Environmental Information Disclosure and Financial Constraint

• Date: 01 October 2019
• Author: Yuan Hong,Sheng Yao,Chen‐Miao Lin
• DOI: http://doi.org/10.1111/ajfs.12277
• Published date: 01 October 2019

Environmental Information Disclosure and

Financial Constraint*

Sheng Yao**

School of Management, China University of Mining and Technology, China

Yuan Hong

School of Management, China University of Mining and Technology, China

Chen-Miao Lin

College of Business, Clayton State University, United States

Received 24 January 2019; Accepted 22 July 2019

Abstract

Using the introduction of Measures for the Disclosure of Environment Information (MDEI)

in China, we investigate the relationship between environmental disclosure and firms’ finan-

cial constraints. We find that cash-cash flow sensitivity decreases by 13.33% after the imple-

mentation of MDEI and that an increase of one point in the disclosure quality score results

in an estimated reduction of 0.86% in cash-cash flow sensitivity. We further find that the

negative association between disclosure quality and cash-cash flow sensitivity is more pro-

nounced for high-polluting firms, as well as for firms with effective internal control. Our

study highlights the importance of a government environmental policy in emerging markets.

Keywords Environmental Information Disclosure; Cash Flow Sensitivity; Financial Con-

straints; Government Policy; Asymmetric Information

JEL Classification: G18, G30, G32

1. Introduction

The literature documents that corporate social responsibility disclosure mitigates a

firm’s financial constraints (Hubbard, 1998) by reducing asymmetric information

(Francis et al., 2005, 2008; Dhaliwal et al., 2011; El Ghoul et al., 2011) and agency

*The authors would like to thank Dr Kee-Hong Bae (the Editor) and anonymous referees.

Sheng Yao acknowledges financial support from the National Natural Science Foundation of

China under grants 71572189 and 71102163. All errors are our own.

**Corresponding author: School of Management, China University of Mining and Technol-

ogy, 1 Daxue RD, Xuzhou 221116, Jiangsu, China. Tel: +86-516-8399-5370, Fax: +86-8359-

1280, email: yaosheng@cumt.edu.cn.

Asia-Pacific Journal of Financial Studies (2019) 48, 666–689 doi:10.1111/ajfs.12277

666 ©2019 Korean Securities Association

and transaction costs (Jones, 2010). In this paper, we investigate the relationship

between environmental disclosure and financial constraints for Chinese firms.

Although environmental issues are taken seriously in developed countries and the

benefits of disclosure have been documented, environmental policies in emerging

markets are often viewed with great skepticism. The OECD (2007) finds that envi-

ronmental laws and regulations in China are usually perceived as having little

authority. However, given that the tradeoff between economic growth and environ-

mental protection is an on-going concern in developing nations, in 2008, the China

Ministry of Environmental Protection issued the Measures for the Disclosure of

Environment Information (MDEI) to improve the disclosure of environmental

information. The uncertain nature of the effectiveness of public disclosure policy

makes it important for stakeholders to examine how Chinese companies react to

increased disclosure requirements.

Exploiting the issuance of MDEI, we investigate whether financial constraints

are mitigated after a major environmental policy change. We follow Almeida et al.

(2004) and use cash-cash flow sensitivity as a measure of financial constraint. How-

ever, with the skeptical view of environmental policy in emerging markets, we find

that the cash flow sensitivity of cash decreases by 13.33% after the implementation

of MDEI and that an increase of one point in the disclosure quality score results in

an estimated reduction of 0.86% in cash-cash flow sensitivity. The main finding is

robust regarding the following alternative measures of financial constraint: the KZ

Index, the WW Index, and the HP Index. Our finding is consistent with evidence

presented in Cheng et al. (2014) who find that firms with superior corporate social

responsibility performance face lower capital constraints. We further find that the

negative relationship between disclosure quality and cash-cash flow sensitivity is

stronger for high-polluting firms. This latter finding is consistent with the notion

that high-polluting firms are more inclined to provide extensive environmental dis-

closures to influence investors’ perceptions and mitigate their concerns (Cho and

Patten, 2007). Our findings are also robust regarding alternative measures of disclo-

sure quality.

Finally, we investigate how internal control affects cash-cash flow sensitivity

after MDEI issuance. Owing to agency conflicts between managers and shareholders,

managers are unlikely to fully disclose corporate information (Lev and Penman,

1990). Prior literature has found a negative relationship between agency cost and

corporate disclosure quality (Healy and Palepu, 2001). Similarly, the agency cost

between managers and shareholders might negatively affect environmental disclo-

sure quality because greater disclosure of the company’s environmental exposure

might place more pressure on management to improve production technology and

lower the discharge of environmental hazards. Additional investment to lower pol-

lution might lead to higher operating costs and lower profit for the firm in the

short run, which might negatively affect managers’ performance-based compensa-

tion if they are paid for accounting performance.

Environmental Disclosure and Financial Constraint

©2019 Korean Securities Association 667