Kate Bewley


The economic consequences of financial reporting standards: the market valuation of environmental liabilities

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This thesis presents a study of the economic consequences of regulatory intervention on the financial reporting of environmental liabilities. The regulatory intervention is the introduction of new financial reporting standards that relate to managers and auditors responsibilities in estimating and reporting environmental liabilities. The research question is whether this regulatory intervention is associated with a change in the market's valuation of environmental liability accruals reported in companies' financial statements. A change in the market's valuation can indicate that market participants perceive the environmental liability information to be more precisely measured when the new financial reporting standards come into effect.

The thesis draws on theory and prior research to generate the testable hypothesis that, as one moves from a regime of low financial reporting standards for environmental liabilities to one of high financial reporting standards, the change in the valuation coefficient on a dollar of reported environmental liability will be negative. More specifically, the valuation coefficient is expected to change from zero, for an imprecise environmental liability measure, to negative one for a precise measure. The research question is studied by using an interrupted time-series design with replications in two settings, Canada and the U.S. The regulatory interventions are expected to have occurred at different times in these two countries, 1995 in Canada and 1993 in the U.S. The impact of the intervention is measured by examining the behaviour of the valuation coefficient on reported environmental liabilities in a multiple linear regression of share price levels on environmental liability book values and other relevant financial statement variables.

The empirical analyses indicate that the market places a negative valuation on environmental liabilities. Results for the U.S. sample are consistent with this coefficient becoming less negative after the regulatory change in 1993. The Canadian sample also indicates a change to a less negative coefficient, but this change is not significant when 1995 is used as the effective date of the regulatory change, while it is significant when 1993 is used. This may indicate that the change in U.S. standards also influenced the companies in the Canadian sample, thus preempting the later change in Canadian standards. The empirical findings indicate that the change in the valuation coefficient is non-negative; this is opposite to the study's ex ante prediction The potential for reporting bias to be an omitted factor that works in the opposite direction to the hypothesized precision effect is explored as one possible ex post interpretation of the findings.

The thesis presents evidence that changes in financial reporting standards are associated with changes in the market valuation of environmental liabilities, contributing to our understanding of the role of financial reporting standards in the reporting and valuation of environmental liabilities.