a dummy variable that takes 1 for companies that belong to industrial metals and mining and 0 otherwise. IDBi,t is the percentage of independent directors sitting on the board of directors. IDACi,t is the percentage of independent directors sitting on the audit committee of the board. BIGAUi,t takes 1 for firms that are audited by a big 4 auditor and 0 otherwise. ACi,t takes 1 if an audit committee exists and 0 otherwise. MOi,t is the proportion of ordinary shares held by managers. IOi,t is the proportion of ordinary shares held by institutional investors. MCi,t takes 1 when changes in the management have occurred in the year and 0 otherwise. CLi,t takes 1 when a company is cross-listed and 0 otherwise.

with firm stock market value. Equally, the coefficient of TCS is positive, indicating that companies that adapt policies that respect and protect the environment are positively valued by investors. 5.6. Environmental disclosures and investor perceptions Table 6 gives support to H5 and shows that environmental disclosures are positively associated with investor perceptions. The positive coefficient of environmental disclosure score (EDS) indicates that the reported environmental disclosures are meaningful for investors and reflect incremental information about company environmental performance. HW and TCS carry a negative and a positive coefficient respectively, suggesting that lower levels of hazardous waste as well as companies' quest to eliminate toxic chemicals would reflect companies' environmental awareness and would positively influence the perceptions of investors about company environmental performance.

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Table 5 Value relevance. Panel A Eq. (7)

Panel B Eq. (9)

Variables

Coefficients

Variables

Coefficients

BVi,t−1

0.0346 (0.0243) 0.1947*** (0.0371) 0.7358*** (0.0516) −0.0229*** (0.0086) 0.9660*** (0.0066) 0.1634 (0.3983)

1/BVi,t

0.0097*** (0.0025) 0.0818 (0.2213) 0.6310* (0.3899) 0.1945* (0.1051) 0.2632 (0.2027) 0.4871*** (0.2043) 0.2254 (0.3981) 0.527 N = 3703

AEPSi,t−1 EDSi,t HWi,t TCSi,t Constant

EAR/BVi,t EAR/BV x EDSi,t EDSi,t HWi,t TCSi,t Constant

2

R adj. Sample size

0.341 N = 3703

R2 adj. Sample size

***, ** and * indicate statistical significance at the 1%, 5% and 10% level (two-tailed) respectively. The standard error is in parentheses. In Panel A, Table 5, the dependent variable is Pi,t, which is the stock price at the end of the year. In Panel B, Table 5, the dependent variable is MBVi,t, which is market value of equity scaled by book value of equity. In Table 6, the dependent variable is JFi,t, which is the Janis–Fadner coefficient and measures the favourability of media coverage regarding companies' environmental activities. The computation of JFi,t is presented in Eq. (1). BVi,t−1 is lagged book value per share at year-end. AEPSi,t-1 is lagged earnings per share at the end of the year, minus the cost of equity capital multiplied by book value of equity at the beginning of the year. The estimation of the cost of equity capital is presented in Eq. (8). EDSi,t is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. TCSi,t takes 1 for firms that adopt such environmental initiatives and 0 otherwise. BVi,t is the book value per share at the end of the year. EAR/BVi,t is net income before extraordinary items scaled by book value of equity. lnAi,t is the natural logarithm of total assets at the end of the year.

Table 6 Investor perceptions. Variables

Coefficients

EDSi,t

1.2755** (0.6149) 0.0362 (0.2672) −0.5858* (0.3417) 0.8781** (0.4033) 0.3181 (0.5022) 0.488 N = 3703

lnAi,t HWi,t TCSi,t Constant R2 adj. Sample size

***, ** and * indicate statistical significance at the 1%, 5% and 10% level (two-tailed) respectively. The standard error is in parentheses. In Panel A, Table 5, the dependent variable is Pi,t, which is the stock price at the end of the year. In Panel B, Table 5, the dependent variable is MBVi,t, which is market value of equity scaled by book value of equity. In Table 6, the dependent variable is JFi,t, which is the Janis–Fadner coefficient and measures the favourability of media coverage regarding companies' environmental activities. The computation of JFi,t is presented in Eq. (1). BVi,t−1 is lagged book value per share at year-end. AEPSi,t−1 is lagged earnings per share at the end of the year, minus the cost of equity capital multiplied by book value of equity at the beginning of the year. The estimation of the cost of equity capital is presented in Eq. (8). EDSi,t is the GRI-based environmental disclosure score and proxies for environmental disclosure quality. HWi,t is the total amount of hazardous waste produced in tonnes divided by net sales. TCSi,t is a dummy variable that shows whether a company reports initiatives to reduce, reuse, substitute or phase out toxic chemicals or substances. TCSi,t takes 1 for firms that adopt such environmental initiatives and 0 otherwise. BVi,t is the book value per share at the end of the year. EAR/BVi,t is net income before extraordinary items scaled by book value of equity. lnAi,t is the natural logarithm of total assets at the end of the year.

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6. Conclusions This study focuses on common-law Malaysia, which is classified as an advanced emerging market. It examines the association between environmental disclosure and environmental performance and the financial attributes of companies with different environmental disclosure scores. This study investigates the association between environmental disclosure quality and corporate governance, and predicts that companies with effective environmental and corporate governance structures would be expected to face less capital constraints. This study also examines the extent to which environmental disclosures are value relevant as well as the association between effective environmental disclosures and investor perceptions. The findings of the study show that environmental disclosure is positively associated with environmental performance. Companies that display smaller amounts of hazardous waste or take on initiatives to reduce toxic chemicals exhibit higher environmental disclosure scores. The need for capital in money and stock markets or large size and market visibility would motivate companies to report environmental disclosures of higher quality in order to reduce information asymmetry and the cost of capital. Higher disclosure scores are also displayed by companies that exhibit high profitability and high capital spending, which would further improve their environmental performance. Environmental disclosure quality and the adoption of environment-friendly policies are positively associated with investor perceptions. Companies that display higher environmental disclosure scores are found to belong to beverages, chemicals, food producers, forestry and paper, and industrial metals and mining. Firms that report higher environmental disclosure scores display effective corporate governance structures, which would subsequently improve environmental reporting. In particular, good disclosers have an audit committee and present a significant percentage of independent directors sitting on the board of directors and on the audit committee of the board. High quality disclosers tend to be audited by a big 4 auditor and cross-listed on foreign stock exchanges. They also display significant levels of managerial and institutional ownership. Further, firms with effective environmental disclosures and corporate governance structures, which would provide evidence of superior reporting quality, are found to face less difficulties in accessing capital markets. High quality environmental disclosures and effective environmental performance, such as lower levels of hazardous waste produced or the reduction of toxic chemicals, provide investors with incremental information that is value relevant and increase stock valuation. This study is useful for investors and companies that operate in environmentally sensitive industries, because it makes them aware of the need to increase the quality of reported environmental information and shows the merits of high quality environmental disclosures. This study helps investors, financial analysts, market authorities and auditors to critically assess the environmental performance and key reporting issues as well as to evaluate how meaningful and relevant the reported information is. The study is also useful for environmental groups, which would need to know why environmental performance and disclosures vary from company to company. Users' needs for improved disclosures and detailed information about company environmental policies would call for the provision of supplementary voluntary reports to shed more light on certain environmental issues. Presenting high quality environmental disclosures would not only report on the impact of environmental decisions on balance sheet and income statement figures, but it would also reflect on the quality of corporate governance, company risk management, reputation and future financial prospects. Although institutional investors may develop private environmental disclosure channels (Solomon and Solomon, 2006), individual shareholders can only use information that is publicly available. It stems that regulators should protect shareholders' interests by improving the quality and integrity of publicly available information. Therefore, this study is useful for accounting standard setters and policy makers in identifying the most influential environmental factors that need to be further illustrated in annual reports in order to make companies more conscious of environmental protection as well as investors more demanding and stricter in their corporate evaluations. These considerations would further reinforce the quality of financial reporting and would assist users in making informed judgements and efficient decisions. A company's environmental performance and disclosures are important for external and internal decision-making. The current regulatory and financial reporting framework should be enhanced to promote transparent and informative reporting of companies' actual environmental performance, costs,

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contingencies and benefits. The reporting of hard and difficult to verify disclosures would assist users in identifying key elements of persistent material risks and would drive their attention to long-term performance indicators. Future research should examine the transition of Malaysian companies to IFRS and the quality of financial reporting and environmental disclosures under IFRS as opposed to former Malaysian accounting standards. Future research should also apply Eq. (1) using the ratio of hard disclosures to total disclosures as the dependent variable. The prediction that should be tested here is that the proportion of hard disclosures, as opposed to soft disclosures, to total disclosures is likely to be positively associated with environmental performance and earnings quality.

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