Issues in Social and Environmental AccountingVol. 1, No. 1, June 2007Pp. 54-71 Legitimacy in Green: Pollution vs. Profit in Canadian Oil Refineries Vanessa Magness Faculty of Business Ryerson University, CanadaAbstractThis paper examines the correlation of financial and environmental performance in the petro-leum refinery sector. Emissions fell while profits rose over a ten-year period. Ongoing effortsto legitimize companies in light of changing societal expectations have created an external en-vironment that encourages the development of new technologies that promote cost efficienciesand good environmental performance simultaneously. Russo and Fouts (1997) argued thatindustries subject to rapid technological advance are well suited to respond to these changes inthe external environment. The findings of this paper suggest that the petroleum refinery sectorof the oil and gas industry may be meeting the challenge of the environmental movement.Key words: environmental performance, environmental accounting, legitimacy theoryIntroduction penalties and court costs if they do not. Insurance is harder to obtain, and moreSocietal concern for environmental pro- expensive. Debt servicing costs aretection has triggered a host of new chal- higher for companies that do not complylenges to corporate managers in the form with environmental regulation. Stake-of new regulation and stakeholder ex- holders demand better disclosure of en-pectations. Both have triggered costs vironmental management information,that profoundly affect the business sec- and put downward pressure on equitytor. For example, there are capital costs prices for companies that do not comply.for pollution control equipment, ongoingmonitoring costs to ensure that emis- There are two competing views on thesions stay within allowable limits, and impact of the environmental movementVanessa Magness is Associate Professor of Accounting at School of Business Management, Ryerson University, Can-ada, email: email@example.com
V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 55on business activity. One says that pol- be part of the manufacturing sector.lution abatement efforts divert resources This sector accounts for 18% of Can-from the production of marketable out- adas gross domestic product, and em-put and lead to a decline in profit ploys 2.3 million people at salaries that(Gollop & Roberts, 1983). The other are 22% above the Canadian averagesays they lead to modernization of op- (Myers, 2005). The refineries are par-erations and higher profits (Freedman & ticularly targeted for regulation. ForStagliano, 1991). Empirical studies example, despite the fact that existinghave produced mixed results. This pa- refineries are operating at full capacity,per explores this question within the and that recovery operations in the Al-context of the Canadian oil and gas in- berta oilsands are expected to triple industry. It is an integrated industry that by 2015 (Ollenbeger, 2005), no new re-begins with the upstream exploration fineries have been built on the Northand recovery activities. Some oil is re- American continent in the past 25 years.covered in Canada by conventional The Ministry of Natural Resources saidmeans, however the country is known that regulation is the primary disincen-for its oilsands operations that entail the tive to build in Canada (Brethour, 2005).removal of vast areas of forested land so The costs of regulation can be difficultthe layers of earth can be mined for the to assess (World Resources Institute,deposits of crude trapped in the soil. 1995). They are known, however, to beThe downstream operations include the substantial. For example, in 1993 thepetroleum and petrochemical refineries, costs for refineries to satisfy environ-which emit a variety of chemicals into mental regulations in the US were esti-the air, earth, and water. The refineries mated to be $152 billion (National Pe-are energy intensive operations, respon- troleum Council, 1993). In Canada, thesible for a substantial portion of the cost of sulphur reduction regulationgreenhouse gases in this country. The alone is estimated to be $5.3 billionlargest firms in this industry participate (Purvin & Gertz, 2004).in both upstream and downstream opera-tions, as well as the production, trans- This research uses National Pollutantportation and distribution of end product Release Inventory information (NPRI)to the wholesale and retail markets. as a proxy for environmental manage-Large, high profile firms such as these ment, and examines the correlation ofare subject to considerable public scru- NPRI releases with profitability over atiny and may be targeted specifically by ten-year period beginning in 1993. Acalls for regulation (Watts & Zimmer- regression of profitability on emissions,man, 1990). The demand for controls on company size, and other independentenvironmental impacts has been growing variables shows an inverse relationshipfor several years. Walden & Schwartz between refinery profits and NPRI re-(1997) said that 1989, the year of the leases.Exxon Valdez oil spill, sparked the pub-lic demand for corporate accountability The results of this study suggest thatfor environmental impacts. compliance with societal expectations can be accompanied by improvements inThis paper focuses on the petroleum re- efficiency, as was suggested by Freed-finery operations, which is considered to man & Stagliano (1991). The key to
56 V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71these findings may lie in technological taining to stock valuation models. Capi-advances that have been inspired by tal market theory says the price of achanging societal expectations, and by share today is derived from the dis-companies efforts to legitimize them- counted stream of expected cash flowsselves in light of these changing de- (Fama, 1965). These cash flows, in themands. Russo & Fouts (1997) argued form of dividends or capital gains, willthat in industries subject to rapid techno- at some time accrue to the shareholder.logical development, good environ- Changes in those expectations will affectmental management and profitability can share price. For example, a decline inbe pursued simultaneously. Further ex- price may be caused by a reduction inamination of the relationship of environ- the cash flows expected from future op-mental and financial performance in erations, or by an increase in the correla-other sectors of the oil and gas industry, tion of the individual stock returns withor other countries, would be a natural the returns of the overall market (Thisextension of this current work. correlation is referred to as the stock’s beta). Based on the assumptions that events which directly involve one com-Literature Review pany will trigger industry information transfers throughout the capital markets,Prior research investigating the eco- thereby affecting the shares of othernomic impact of regulation in general, companies in the same industry (Clinchand environmental regulation in particu- & Sinclair, 1987), and that anticipatedlar, has tended to focus on three ques- changes in legislation (as could occur intions: the aftermath of an accident) affect in- vestors’ expectations of future economic1. How do shareholders react to the performance (Blacconiere & Patten, threat of new regulation? 1994), numerous studies have looked for2. How do they react to the imple- evidence that certain events affect share mentation of new regulation? prices across an entire industry.3. How does regulation affect profit- ability or productivity? One methodology often employed in a study of shareholder response is theThis current work focuses on the third event-study, where the event is definedquestion. However, the literature that as an information shock in the capitalexamines the earlier questions must also markets. Share behavior immediatelybe reviewed since the results of this cur- after the event is contrasted with the be-rent work may affect the interpretation havior prior to the event. Using event-of these earlier studies. study methodology, Blacconiere & Patten (1994) observed a price decline in the shares of chemical companies imme-How do shareholders react to the diately after the Union Carbide gas leakthreat of new regulation? in Bhopal, India. Share prices fell for electrical utility companies with nuclearPrior literature examining this question capacity in the days following the Threehas employed empirical tools of modern Mile Island accident in 1979 (Hill &finance theory, particularly those per- Schneeweis, 1983). A separate study of
V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 57that same accident showed evidence of the textile industry, in response to Occu-an increase in beta for competing com- pational Safety and Health regulationpanies (Bowen et al., 1983). A tailings that reduced allowable cotton dust limitsdam failure at a Placer Dome mine in (Freedman & Stagliano, 1991).1996 was immediately followed by adecline in the price of gold mining com- These reactions are consistent withpany shares (Magness, 2007). Share- shareholders’ fear that new regulationholder reactions like these may be has a dampening effect on future cashcaused by fears that a public outcry will flows. Company managers appear totrigger a legislative backlash with new share this fear. In some industries, com-cash flow impacts on economic perform- panies respond proactively to the threatance. of new regulation by policing them- selves to show that additional legislation is unnecessary (LaBar, 1988).How do shareholders react to the im-plementation of new regulation? How does regulation affect profitabil-When an accident occurs – such as the ity or productivity?gas leak, the nuclear accident, or thedam failure – the nature, timing, and The previous discussion suggests thatextent of the new regulation, if any, is share reaction is at least partially drivenunknown. This means that when share- by assumptions about the answer to thisholders react to the threat of legislation, third question, as this one focuses di-they act with uncertainty. When legisla- rectly on economic impacts. Ironically,tion finally comes, new information is this final question has received the leastavailable to the market, thereby prompt- attention: the basis for the argument thating investor reaction once again. Sev- shareholders do not like regulation be-eral event-studies have examined share cause regulation lowers future cashreaction to new legislation. For exam- flows has not been thoroughly evaluated.ple, Moreschi examined the share reac- Some companies within an industry maytion of pulp and paper companies in re- actually benefit while others suffer, de-sponse to the Federal Water Pollution pending on the nature and structure ofControl Act Amendments introduced by the market. Differential responses maythe U.S. Environmental Protection be attributed to incremental profits ac-Agency. He observed price declines, as cruing to some companies when regula-well as beta changes (Moreschi, 1988). tory changes create barriers to entryOther studies observed negative price (Pashigan, 1984; Maloney & McCor-reactions in the chemical industry, when mick, 1982). In slow growing markets,the Superfund Amendments and Reau- established companies are in a betterthorization Act was changed to expand position to satisfy new regulations thanthe reporting requirements for firms that newer (smaller) competitors (Therelease hazardous materials into the en- Economist, 1994). On the other hand,vironment (Blacconiere & Northcut, new legislation may specifically target1997); in the electrical utilities industry, the larger firms. This could be becausewhen it was targeted by the Clean Air the larger firms have the financial re-Act Amendments (Hughes, 2000); and in sources needed to implement new con-
58 V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71trol standards without undue restriction hand, Spicer (1978) found that betterin operations (Watts & Zimmerman, pollution control was associated with1990). Furthermore, larger firms are return on investment for these compa-subject to greater public scrutiny and nies.may be targeted specifically by calls forregulation (Watts & Zimmerman, 1990). Legitimacy theory and stakeholder the-These issues make the overall financial ory together provide a conceptual foun-impact of environmental regulation un- dation for a relationship between envi-clear. ronmental management and financial performance. Legitimacy theory es- There are two competing views on how pouses a social contract between the cor-business is affected by environmental poration and society. A company’s sur-regulation. One says that environmental vival and growth depend on its ability tolegislation diverts resources from the deliver desirable ends: to distribute eco-production of marketable output, and nomic, social or political benefits to theleads to a decline in profitability groups from which it derives its power(Bragdon & Marlin, 1972). The other (Shocker & Sethi, 1974). A company’ssays it leads to modernization of opera- right to exist can be revoked if ittions, thus increasing plant efficiency breaches any of the terms of its socialand profit (Freedman & Stagliano, contract (Deegan, 2002). This revoca-1991). Klassen & McLaughlin (1996) tion may be accomplished by consumersproposed a theoretical model linking reducing demand for the companysstrong environmental performance with product or service, by suppliers limitinggood financial performance. Efforts to access to labor or financial capital, or byidentify a consistent positive correlation stakeholders lobbying for legislation thatof environmental performance with fi- would impact company cash flowsnancial performance, however, produced (Terreberry, 1968). Stakeholder theoryconflicting results. For example, pollu- maintains that shareholders benefit whention abatement reduced productivity in management meets the demands of mul-both the brewing industry (Smith & tiple groups (Ruf et al., 2001). How-Sims, 1985) and the electrical utilities ever, while the social contract containsindustry (Gollop & Roberts, 1983). explicit terms, spelled out in the form ofKlassen & McLaughlin (1996) identified legal requirements, it also has implicita positive correlation in a sample of terms, which include non-legislated so-companies including manufacturing cietal expectations (Gray et al., 1996).firms, electrical utilities, and oil and gas Because these terms are by their natureextraction firms using share returns as a implied, managers vary in their interpre-proxy for investors’ expectations of fu- tation of these social requirements, andture financial performance. However, in their response. Furthermore, theseFreedman & Jaggi (1992), using a vari- terms are subject to change.ety of financial performance indicatorssuch as return on equity, return on as- Earlier empirical studies that examinesets, cash flow to equity and cash flow the legislative repercussions of the envi-to assets, and found no evidence to sup- ronmental movement and its impact onport claims that it hurt profitability in the profitability have employed a variety ofpulp and paper industry. On the other
V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 59proxies for the key independent vari- ute to profitability. They suggested thatables, such as, a company can obtain a competitive ad- vantage by nurturing internal competen-• the number of environmental cies (a combination of tangible items charges a company has faced; such as plant and equipment, and intan-• the number convictions a company gibles such as human resources, technol- has faced; ogy, culture, and management skill) into• the size of monetary penalties; and a proprietary resource. However, the• the direct cost of complying with value of such a resource is driven at least regulation. partly by the interaction of the company with its external environment (Collis &Each has its limitations. For example, Montgomery, 1995). This means thatthe number of charges is driven as much the correlation between environmentalby enforcement efforts as by company and economic performance may beactions, and thus may not truly measure driven to some extent by societal de-the way managers are addressing envi- mand, which changes over time. Wal-ronmental concerns (Illinitch et al., den & Schwartz (1997) said that 1989,1998). Fines and convictions are driven the year of the Exxon Valdez oil spill,by regulatory efforts too, as well as by marked a turning point in the public de-companies’ efforts to defend themselves mand for corporate accountability forin court (LaPlante & Lanoie, 1994). For environmental impacts. If they are cor-this reason neither infractions nor fines rect, the external environment appropri-and convictions reflect the pervasive ate for the development of a competitiveimpact on operations of the environ- advantage based on effective environ-mental movement. Compliance costs mental management may have devel-would be a better proxy, but this cost oped in the 1990s. For this reason, theinformation is not easily obtained. Fi- relationship between environmental andnancial statements rarely show this in- economic performance should be revis-formation clearly. While it may be pos- ited.sible to obtain this information directlyfrom some of the companies, managers In summary, prior research has exam-do not always have accurate data. For ined the economic impact of environ-example, managers at an Amoco refin- mental regulation by focusing on inves-ery in Virginia initially believed the cost tor response to the threat – and the im-of complying with environmental regu- plementation – of legislation. In bothlation was about three percent of non- cases, negative share reaction is inter-crude operating costs. A two-year study preted to reflect investors’ assumptionreassessed the figure at twenty-two per- that regulation is bad for business. Evi-cent (World Resources Institute, 1995). dence as to the accuracy of this assump- tion has thus far been inconclusive.Russo & Fouts (1997) argued that some Changes in societal expectation of com-of the earlier studies of the relationship pany performance, however, along withbetween environmental and economic the changes in technology that these ex-performance can be challenged on meth- pectations may have engendered, meanodological grounds, for failing to control that effective management of environ-for industry-specific factors that contrib- mental resources may now be an impor-
60 V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71tant factor in determining company suc- 1978). Whether these capital marketcess. responses mean investors are expressing concern that current (legal) behavior may in the future be challenged by ex-Model design panding regulation, or are merely ex- pressing their personal values is a matterThis research explores the hypothesis of speculation. Nevertheless, these re-that environmental management can be sults argue in favor of a measure for en-good for business within the context of vironmental performance that goes be-the Canadian oil and gas industry – spe- yond regulation or the cost of compli-cifically, in oil refinery operations. Oil ance to include voluntary efforts as well.and gas companies have a high publicprofile among environmental groups, Two US studies have examined reac-and are therefore specifically targeted tions to the first public release of Toxicfor regulation. Furthermore, as part of Release Inventory (TRI) data. This is athe natural resource industry, petroleum US database disclosing the volume ofrefineries play a significant role in the emissions of numerous substances fromCanadian economy. The findings of this manufacturing facilities operating understudy are therefore relevant to parties SIC codes 20-39, with 10 or more em-both inside and outside the industry. ployees. These companies are required to report their annual on-site releasesA rough configuration of the statistical and off-site transfers of each of over 300model to examine the foregoing hy- specific chemicals. Hamilton (1993)pothesis is as follows: noted an abnormal negative share price response in companies that reported un- Profitt- -= B-----0 + B---- expectedly high emissions in 1989, the1EnvirPerformance + B2Control#1 + first year the data were released. KonarB3Control#2+ … & Cohen (1997) found that those com- panies whose shares suffered the mostPrior work has often measured environ- responded by reducing emissions moremental performance in terms of legal than their peers. The authors used theseactions against a company, or the related findings to argue that public informationcourt costs. Problems associated with is “quasi-regulatory.” In other words, bythese choices of proxy have already been releasing information that might be useddiscussed. Furthermore, shareholders to organize boycotts, lobby for addi-have been known to react when compa- tional regulation, or bid share pricenies respond to environmental concerns, down, the government has effectivelyeven when regulatory action is not in- raised the cost of pollution, thereby giv-volved. For example, shares of ing companies an economic incentive toMcDonalds rose when the company an- reduce emissions.nounced it would reduce waste(McMillan, 1996). Pulp and paper com- More recent studies have used TRI datapanies with better pollution control re- to investigate the relationship betweencords have higher price–earnings ratios, financial and environmental perform-and lower share price volatility than ance (King & Lenox, 2001a; 2001b;companies with poor records (Spicer, 2002). For example they found that fi-
V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 61nancial performance, as measured by to identify control variables that captureReturn on Assets and Tobin’s q, is the specifics of the operation. For exam-driven by waste prevention (King & ple, each refinery is configured to pro-Lenox, 2002). The Canadian equivalent duce a complement of products thatof the TRI is the National Pollutant Re- maximizes profit margins. This involveslease Inventory (NPRI). Like TRI emis- taking the proximity of nearest marketssions, NPRI emissions are not illegal. into consideration, and it implies thatEnvironment Canada collects the data two refineries will not necessarily benot to punish companies, but as a means designed to produce the same outputs.of assessing trends over time. Further- This means that volume of output cannotmore, emissions reduction is not a legis- be used as an activity control variable.lative requirement. In this sense, it can However, the main feedstock for each ofbe argued that the NPRI reporting re- these refineries is the crude itself. Inquirements embody the objectives of the this analysis, the total volume of crudeenvironmental movement, and reflect processed will be used as a size controlthe extent to which companies address variable. Refinery-specific data weresome of the implied terms of the social unavailable, so the data were collectedcontract. NPRI data are reported annu- on a per-company basis. A positive cor-ally, quantified, and available electroni- relation with profit is anticipated.cally, all of which simplifies the datacollection process. For these reasons, Productive capacity is tied to investmentthe volume of NPRI emissions is used as in refinery assets. The refinery opera-the key dependent variable in this study. tion is capital intensive, with the cost of energy being the second highest operat-The data collected span the years 1993 ing cost. Capital employed will be used(the first year that NPRI data were avail- as a second control variable, to captureable) to 2002. A statistically significant the impact of company size. The direc-and negative emissions factor would tion of correlation of this variable withsupport anecdotal reports that invest- profit is expected to be positive.ments in effective environmental man-agement earn superior long-term returns Time is included- in this paper as a trend(Israelson, 1998). On the other hand, a variable, to capture the impact of uni-significant and positive coefficient dentified factors that may be correlatedwould support investors’ assumption with the dependent variable (Gujarati,that efforts to reduce emissions decrease 1995) These factors could includeeconomic performance. changes in technology, energy effi- ciency, or the cost of labor. The direc- tion of association is indeterminate be-Control variables cause the time variable Yeart captures the aggregate impact of numerous fac-The petroleum refinery process trans- tors.forms crude oil, which is virtually use-less in its natural state, into a wide vari- The model for this analysis is as follows:ety of products such as propane, auto- NetInc-i,,t- -= B-----0 + B----1NPRIi,tmotive and aviation fuel, furnace oil, + B2Crudei,t + B3CapEmpi,t + + B4Yrtlubricants, and asphalts. It is important 
62 V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71where: Data description and discussion of variablesNetInci,t is the net income (in mil- lions of Canadian dollars) Total petroleum refinery capacity in from refinery operations of Canada (measured in volume of crude company i in year t; oil input) is about 1,855,850 barrels perNPRIi,t is total NPRI emissions (in day in 2004. There were 19 petroleum metric tons) from company i refineries in Canada in 2003, owned by refineries in year t; 10 organizations. This excludes refiner-Crudei,t is the volume of crude oil ies classified as upgraders, as well as input (in millions of barrels) petrochemical refineries. Of the 19 pe- processed by company i in troleum refineries, those operated by year t; private companies were eliminated fromCapEmpi,,t is total capital employed (in this study because of difficulty in obtain- millions of Canadian dol- ing financial performance data. Refiner- lars) in refinery operations ies belonging to US companies were for company i in year t; and, also eliminated, in order to avoid com-Yrt is the year, ranging from plications that could arise from the dif- 1993 to 2002. ferences between US and Canadian fi- nancial reporting guidelines. Data were Table 1 Companies Included in the Regression Analysis Total production capacityCompany Name No. Refineries (barrels of crude input per day)Husky 2 35,250Imperial Oil 4 502,200Parkland 1 6,000Petro-Canada 4 313,200Shell 3 299,200Sunoco 1 78,000Subtotal 15 1,233,850 Companies Excluded (Each with one refinery) Total production capacityCompany Name (barrels of crude input per day)Valero (a US company; formerly Utramar, in Quebec) 215,000Irving Oil (private Canadian company in 250,000New Brunswick)North Atlantic Refinery (private Canadian company in 105,000Newfoundland)Chevron/Texaco (US company operating in BC) 52,000Subtotal 622,000
V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 63collected from the remaining six compa- company until 2000. Huskys annualnies (15 refineries) identified below: reports contain sufficient historic infor- mation to provide data for the years1. Husky Energy, with refineries in 2000 to 2002 only. Parkland required Lloydminster and British Columbia; special treatment (discussed below) be-2. Imperial Oil, with operations in cause of its size. Parkland sold its refin- Nova Scotia, Ontario, and Alberta; ery in 2000. For this reason only eight3. Parkland Industries, in Alberta; years of data are available for this com-4. Petro-Canada, with refineries in Al- pany. berta, Ontario, and Quebec;5. Shell Canada, in Quebec, Ontario, Based on the six companies included in and Alberta; and this analysis, the total dataset includes6. Sunoco, in Ontario. 51 company-year observations. Addi- tional detail about the measurement ofThe refineries included in this study ac- the individual factors in model  iscount for a production capacity of provided below.1,233,850 barrels per day (see Table 1),or about 66% of total capacity in Can- NetInci,t For the integrated companies,ada. the net income from refinery operations is shown in the seg-Refineries classified as upgraders use a mented disclosures either inhigher density feedstock which is much the financial statement notes,heavier and cheaper than the crude used or in the Management Discus-by the petroleum refineries. For exam- sion and Analysis section ofple, in early October 2004, Cold Lake the annual report. The annualheavy crude cost about $29 US per bar- report of Parkland Industries,rel, compared to about $54 US for the the smallest company in thelighter West Texas Intermediate crude analysis, did not provide theused by the petroleum refineries. Up- level of detail provided by thegraders were excluded from this study other companies. While Park-because the influence on profit of these land operated one refinery updiverse input costs would complicate the until 2000, its main businessanalysis. Petrochemical refineries were was marketing gasoline, andalso excluded. This is a separate pro- the company did not discloseduction process downstream from petro- petroleum refinery operationsleum refinery operations. as a separate segment. For this reason an estimate of NetInci,tMost of the refineries are owned by for Parkland Industries waslarge integrated companies whose opera- based on the proportion oftions include exploration and recovery, sales volume for which cost ofpetroleum refining, petrochemical refin- sales was produced internally.ing, and retail marketing. Ten years of NPRIi,t Each refinery has a specificdata (1993 to 2002) were collected for NPRI Site Identification num-all of the integrated companies except ber. The annual emission vol-Husky Oil and Parkland Industries. umes (in metric tons) of eachHusky did not become a publicly traded reported substance are aggre-
64 V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 gated into a single figure. For Parkland, the information companies with more than one came directly from the balance refinery the NPRI emissions sheet. from each refinery are aggre- gated into a single number. Summary statistics are shown for the (This adjustment was neces- independent variables in Table 2. Given sary because refinery-specific that refineries are built to accommodate financial performance infor- a specified crude input capacity, that mation was not available.) management wants to run the refineriesCrudei,t Volume of crude processed at or near full capacity each year, that was obtained from the annual higher volume of production means reports. greater emissions, and that volume is aCapEmpi,,tThis is the investment cost of factor in model , correlations between refinery assets less accumu- Crudei,t, CapEmpi,,t,. and NPRIi,t. are lated amortization. likely to be high. The correlation matrix (Technological innovation re- in Table 2 confirms this expectation. In quires ongoing investment in order to avoid issues arising from multi- these assets, as discussed later collinearity in the data, CapEmpi,,t,. and in this paper, such that net in- NPRIi,t are each regressed against vol- vestment increases over time.) ume (Crudei,t), and the residuals from The integrated companies pro- each regression are used in place of the vided this information in their original data in model . segmented disclosures. For Table 2 Summary Statistics for Independent Variables N = 51Variable Mean St. Dev. Minimum MaximumNPRIi,t 4600 11963 21.52 77482CapEmpi,t 1361 946 24 3027Crudei,t 76 58 1.6 164 Description of Variables NPRIi,t Total National Pollutant Release Inventory emissions (metric tons) CapEmpi,,t Total cost of capital employed, in Canadian dollars (millions). Crudei,t Barrels of crude input as feedstock (millions) Correlation MatrixNPRIi,t 1.000CapEmpI,t 0.3031 1.000Crudei,t 0.3029 0.9561 1.000 NPRIi,t CapEmpI,t Crudei,t
V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 654. Results model. The key independent variable NPRIi,t is statistically significant at α =Regression results are shown in Table 3. 0.05, and negative. These results argueAll control variables are statistically that when aggregate NPRI emissionssignificant at α = 0.05 or less, with signs drop by one metric ton (while size ofin the direction anticipated. About operation and volume of crude input aresixty-six percent of the variation in controlled), the income from petroleumNetInci,t is explained by variation in the refinery operations rises by about twoindependent factors identified in this thousand dollars. Table 3 Results of Linear Regression Analysis NetInci,t = B0 + B1NPRIi,t + B2Crudei,t + B3CapEmpi,t + B4Yrtwhere:NetInci,t is the net income from refinery operations in Canadian dollars (millions)NPRIi,t is total NPRI emissions (in metric tons), adjusted for volumeCrudei,t is the volume of crude oil input in barrelsCapEmpi,,t is total capital employed in refinery operations in Canadian dollars (millions), adjusted for volumeYrt is the year, ranging from 1993 to 2002 Expected sign Coefficient t-valueB0i Intercept +/– -28,878 -3.922***B1i NPRIi,t +/– -0.002 -2.451**B2i Crude-i,t + 0.001 8.854***B3i CapEmpi,t + 0.087 2.545**B4i Yrt +/– 9.878 2.779*** Significant at: α = 0.01*** α = 0.05** R----2 = 0.66These results conflict with the “dead loss pay equity, and child labor laws increaseexpenditure” argument that says envi- the costs of doing business, environ-ronmental legislation channels cash to- mental regulation also increases the costward expenses that satisfy environ- of doing business. A reconciliation ofmental performance expectations, but the intuitively unacceptable finding thatdoes nothing to enhance the financial rising costs mean higher profit mayperformance of the company (Gollop & come from Freedman & Stagliano,Roberts, 1983). An explanation for (1991), who suggest that the moderniza-these findings is not immediately obvi- tion of operations to meet environmentalous. After all, just as minimum wage, control requirements leads to increases
66 V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71in plant efficiency and profit. It should can lead to cost efficiencies as well asbe noted that the correlation between improvements in environmental per-these two performance measurements, formance.profit and emissions, is driven at leastpartially by external factors such as so- Prior studies of the relationship betweencietal expectations (Russo & Fouts, financial and economic performance1997). Possibly the ongoing effort to have produced equivocal results. Russolegitimize business operations has trig- & Fouts (1997) said these findings aregered the demand for technological ad- inconclusive because they are derivedvancements that include environmental from statistical models that fail to con-impact considerations in the quest for trol for factors that contribute to profit-higher production efficiencies. If this is ability. This study addresses that issuethe case, the conclusions drawn in ear- by focusing on a single industry seg-lier studies that shareholders are op- ment, and by identifying profit relatedposed to calls for environmental man- control factors specific to that segment.agement are not incorrect. They are, The findings of this study support thehowever, interpretations made in light of conclusion that over the ten-year periodcurrent-day technology and current-day from 1993 to 2002, a decline in NPRImores. Changing social expectations reportable emissions has been associatedaffect not only the regulatory environ- with growing profits. In other words,ment, but also the drive for technologi- there is a positive relationship betweencal advancements. It is through such environmental and financial perform-advancements that profitability and envi- ance.ronmental performance – once consid-ered irreconcilable – can now be consid- Russo & Fouts (1997) also argued thatered simultaneously. industry growth plays a role in determin- ing when good financial performance and good environmental performance5. Summary, discussion and sugges- can be pursued simultaneously. Whiletion for future studies the use of new, unproven technologies involves pay-off uncertainties, techno-Prior literature shows that shareholders logical innovation is accelerated for in-factor the perceived repercussions of dustries in a growth phase. While noenvironmental legislation into share new petroleum refineries have been builtprice. Regulation that limits allowable in North America since 1980 (in fact,emissions restricts volume of activity some have been shut down) core petro-and/or commits a company to significant leum technology continues to be devel-capital cost and operating expenditures. oped, and net refinery capacity continuesFor this reason, the environmental to keep up with a growing demandmovement has been accused of subject- through incremental expansion and tech-ing firms to costs that satisfy legislative nological upgrades in existing refineries.requirements at the expense of financial For example, the introduction of a pat-performance. On the other hand, it has ented process to improve the perform-also been argued that given the appropri- ance of the catalytic cracking units pre-ate internal and external environment, sent in most refineries has increasedmodernization of production facilities the yield of gasoline per unit feedstock
V. Magness / Issues in Social and Environmental Accounting 1 (2007) 54-71 67from 55% liquid yield to over 75% resource perspective (1995), which ar-(Orr ,2004). gues that a positive correlation between environmental performance and profitAnother reason that some of the earlier can be a distinct competitive advantageliterature reported contrary results – a available only to certain companies.negative correlation of environmental Clarkson et al., (2006) have made somewith financial performance – could be progress here, with findings that a com-time-related. A long-term orientation panys financial liquidity and R&D ex-toward environmental stewardship calls penditures contribute toward the deter-for a commitment at all company levels, mination of a competitive advantageincluding production planning, perform- across the US manufacturing sector. Anance measurement, and product/process examination of this nature would be adesign, and management expertise in logical extension to the current study.environmental stewardship can, over Furthermore, this study looks only at thetime, evolve into a proprietary resource. petroleum refinery section of the oil andHowever, the value of such a resource is gas industry, and no assumption is madedriven at least partly by external factors that these findings extend to other parts(Collis & Montgomery, 1995). As so- of the industry.cietal demand for cleaner technologieshas grown over time, these technologies The findings of this paper could also tiehave become increasingly available. For into a related branch of environmentalexample, the process of scanfining was accounting research – the examinationintroduced about five years ago. This of disclosure versus environmental per-process removes virtually all sulphur formance. The disclosure studies havefrom gasoline at about one-third the en- produced evidence that is once again,ergy costs of older processes, thus help- inconclusive. It has been argued on theing refineries to meet new regulatory one hand that companies use environ-requirements while reducing their sec- mental disclosure to explain poor finan-ond highest operating cost. It can there- cial results (Neu et al., 1998; Freedmanfore be argued that the environmental & Jaggi, 1988). On the other hand,movement is a major social force that Cormier & Gordon (2001) found thatnot only presents new challenges to companies in good financial health madebusiness, but also the opportunity to sat- greater financial disclosures. Possiblyisfy those challenges. In this way, envi- the correlation is industry specific. Inronmental management has become a their analysis of social and environ-legitimizing, value-creating activity, at mental disclosure, Gray et al. (2001)least in some industry segments. have also identified time and industry segment as important factors. By identi-Many questions remain unanswered. No fying those industries for which environ-effort has been made in this study to test mental performance has become a profitwhether or not the best environmental creating activity, as this current paperperformance (lowest emissions) is asso- begins to do, efforts to better captureciated with the best financial perform- the disclosure decision making proc-ance. This paper does not attempt to find ess may be possible.evidence in support of Harts natural
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