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The real effects of risk disclosures: evidence from climate change reporting in 10-Ks

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Abstract

We examine the economic impacts of risk disclosures in accounting reports on the real decisions made by information senders (i.e., managers of the disclosing firms). In so doing, we exploit the SEC rule enacted in 2010 regarding climate change risk (CCR) reporting in 10-Ks as a quasi-natural experimental setting in which to apply a difference-in-differences analysis. We focus on CCR because of its vast influence on economic activities and the relative ease of identifying managerial behaviors related to climate change. Our results reveal that CCR-disclosing firms tend to engage more (less) in pro-environmental (anti-environmental) activities after the SEC 2010 rule. These real effects are more pronounced in firms that are under higher pressure from climate-minded external stakeholders and when firms’ businesses are more sensitive to climate change-related risks. We also find improved environmental performance in terms of reductions in the quantity, intensity, and cost of carbon emissions surrounding the SEC 2010 rule. Overall, our findings suggest that CCR disclosures alter corporate behaviors and help curb climate change.

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Notes

  1. For U.S. public firms, risk disclosures represent more than 10% of the words in their annual reports (i.e., 10-Ks) (Campbell et al. 2014).

  2. For these firms, there was no information about the coverage and presentation of climate risk disclosure in the pre-rule period. Corporate managers thus are less likely to use a copy-and-paste strategy to disclose stale information at the initiation of the rule.

  3. Commission Guidance regarding Disclosure Related to Climate Change; Final Rule, Securities and Exchange Commission, 17 CFR Parts 211, 231, and 241.

  4. Please refer to Section 3.1.1 for more details about the debates.

  5. According to the database maintained by the Grantham Research Institute and the Sabin Center, there were 1,260 climate change-related laws covering 164 countries and regions in 2017, a 20-fold increase over 20 years (there were 60 laws in place in 1997) (https://www.carbonbrief.org/mapped-climate-change-laws-around-world).

  6. In this sense, CCR disclosures could be costly to the disclosing firms and thus serve as a credible signal.

  7. Increased regulatory risk as entailed by the SEC 2010 rule also contributes to the negative external responses to the initiation of CCR disclosure.

  8. For example, Mary Schapiro, then-SEC chair, commented on the SEC’s approval of the 2010 CCR disclosure rule that “a company must consider whether potential legislation—whether that legislation concerns climate change or new licensing requirements—is likely to occur. If so, … the company must then evaluate the impact it would have on the company’s liquidity, capital resources, or results of operations, and disclose to shareholders when that potential impact will be material” (Schapiro 2013).

  9. Petition for Interpretive Guidance on Climate Risk Disclosure. Available at http://www.sec.gov/rules/petitions/2007/petn4-547.pdf.

  10. Senate Oversight Highlights Week of October 29, 2007. Available at http://dpc.senate.gov/dpcdoc.cfm?doc_name=or-110-1-191. The quotation is from the chief investment officer of the California Public Employees’ Retirement System.

  11. Letter from Christopher J. Dodd, Chairman, U.S. Senate Committee on Banking, Housing, and Urban Affairs, and Jack Reed, Chairman, U.S. Senate Subcommittee on Securities, Insurance, and Investment, to Christopher Cox, Chairman, United States Securities and Exchange Commission (December 6, 2007). Available at http://dodd.senate.gov/multimedia/2007/120607_CoxLetter.pdf.

  12. For example, then-Commissioner Luis Aguilar claimed: “Climate change and related governmental action can create risks and opportunities for companies. It is clear that disclosure of this material information will inform and aid investors in their decision making ... This release clarifies that effects resulting from climate change that are keeping management up at night should be disclosed to investors” (http://www.sec.gov/news/speech/2010/spch012710laa-climate.htm). In contrast, then-Commissioner Kathleen Casey concluded: “The issuance of this release, however, at a time when the state of the science, law and policy relating to climate change appear to be increasingly in flux, makes little sense ... I do not believe that this release will result in greater availability of material, decision-useful information geared toward the needs of the broad majority of investors” (http://www.sec.gov/news/speech/2010/spch012710klc-climate.htm).

  13. For examples of such views, see Burton (2010) and Shorter (2013).

  14. Specifically, Senator John Barrasso and Representative Bill Posey introduced bills (S. 1393 and H.R. 2603, respectively) that would prohibit the enforcement of the SEC’s climate change disclosure rule. Please see http://posey.house.gov/News/DocumentSingle.aspx?DocumentID=252940.

  15. The SEC rule came into effect on February 8, 2010. A rather small number of 10-Ks for the fiscal year 2009 were filed before this date in 2010 (i.e., between January 1 and February 7), which does not have any material impacts on our results. In Section 5.3.3, we also report robustness test results after excluding the 2010 10-K filing year.

  16. The Equator Principles as a risk management framework for environmental risk were formulated in 2003 and have now been adopted by 93 financial institutions in 37 countries (https://equator-principles.com.about). The Carbon Principles were established in 2008 by three leading banks (Citigroup, JP Morgan Chase, and Morgan Stanley) to assess carbon risk in financing electric power projects (https://issuu.com/tobend/docs/the_principle_matter). The Climate Principles, adopted by Crédit Agricole, Munich Re, Standard Chartered, Swiss Re, and HSBC, are a similar framework for responding to climate change (https://en.wikipedia.org/wiki/The_Carbon_Principles).

  17. To isolate the effects of initial mandated CCR disclosure, we exclude 10-K filings after the first mandated CCR disclosure year and firms with voluntary CCR disclosures in the pre-rule years.

  18. Using CARs of other window lengths delivers similar results.

  19. In Eq. (3), we examine annual stock price change for the full sample period, during which stock splits and stock dividends are likely to occur for some firms. In contrast, in Eq. (2), we only consider a five-day window to examine stock price change, for which the mechanical price changes are unlikely to add significant noise.

  20. We thank the anonymous referee for pointing out this issue and suggesting the relevant tests.

  21. We consider only climate-related natural disasters, namely, coastal storms, droughts, flooding, heatwaves, hurricanes/tropical storms, landslides, lightning, severe storms/thunder storms, tornadoes, wildfires, wind, and winter weather that are recorded at SHELDUS.

  22. For example, FairChild Corp. has three subsidiaries: one in Kentucky and two in Ohio. In 2007, Kentucky and Ohio experienced 13 and 25 climate change-induced natural disasters, respectively. FairChild’s subsidiary-weighted number of natural disasters for 2007 is (1/3 × 13 + 2/3 × 25) = 21. We perform a similar computation each year during the post-period, scaled the values by 100, and take the average as the final measure of the company’s natural disaster exposure.

  23. We are grateful to the anonymous referee for bringing this issue to our attention.

  24. Untabulated test results confirm that the difference in the pre-period average value of Climate Change Practice between the treatment and control groups is insignificant, with a p-statistic of 0.92.

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Acknowledgements

We thank Peter Easton (the Editor), an anonymous referee, Alex Bassen, Wen Chen, Ahrum Choi, Yuyan Guan, Liangliang Jiang, Zhenbin Liu, Kerstin Lopatta, Ying Mao, Thomas Schmid, Byron Song, Nancy Su, Weiqiang Tan, Dragon Tang, Rui Wang, Wenming Wang, Zheng Wang, Xiangang Xin, Rengong Zhang, Yue Zhang, Liu Zheng, Hong Zou, and workshop participants at City University of Hong Kong, Hong Kong Baptist University, Lingnan University, Peking University, University of Hamburg, University of Hong Kong, and Yonsei University for valuable comments. The authors acknowledge research supports from Department of Accountancy, City University of Hong Kong, School of Accounting and Finance, Hong Kong Polytechnic University, and Department of Accountancy, Lingnan University. All errors are our own.

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  1. Department of Accountancy, City University of Hong Kong, Kowloon, Hong Kong

    Jeong-Bon Kim

  2. School of Accounting and Finance, Hong Kong Polytechnic University, Hung Hom, Hong Kong

    Chong Wang

  3. Department of Accountancy, Lingnan University, Tuen Mun, Hong Kong

    Feng Wu

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  1. Jeong-Bon Kim
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Appendices

Appendix A Examples of climate change-related risk disclosures in 10-Ks

1.1 Goodyear Tire & Rubber Co., 2011 10-K

In addition, our manufacturing facilities may become subject to further limitations on the emission of “greenhouse gases” due to public policy concerns regarding climate change issues or other environmental or health and safety concerns. While the form of any additional regulations cannot be predicted, a “cap-and-trade” system similar to the one adopted in the European Union could be adopted in the United States. Any such “cap-and-trade” system (including the system currently in place in the European Union) or other limitations imposed on the emission of “greenhouse gases” could require us to increase our capital expenditures, use our cash to acquire emission credits or restructure our manufacturing operations, which could have a material adverse effect on our operating results, financial condition and liquidity.

1.2 Sanderson Farms, Inc., 2013 10-K

Various factors can affect the supply of corn and soybean meal, which are the primary ingredients of the feed we use. In particular, global weather patterns, including adverse weather conditions that may result from climate change, the global level of supply inventories and demand for feed ingredients, currency fluctuations and the agricultural and energy policies of the United States and foreign governments all affect the supply of feed ingredients. Weather patterns often change agricultural conditions in an unpredictable manner. A sudden and significant change in weather patterns could affect supplies of feed ingredients, as well as both the industry’s and our ability to obtain feed ingredients, grow chickens or deliver products.

1.3 United Parcel Service Inc., 2014 10-K

Moreover, even without such legislation or regulation, increased awareness and any adverse publicity in the global marketplace about the GHGs emitted by companies in the airline and transportation industries could harm our reputation and reduce customer demand for our services, especially our air services.

Appendix B Algorithm of CCR information collection from 10-Ks

We download 10-K reports of all sample firms from the EDGAR database from the fiscal years 2005 to 2015. Following Campbell et al. (2014) and Hope et al. (2016), we identify the risk factor item using specific HTML tags. However, the disclosure of CCRs does not have item heading, presenting a challenge in identifying the location of CCR-related information. We use a three-step approach to overcome this challenge. First, we summarize the regularity of CCR disclosures by examining 600 randomly selected firms (200 from each year of 2010–2012, the first three years after the SEC rule) based on visual inspection. We identify 64 keywords relevant to firm disclosures of CCR, as listed in Table 12.

In the second step, we validate the CCR reporting regularity using out-of-sample checking. To do so, we randomly choose 20 firms each year from our full 11-year sample period and manually collect CCR information in their risk factor disclosures in 10-Ks. At the same time, we employ a textual analysis algorithm to extract the related CCR information. The algorithm scans the full text of the risk factor portion in Form 10-Ks to search for the CCR keywords in Table 12; when any of the keywords is detected in a particular sentence, the algorithm extracts all CCR information from the whole sentence. We then compare the algorithm extraction with the manual collection and find that our algorithm extracts the only and correct subsections from 10-Ks in over 97.7% of the selected cases.

Based on the validated regularity, in the third step, we apply our textual analysis algorithm to extract CCR disclosures from all years’ 10-Ks for all firms to generate a comprehensive dataset.

Table 12 Keywords of CCR disclosures in 10-Ks
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Appendix C Variable definitions

Appendix C Variable definitions
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Kim, JB., Wang, C. & Wu, F. The real effects of risk disclosures: evidence from climate change reporting in 10-Ks. Rev Account Stud 28, 2271–2318 (2023). https://doi.org/10.1007/s11142-022-09687-z

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