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· Earth
Summit 101 Corporate Impacts Issue Briefs: Water, Biodiversity Polluted
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Environmental Accounting Tricks |
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The Viacom Trick: Lowballing Superfund Liabilities The dangers of inadequate and/or misleading corporate disclosure are starkly clear, as demonstrated by the widespread economic damage and misfortune that has accompanied the fraudulent behaviour of Enron, WorldCom and other companies. The Bush administration and the Securities and Exchange Commission (SEC) has both responded by proposing improved corporate disclosure on issues such as related party transactions, corporate governance, and critical accounting policies. But will these disclosure reforms be enough to restore investor confidence and ensure corporate responsibility? Americans' outrage and distrust towards big business stems from more than just accounting fraud. It comes from broader public questions regarding corporations' commitment to society, and whether they are living up to our collective expectations of social and environmental responsibility. Thanks to Enron and WorldCom, investors have received a crash course on accounting tricks, such as the creation of special purpose entities (Enron) or the false claiming of regular expenses as capital expenditures (as WorldCom did to the tune of $3.85 billion). But companies use other creative accounting methods to obscure losses and overstate earnings through the manipulation of liabilities such as environmental remediation costs. For example, when a corporation indefinitely and egregiously postpones booking its environmental liabilities, not only does it injure shareholders, it also potentially harms communities and impacts environmental health. The Viacom Trick: Lowballing Superfund Liabilities One example of how environmental liabilities can be manipulated to "manage earnings" relates to toxic waste liabilities such as Superfund (Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA) cleanup costs. Companies can put off remediation expenses by drawing out litigation to delay booking these costs, and they can also use accounting loopholes to minimize their clean up cost estimates. Accounting rules say that a company has to provide the best clean-up cost estimate that it can, but if it cannot arrive at such a number, it can report a minimum cost estimate. Companies can easily lowball their estimates so that they fall under the threshold of materiality, or significance, and therefore not subject to disclosure. The Halliburton Trick: Hiding Asbestos Liability Another way companies use environmental health issues to "manage earnings" is by minimizing the impact of asbestos claims. Asbestos liabilities are currently estimated at $200 billion (Enron's losses were about $63 billion, while the bankruptcy totals about $107 billion), and many companies are on the hook for tens of millions of dollars worth of these claims. However, some companies attempt to minimize the appearance of these liabilities on their balance sheets by exploiting loopholes in environmental disclosure rules. For example, when Halliburton urged its shareholders in 1998 to approve a merger with rival Dresser Industries, it downplayed Dresser's environmental liabilities. Halliburton portrayed Dresser as basically having no litigation or environmental problems except for those outlined in other referenced documents. If shareholders had looked at these other documents, they would have found that Dresser actually had 66,000 pending asbestos claims. To be fair to shareholders, Halliburton should have directly disclosed the existence of Dresser's asbestos liabilities, rather than obliquely reference them. For the next three years, Halliburton continued to assert that asbestos claims would not have a material impact on their business - even though in 2001 Moody's and Standard & Poor's downgraded Halliburton's credit rating based on the company's asbestos liability burden. Halliburton was finally forced to come clean with investors on July 24, 2002 by releasing an independent report that finally told the real story on asbestos claims. Halliburton's asbestos litigation expenses were estimated to total $2.2 billion by 2017, and the company was forced to set aside $391 million to deal with these costs. Because of this charge, the company reported a quarterly loss for the first time in four years - tarnishing the rosy financial picture that the company painted by lowballing asbestos liabilities for so long. However, at the end of the day, Halliburton's shares rose because investors, who were operating among rumors of asbestos-induced bankruptcy, rewarded the company for telling the truth rather than hiding it. The Dow Trick: Painting a Rosy Picture Although SEC rules require companies to fairly describe known trends or uncertainties that could pose risks, many companies get away with painting rosy pictures of the future by neglecting to identify pending environmental or labor regulations, consumer trends and scientific evidence that could adversely impact them. Sometimes, a company may lobby against a particular regulation, claiming that it would have a devastating effect on the bottom line while not mentioning a word to investors that these allegedly disastrous regulations could pose risks to the company. For example, DuPont's Management's Discussion & Analysis section of its 2001 annual report talked about the Kyoto Protocol, saying, 'While well ahead of the target/timetable contemplated by the Protocol on a global basis, the company faces prospects of country-specific restrictions where major reductions have not yet been achieved." Because DuPont is aware of the impact that climate change will have on its business, it is attempting to manage its greenhouse gas emissions as a matter of business and shareholder value. In contrast, Dow Chemical, which produces similar products and is exposed to similar regulations and markets as DuPont, did not mention anything about climate change in its 2001 annual report. Climate change disclosure also varies greatly among companies in the insurance sector, which may be significantly impacted by increased property claims due to climate change - related severe weather events. Munich Reinsurance and Swiss Reinsurance both take climate change very seriously and discuss this issue with their shareholders in their annual reports. However, among U.S. insurers who face this same climatological phenomenon, Chubb provides only a little discussion of the issue while companies like Hartfold and Allstate do not mention anything. A Systemic Problem of Under-Reporting Environmental Legal Proceedings The SEC requires companies to disclose legal proceedings initiated or contemplated by an environmental agency that would result in monetary sanctions of over $100,000. The Environmental Protection Agency surveyed companies 1996-97
SEC filings and found that 74% of companies failed to report environmental
legal proceedings, illustrating that this particular environmental
disclosure rule is regularly flaunted by companies. Among these companies was Exxon, which should have disclosed the fact that in 1997 was ordered to pay $209,600 in a civil case brought by the Department of Justice on behalf of the Environmental Protection Agency for hazardous air emissions and other environmental violations. Although $100,000 may be a small amount of money for some companies, keeping these proceedings off the books allows companies to hide evidence suggesting that they are bad corporate actors. When Bush uttered his now famous quote: "In the corporate world, sometimes things aren't exactly black and white when it comes to accounting procedures," the President did have a valid point. Vague accounting rules, combined with companies' desire to boost the bottom line, can lead to numerous accounting tricks that hurt investors and in some cases, the environment and communities as well. For example, poor labor-related disclosure can also hurt employees and shareholders. Current SEC rules on reporting labor-related information is relatively vague. Companies generally do not disclose much about the quality of labor-management relations until a strike is imminent or declared, which is far too late. By that time the company, its shareholders and its workers are all adversely affected. Similarly, Occupational Safety and Health Administration (OSHA) data such as lost work days, fatalities, and near-miss accidents are value-relevant for shareholders and can provide a leading indicator of the quality of a company's risk management systems. But because worker health and safety data is left off the balance sheet, companies may be able to get away with perpetuating unsafe working conditions (particularly since OSHA's inspection capabilities are severely limited). Thus, keeping environmental and labor matters off the balance sheet is especially dangerous, because it can harm not only investors, but workers, human health and the environment as well. Putting these environmental, labor and public health issues onto company balance sheets may cause earnings to decrease. However, if companies fairly and accurately book these costs, they will be given a permanent and strong incentive to cease engaging in activities that cause environmental and social harm. |