The Effects of Financial Distress, Organizational Structure, and Auditing Rules on Firm EmissionsEPA Grant Number: R832847
Title: The Effects of Financial Distress, Organizational Structure, and Auditing Rules on Firm Emissions
Investigators: Evans, Mary F. , McKee, Michael , Vossler, Christian , Gilpatric, Scott
Institution: University of Tennessee
EPA Project Officer: Hahn, Intaek
Project Period: April 17, 2006 through April 19, 2009
Project Amount: $299,872
RFA: Environmental Behavior and Decisionmaking: Determining the Effectiveness of Environmental Information Disclosure and Provision (2005) RFA Text | Recipients Lists
Research Category: Environmental Justice
The proposed research will investigate the design and effectiveness of Federal environmental information disclosure programs, such as the Toxic Release Inventory and the Fuel Economy Information Program, that require firms to report on their environmental releases or performance. In particular, through both theoretical and empirical research, the results of this project will help us to understand (1) the role of firm organization and financial status on the accuracy of reported environmental behavior and (2) how to design enforcement programs that encourage compliance with environmental programs.
Objective 1: Develop a consistent and general theoretical analysis of firm-level environmental compliance with mandatory disclosure programs and use the model to examine firm-level incentives for noncompliance.
Objective 2: Develop a model of decision-making within the firm and examine incentives for malfeasance. Identify how potential disparities between the incentives of the firm and the incentives of individual decision-makers within the firm lead to divergent results.
Objective 3: Test hypotheses stemming from the theoretical models using data from laboratory economics experiments and field data.
Objective 4: Develop endogenous audit regimes consistent with our theoretical models and test their effectiveness in the experimental economics lab.
Phase I will be devoted to the development of theoretical models of firm environmental malfeasance. These models incorporate observable (financial reporting data) characteristics of firms such as the risk of bankruptcy and the compensation schemes for division managers into the firm level decisions to emit and to report under mandatory reporting programs. We develop models of a firm in which we explicitly incorporate the incentives for emissions decisions and information disclosure and examine the implications for two classes of firms—a firm managed by an entrepreneur-manager and a firm consisting of an upper level manager and several divisions in which the division managers are compensated by a rank order tournament (such as a promotion ladder).
Phase II will be devoted to testing these models with available field data and a series of laboratory market experiments. The laboratory experiments will allow us to gain insights into the behavioral and strategic aspects of emissions and disclosure choices as we manipulate the financial health of the “firms” in the lab and the organization structure and management compensation schemes.
Phase III will be devoted to the design and testing of enforcement mechanisms to promote compliance with emission and reporting regulations. The mechanism design will borrow heavily from the tax compliance literature, as well as from the models of firm behavior developed and tested in the previous phases.
This project will inform the policy discussion as it pertains to the use of information disclosure programs as an input to the use of market based regulation. Market forces can discipline the environmental performance of firms through liability for environmental malfeasance (harm) and associated capital market responses. For such information to have the intended effect, it must be provided to the market with appropriate assurance that it is correct and the information must be provided in a timely fashion.
The project will provide guidance as to the selection of firms for auditing of reporting compliance through focus on observable characteristics of firms that are predicted to affect emissions and disclosure decisions. The project will provide insights on the structure of an enforcement mechanism, i.e., the relative weights to be applied to the components of an enforcement mechanism. The models suggest certain program characteristics that may alter the effectiveness of reporting requirements including the timeliness of information release and the probability of audit. Exploring these relationships in the lab and with field data analysis will identify regulatory tools to target particular firms for auditing and improve compliance with reporting requirements.
The combination of experimental and field data analysis provides complementary means for the analysis of behavioral and strategic decision making, and their application to naturally occurring settings.