governmental guidance and voluntary environmental disclosure in ...

GOVERNMENTAL GUIDANCE AND VOLUNTARY ENVIRONMENTAL DISCLOSURE IN STANDALONE REPORTS: AN ANALYSIS OF DIFFERENCES ACROSS SOUTH KOREAN AND U.S. COMPANIES

Charles H. Cho* Assistant Professor Department of Accountancy John Molson School of Business Concordia University 1455, de Maisonneuve Blvd West Montréal, Québec H3G 1M8, Canada Tel: (514) 848-2424 ext. 2319 E-mail: [email protected] Jong-Seo Choi Professor Department of Accounting College of Business Adminstration Pusan National University South Korea E-mail: [email protected] Young-Min Kwak Doctoral Student Department of Accounting College of Business Adminstration Pusan National University South Korea E-mail: [email protected] Dennis M. Patten Professor Department of Accounting College of Business Illinois State University Stevenson Hall Campus Box 5520 Normal, IL 61761-5520 E-mail: [email protected]

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* Corresponding author


ABSTRACT In contrast to U.S. governmental departments (and other authoritative boards), South Korea’s Ministry of the Environment provides formal guidelines on standalone corporate environmental reporting. The purpose of our investigation is to determine whether this higher level of governmental support for standalone reporting is associated with differences in the extent of disclosure. Using two separate environmental disclosure scoring metrics (Clarkson et al., 2008, Patten and Crampton, 2004), we examine the extent of environmental disclosure made by a matched sample of 25 South Korean and 25 U.S. companies in standalone sustainability-type reports. Empirical results show, using either disclosure scale, that South Korean companies’ environmental disclosures are significantly more extensive than the disclosures for their U.S. counterparts. These findings provide strong evidence that governmental support and guidance appears to lead to more extensive provision of environmental information in standalone sustainabilitytype reports, and suggests that calls for more authoritative support for environmental disclosure (see, e.g., Cho and Patten, 2008; Patten and Freedman, 2008) are justified.


1. Introduction Ballou, Heitger, & Landes (2006) argue that increasing stakeholder pressure is leading to an increase in corporate reporting on social and environmental performance, largely through the issuance of standalone sustainability-type reports. As evidence of that growth, KPMG International, in its 2008 survey of corporate social responsibility and sustainability reporting, claims that “nearly 80 percent of the largest 250 companies worldwide” are now issuing some type of a corporate social responsibility report (KPMG International, 2008, p.13). Unfortunately, much of the standalone sustainability reporting has been criticized as being limited in scope (Jupe, 2007), trivial (Gray, 2006), and even disingenuous (Aras & Crowther, 2008). The problem is that this reporting, like the provision of social and environmental information in annual reports, continues to take place largely in a voluntary regime (see, e.g., Gray & Bebbington, 2000; 2007). Given the concerns with the quality of voluntary environmental disclosure and the growth of standalone reporting as a tool for disseminating this information, the intent of our investigation is to provide evidence on whether a higher level of governmental support for standalone reporting is associated with differences in the extent of disclosure. In contrast to governmental departments (and other authoritative boards) in the U.S., who offer no formal guidance on standalone environmental reporting, South Korea’s Ministry of the Environment (MOE) has had a formal (annually updated) guideline in place since 1999. The MOE’s Business Environmental Report Guideline lays out specific recommendations for corporate environmental reporting. The existence of this

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governmental guidance is particularly interesting because South Korea’s historical emphasis on economic development above all else, as well as its cultural, legal, and institutional characteristics (Nelson & Deegan, 2002; Leuz, Nanda, & Wysocki, 2003) both suggest corporate environmental disclosure would otherwise be expected to trail that of similar U.S. companies. Using two separate environmental disclosure scoring metrics (Clarkson, Li, Richardson, & Vasvari, 2008; Patten & Crampton, 2004), we examine the extent of environmental disclosure made by a matched sample of 25 South Korean and 25 U.S. companies in standalone sustainability-type reports.1 Our results show, using either disclosure scale, that the South Korean companies’ environmental disclosures are significantly more extensive than the disclosures for their U.S. counterparts. This is true for all major sub-groupings included within each of the respective scoring metrics. These findings provide strong evidence that governmental support and guidance appears to lead to more extensive provision of environmental information in standalone sustainabilitytype reports. The results thus suggest that calls for more authoritative support for environmental disclosure (see, e.g., Cho & Patten, 2008; Patten & Freedman, 2008) appear to be warranted. 2. Background and Hypothesis Development While a number of studies investigate whether changes in reporting regulations and/or authoritative guidance are associated with subsequent changes in environmental disclosure2 (e.g,, Alciatore, Dee, & Easton, 2004; Larrinaga, Carrasco, Correa, Llena, &

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Although many of the reports we examine provide information across both social and environmental dimensions, we limit our analysis in this study to only the latter category. 2 Results of these investigations are mixed. For example, both Alciatore et al. (2004) and Patten (2000) report increases in disclosure related to changes in regulations and authoritative guidance for firms in the

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Moneva, 2002; Patten, 2000), this prior work focuses on mandated (at least in theory) disclosures to be included in companies’ annual reports. In contrast, in this investigation we concentrate on disclosures included in voluntary corporate sustainability reports and attempt to determine whether stronger governmental guidance is associated with more extensive disclosure. This issue is relevant, because with the exception of one or two countries (see Hibbitt & Collison, 2004), the choice to issue separate standalone sustainability-type reports is purely voluntary. Unfortunately, as noted by Gray (2006, p.803), this voluntary regime has led to a situation where “the vast majority of reports are company-based . . . partial, and mostly, fairly trivial.” If it can be shown that a proactive and supportive governmental stance for reporting leads to better information provision, even given that the reports remain voluntary in nature, then justification can be offered for increasing pressures on government (and other authoritative bodies) to provide better disclosure guidance. We examine the issue of differing governmental guidance for environmental disclosure relative to standalone reporting by identifying this disclosure for a sample of companies in South Korea and the United States. In contrast to the U.S., where no formal governmental guidance on voluntary corporate environmental disclosure3 exists, the South Korean government, as will be discussed below, does provide substantial guidance. We believe comparing voluntary disclosure by corporations across these two countries is a particularly strong test of the value of governmental guidance because other factors the longer history of social and governmental interest in environmental protection and U.S., whereas Larrinaga et al. (2002) find that Spanish company disclosures did not appear to increase following inclusion of requirements for environmental information in disclosure standards issued in 1998. 3 Our focus is entirely on voluntary environmental disclosure through standalone reporting. As discussed below, U.S. companies are required to make some mandatory environmental disclosures, primarily with respect to hazardous waste remediation liabilities, in their financial reports.

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disclosure, and stronger legal and institutional characteristics in the U.S. - appear to suggest that South Korean corporate disclosure would otherwise be lower. We discuss these inter-country differences, as well as the South Korean disclosure guidance, in more detail below. Differing Backgrounds As noted by Heard and Bolce (1981), societal and governmental concern for environmental matters in the U.S. dates back to at least the early 1960s, and many of the major governmental enactments relating to corporate environmental performance go back nearly as far. For example, many major pieces of environmental legislation including the Clean Air Act and the Federal Water Pollution Control Act were passed in the early 1970s. Requirements for 10-K report disclosures on environmental matters were also initiated in the 1970s, with major additional guidance for financial report disclosure of exposures relating to Superfund and other hazardous waste liabilities promulgated in the late 1980s and early 1990s. And although standalone environmental reporting didn’t take hold until the early 1990s (Buhr, 2007), disclosure of environmental information in annual financial reports was already widespread by the 1970s (see, e.g., Ernst & Ernst, 1973 et seq.). In spite of this history and in spite of the growing trend of standalone sustainability reporting over the past twenty years (Buhr, 2007), no governmental (or other authoritative board) guidance for standalone sustainability-type reporting has been issued in the U.S. South Korea has a different history with respect to its relation between business and the environment. Compared to other advanced economies, and in particular the U.S., the most contrasting feature of South Korea in terms of the relationship between the

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economy and the environment arises from the fact that the country achieved its economic development in an extremely short period of time. South Korea transformed itself from post-war ruins in 1954 into the eleventh largest economy in the world and a member of the Organization for Economic Cooperation and Development by the end of 1996. The South Korean government put supremacy on economic success over any other values, including environmental conservation, during the process of compressed economic development. Historically, the South Korean business community at large shared the same sentiments as the prevailing governmental powers regarding the value of the environment. As a result, environmental degradation and exploitation was an inevitable side effect. However, the growth of the Korean economy also accelerated the expansion and globalization of business enterprises, which in turn led to increased societal demands for a cleaner environment. Spurred by high profile cases of river pollution caused by effluents discharged by South Korean firms during the early 1990s, the South Korean government passed extensive environmental legislation. These enactments include the Basic Environment Policy Act of 1990, the Liability for Environment Improvement Expenses Act of 1991, the Environmental Pollution Damage Dispute Adjustment Act of 1990, and the Natural Environment Preservation Act of 1991, among others (Choi, 1999). Thus, governmental concern with environmental matters trailed the U.S. by two decades. Similar to the time lag for environmental protection legislation, requirements for mandatory financial report environmental disclosure also came about much later in South Korea than in the U.S. Requirements for disclosure in the financial reports dates back to the enactment of article 90, clause 21 of the Corporate Accounting Standards of 1996, whereby audited firms are required to disclose environment related information in the

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notes to the financial reports (Choi, 1999). The categories of information required by the clause include environmental standards and policies, safety and accidents, environmental investments, consumption of resources and energy, and treatments of wastes and byproducts. However, the disclosure requirement is subject to company discretion as to the applicability of the information and might be interpreted as subject to a discretionary materiality threshold. As a result, not all companies provide this information in their financial reports (Choi, 2006). Aside from the differences in the history of social and political concerns with environmental degradation and differences in requirements for mandatory financial report environmental disclosures, South Korea’s cultural, legal, and institutional characteristics also suggest that corporate voluntary disclosure would be expected to trail that of U.S. firms. Nelson and Deegan (2002, p.190-191) note for example, that based on the work of Hofstede (1980, 1991), Gray (1988) and Eddie (1996), South Korea can be classified as having “high level of secrecy”, a factor argued to lead to lower disclosure. In support of this claim, Nelson and Deegan (2002) document that 1998 social disclosure by South Korean corporations was significantly lower than that of firms from Australia and Singapore. Somewhat similarly, Leuz et al. (2003) classify the U.S. and South Korea very differently with respect to legal and institutional characteristics as they apply to market economies. More specifically, Leuz et al. (2003, p.519) classify the U.S. as having an “outsider economy.” Countries included in this class all have common law legal tradition, but also tend to exhibit larger stock markets, low ownership concentration, and extensive outsider rights. Importantly, Leuz et al. (2003, p.519) also note that relative to other countries, those with outsider economies are also characterized by strong

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legal enforcement and higher disclosure levels. In contrast, Leuz et al. (2003) classify South Korea as an insider economy country with weak legal enforcement.4 Leuz et al. (2003) provide evidence that companies from countries with outsider economies exhibit lower levels of earnings management, presumably because the stronger protections limit insiders’ ability to mask firm performance. Although not discussed by Leuz et al. (2003), differences in legal enforcement appear to exist with respect to environmental protection as well. South Korea is not yet equipped with strong regulatory sanction mechanisms such as the U.S.’s Superfund Act. Even when violations occur with regard to environmental protection, the guilty companies are seldom severely punished out of fear of causing substantial operational risk for the offenders.5 Everything else being equal, it appears that South Korea’s shorter history of social and political interest in environmental protection and disclosure, along with the differences in cultural, legal, and institutional factors highlighted by Nelson and Deegan (2002) and Leuz et al. (2003), would suggest that voluntary environmental disclosure by South Korean firms would be expected to lag behind that of their U.S. counterparts. However, all else is not equal. Separate from the Corporate Accounting Standards, South Korea’s MOE, in late 1999, issued its initial Business Environmental Report Guideline. The Guideline, which has been updated on an annual basis, provides recommendations for disclosures in

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Leuz et al. (2003) identify three distinct country clusters. The first cluster includes companies with outsider economies. Clusters two and three both are classified as having insider economies. The distinction, as noted by Leuz et al. (2003, p.519) is that cluster two countries “have significantly better legal enforcement than countries in the third cluster.” 5 For example, in spite of a major oil spill by Samsung Heavy Industries near the port of Daesan in Taean County in 2007, sanctions were minimal.

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corporate environmental reports including a declaration by the CEO, and information on the firm’s environmental policy and goals, environmental management systems, environmental audits, environmental impacts and performance, and stakeholder partnerships, among other things. These items are encouraged to be included as core indicators in the environmental reports. Further, since August of 2001, the MOE has been operating the Corporate Environmental Report pilot project with selected businesses sporting good environmental management records. The objective of the pilot project was to publish and disseminate standalone environmental reports that disclose corporate environmental management records, environmental improvement efforts and other environmental information to financial institutions and other interested parties. Mainly motivated by these governmental initiatives, the number of firms preparing standalone environmental reports or disclosing environment-related information on firm websites has increased substantially since the early 2000s (Choi, 2006). In addition to the Corporate Environmental Report pilot project undertaken in 2001, MOE is in the process of developing an Environmental Management Performance Index to help executives make informed decisions and to meet the demand for reliable data by interested parties. The index will include information on environmental improvement impacts and the development of new products, not to mention physical and chemical indicators of the entire process, so that corporate environmental management performance may be compared and evaluated. Furthermore, MOE is also proceeding with the introduction of environmental accounting that enables accurate quantification of corporate environmental performance. It also supports the development of guidelines for corporate environmental performance evaluation so that financial institutions can assess

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corporate environmental performance or environmental risks in advance and confirm the borrowing company’s asset management. The guideline will also enhance the competitiveness of environment-friendly businesses through market-based valuation and encourage the implementation of an environmental management policy (MOE, 2007). As noted above, and in contrast to the guidance for standalone environmental reporting being provided by the MOE in South Korea, no governmental agencies in the U.S. have issued any type of guidance or requirements for environmental or other disclosure in standalone environmental or sustainability-type reports. We believe the existence of the guidance in South Korea is likely to lead to more extensive disclosure of environmental information in standalone reports for their companies relative to those from the U.S., both because the guidance offers specific recommendations on the types of information to disclose and because the Guidelines (and other related initiatives) signal public policy interest in the reporting. We state our formal hypothesis (in alternative form) as: H1: Ceteris paribus, standalone sustainability-type reports issued by South Korean companies will include more extensive environmental disclosures than reports issued by firms from the United States. 3. Research Methods Sample selection Sample selection was based on the following criteria: 1. Companies had to have issued a stand-alone sustainability report over the period from 2006 through 2008.6 2. Companies had to have an identifiable industry or sector in their respective country.

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In contrast to financial reports, many companies do not issue standalone sustainability reports on an annual basis.

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3. Companies had to have financial data available (for size proxy). We started by identifying a sample of 33 firms listed on the Korea Securities Exchange with recently issued and available standalone sustainability-type reports. We then attempted to match each of these companies with a U.S. firm based on industry and relative size within industry (based on total assets) by country.7 However, the U.S. matched company also had to have issued a standalone sustainability-type report over the period of interest. Using these criteria we were unable to identify suitable matches for eight Korean firms. Our final sample thus consists of 50 companies, 25 Korean and 25 U.S. matched firms. Sample companies represent 12 industries. Firm size (based on 2006 total assets) ranges from $3.2 billion to $1.35 trillion with a mean (median) of 132.4 billion ($25.4 billion) for the U.S. firms and ₩986.6 billion ($1.1 billion) to ₩119.3 trillion ($128.3 billion) with a mean of ₩19.32 trillion ($20.8 billion) and median of ₩11.96 trillion ($12.9 billion) for the Korean companies.8 Disclosure indexes To measure the extensiveness of environmental disclosures, we use, first, the discretionary disclosure index from Clarkson et al. (2008). This comprehensive scheme was largely designed based on the guidelines set forth by the Global Reporting Initiative (GRI). The GRI is a large joint initiative launched in 1997 by the Coalition for Environmentally Responsible Economics, a U.S. non-governmental organization, and the United Nations Environmental Program. Its major objective is to develop a global 7

Due to the inherent size difference between Korean and U.S. markets and economies, relative rank within industry was deemed a better match choice than absolute size. 8 Due to our matching on relative position within industry, the U.S. firms are, on average, significantly larger than their Korean counterparts. Almost all prior studies of environmental disclosure find that the extent of environmental disclosure is positively related to firm size, suggesting a potential bias in our analysis. However, as we report below, we find less extensive disclosure for the U.S. companies, indicating, if anything, the matching understates the magnitude of the difference in disclosure between U.S. and Korean firms.

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reporting framework to continuously improve the quality, credibility and relevance of sustainability reporting (Global Reporting Initiative, 2009). The G3 guidelines constitute the “cornerstone” of the GRI framework and the organization recommends it should be used as the basis for annual reporting on sustainability. These guidelines present principles and guidance related to both report content (materiality, stakeholder inclusiveness, sustainability context, and completeness) and report quality (balance, comparability, accuracy, timeliness, reliability, and clarity). The Clarkson et al. (2008) index consists of two major sections, classified as “hard disclosure items” and “soft disclosure items.” The “hard disclosure” area includes four sub-groups categorized as (1) governance and structure management systems, (2) credibility, (3) environmental performance indicators (EPIs) and (4) environmental spending/ On the other hand, the “soft disclosure items” include three sub-groups labeled as (1) vision and strategy claims, (2) environmental profile and (3) environmental initiative. Several disclosure items are included within each sub-group. The total maximum possible score is 95 of which 60 are potentially generated by the EPIs subgroup due the various weights attributed for each EPI item. We repeat our analysis using a second disclosure metric, the scale developed by Patten and Crampton (2004). While less comprehensive in scope than the Clarkson et al. (2008) scale, Patten and Crampton’s (2004) scheme better captures both more specific environmental spending disclosures as well as information relating to negative aspects of environmental performance. Patten and Crampton (2004) break their scale into “positive or neutral” disclosures (17 separate items across three major sub-groups – economic,

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pollution abatement, and other), and negative disclosures (four items). With the Patten and Crampton scale, total disclosure scores can range from zero to 21. 4. Analysis and Results We use a t-test of means to identify the statistical significance of our hypothesized relations.9 Table 2 presents the results of the analyses of differences in voluntary environmental disclosure scores, measured using the Clarkson et al. (2008) index, between U.S. and South Korean firms. Panel A of the table summarizes the hard disclosure items while Panel B presents the differences in disclosure across the soft disclosure items. As highlighted in Table 2 Panel A, the South Korean firms have significantly higher disclosure scores than their U.S. counterparts for all four sub-groups within the hard disclosure category. More specifically, (1) South Korean firms’ mean government structure and management systems score is 3.08 in comparison to a mean score of 1.36 for U.S. firms; (2) South Korean firms’ environmental credibility is 6.32, on average, versus 2.56 for the U.S. firms; (3) South Korean firms’ environmental performance indicator mean score is 26.56 as opposed to a mean of 7.44 for U.S. companies; and (4) South Korean firms’ environmental spending score is 1.88, on average, compared to 0.56 for the U.S. sample companies. Finally, the mean total score for hard item disclosure is 37.84 for South Korean firms while their U.S. counterparts’ average score is only 11.09. All these differences are highly significant (p < .01, two-tailed). Results for soft disclosure items are presented in Table 2 Panel B and are similar to hard disclosure item results. All sub-groups (vision and strategy claims, environmental

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Tests of differences were repeated using non-parametric Mann-Whitney tests. Results, not presented, were essentially equivalent to the results of our parametric tests.

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profile, and environmental initiative) reflect significantly higher mean total disclosure scores for the South Korean firms in comparison to the U.S. companies (p < .01, twotailed). Mean disclosure scores for the South Korean companies are 5.08, 2.28, and 3.96 across the vision and strategy claims, environmental profile, and environmental initiative areas, respectively, in comparison to the U.S. mean scores of 3.68, 1.44, and 0.92. The differences in both soft disclosure total score (mean of 11.32 for South Korean companies and 6.04 for U.S. firms) and total disclosure scores (South Korean firms’ average score is 49.16, U.S. mean score is 17.96) are also highly significant (p < .01, two-tailed).

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worth noting that there were no items of either hard or soft disclosure where the U.S. sample firms out-disclosed (at statistically significant levels) their South Korean matches. These results provide strong evidence in support of our hypothesis that stronger governmental guidance is associated with more extensive voluntary environmental disclosure. [Table 2 about here] Table 3 presents results for the analysis of differences in disclosure based on the Patten and Crampton (2004) disclosure scale. Consistent with the results presented above, South Korean firms again are shown to provide significantly more extensive environmental disclosure in their standalone reports than the cohort of U.S. companies. This is true across both positive/neutral disclosures (summarized in Panel A of Table 3) and negative disclosures (Panel B). The average positive item total score for the South Korean firms was 12.84 in comparison to a mean score of 6.16 for the U.S. companies. This difference is statistically significant at p < .01, two-tailed. While the South Korean companies, on average, disclosed significantly more across all three sub-groups within

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the Patten and Crampton (2004) positive/neutral category, perhaps the most interesting difference relates to the disclosure of economic information. The mean score for the South Korean firms for this area was 1.96 (out of a possible 4) compared to an average of only 0.24 for the U.S. companies. The South Korean companies were also more forthcoming than their U.S. counterparts with information of a negative nature (a mean of 1.00 compared to the U.S. average of 0.32), although disclosure in this area was more limited than for any positive/neutral sub-groups.10 The difference in mean negative disclosure scores is also statistically significant (at p