Rule- Versus Principle-Based Environmental Reporting Guidelines

Ji, Hyunjung; Ji, Hyunjung

A dearth of environmental information disclosure laws has created significant information asymmetries between firms and their external stakeholders because firms have greater access than others to information about their environmental impacts (and their related harms). Consumers, investors, regulators, environmental groups and other stakeholder who therefore wish to support (and reward) environmentally friendly companies have little information to do so. Moreover, a regulatory solution is prevented because of a general lack of political will. In response, some firms are voluntarily disclosing their environmental information by way of corporate environmental reports. However, as yet, there is no commonly accepted standard for this sort reporting, its content, measurement, and format. Moreover, no regulatory mechanism exists that would penalize firms’ misreporting. This setting has caused some stakeholders to question the credibility of the firms’ environmental reports, and raise concerns about whether some firms are merely creating the appearance of being environmentally responsible when in fact they are not.

In response, NGOs, such as the Global Reporting Initiative and Carbon Disclosure project, and governments (e.g., Japan, Denmark and France) have developed environmental reporting guidelines in an attempt to harmonize reporting approaches and enable firms to communicate more effectively with their stakeholders. However, these guidelines tend to vary according to whether they are rule- or principle-based. Rule-based reporting guidelines emphasize standardized reporting content within a uniform format, whereas principle-based guidelines emphasize flexibility in reporting by suggesting firms identify their relevant stakeholders and their preferences, and provide them with customized environmental information. We suggest that variations in these guidelines necessarily lead to differences in the quantity and quality of information that firms disclose. However, as yet, we have little understanding of how different sorts of environmental reporting guidelines are related to firms’ voluntary information disclosure behaviors. As a consequence, external stakeholders are more likely to regard all firms that self-disclose their environmental information similarly, when in fact some are reducing their information asymmetries to a greater extent than others.

We address these concerns by considering how rule- and principle-based reporting guidelines are related to the quantity and credibility of (i.e., externally verified) environmental information that firms disclose for 202 manufacturing companies that published environmental reports in the Database of Social/Environmental Reports. After controlling for self-selection bias related firms’ choice of reporting approach, we offer evidence that firms which follow rule-based environmental reporting guidelines tend to report more extensive and credible environmental information, whereas firms that follow principle-based guidelines tend to disclose fewer details about their environmental impacts, and what they do disclose is less likely to be externally verified. The flexibility afforded by principle-based guidelines therefore appears to create additional opportunities for firms to misrepresent their environmental activities. Our findings offer important implications about what sorts of environmental reporting guidelines are more likely to encourage firms to report reliable information, thus reducing information asymmetries between firms and their critical stakeholders and therefore facilitating the market mechanism to reward environmentally friendly companies.

Association for Public Policy Analysis & Management

Panel Paper: Rule- Versus Principle-Based Environmental Reporting Guidelines