On the EPA's Radar: The Role of Financial Reports in Environmental Regulatory Oversight

• Published date: 01 December 2024
• Author: BIN LI,ANNIKA YU WANG
• Date: 01 December 2024
• DOI: http://doi.org/10.1111/1475-679X.12572

DOI: 10.1111/1475-679X.12572

Journal of Accounting Research

Vol. 62 No. 5 December 2024

Printed in U.S.A.

On the EPA’s Radar: The Role of

Financial Reports in Environmental

Regulatory Oversight

BIN LI ∗AND ANNIKA YU WANG †

Received 1 September 2022; accepted 11 May 2024

ABSTRACT

This paper investigates the role of corporate financial reports in the Environ-

mental Protection Agency’s (EPA) regulatory activities. By tracking the EPA’s

direct retrieval of SEC filings, we identify three key findings. First, the EPA

retrieves a large volume of financial reports, especially from firms in high-

pollution industries. Second, the EPA is more likely to access financial reports

during enforcement investigations and significant rule proposals, but less

so during compliance monitoring, with patterns varying predictably across

firms. Third, the EPA’s reliance on financial reports is potentially driven

by its demand for information on firm liquidity, solvency, and profitability.

∗Vanderbilt University; †University of Houston

Accepted by Christian Leuz. We appreciate helpful comments and suggestions from an

anonymous associate editor, an anonymous referee, Zhenhua Chen, Daniel Cohen, Joseph

Johnson, Stanimir Markov, VolkanMuslu, Emily Shafron (discussant), Sorabh Tomar, Mohan

Venkatachalam, and workshop and conference participants at Fudan University, Louisiana

State University, Shanghai Jiao Tong University, Vanderbilt University, Xiamen University,

Yeshiva University, the 2023 AAA FARS Midyear Meeting, the 2023 Nanyang Business School

Accounting Conference, the 2023 AAA Sustainability, ESG, and Accounting Conference, the

2023 TexasA&M Accounting Conference, and the 33rd Annual Conference on Financial Eco-

nomics and Accounting. We would like to extend special thanks to two EPAofficers (attorney-

advisors) for their invaluable input and insights. We have no conflicts of interest to declare.

All views and errors remain our own. An online appendix to this paper can be downloaded at

https://www.chicagobooth.edu/jar-online-supplements.

1849

© 2024 The Author(s). Journal of Accounting Research published by Wiley Periodicals LLC on behalf of The

Chookaszian Accounting Research Center at the University of Chicago Booth School of Business.

This is an open access article under the terms of the Creative Commons

Attribution-NonCommercial-NoDerivs License, which permits use and distribution in any medium,

provided the original work is properly cited, the use is non-commercial and no modifications or

adaptations are made.

1850 b. li and a. y. wang

Overall, our study highlights the usefulness of financial reports for the EPA

as an environmental regulator.

JEL codes: M40, M41, Q50, K32, K40, L51

Keywords: Environmental regulatory activities; EPA; information

acquisition; EDGAR downloads

1. Introduction

Over the past few decades, environmental problems have become a world-

wide concern, and the importance of environmental protection has been

widely recognized by regulators, practitioners, investors, and academics. As

the main environmental regulator in the United States, the Environmental

Protection Agency (EPA) plays a central role in environmental protection

in this country. With a workforce of approximately 15,000 employees, the

EPA spends billions of dollars annually to enforce hundreds of pollution

cases, inspect thousands of facilities, and issue a myriad of policies and

rules.1Despite its critical role in environmental protection, there is lim-

ited understanding of whether and how firm-level accounting information

is useful for the EPA. Our paper takes the first step in this direction by in-

vestigating how, if at all, the EPA uses corporate financial reports to inform

its regulatory activities.

Anecdotal evidence from internal EPA documents suggests that cor-

porate financial reports could be used for three regulatory purposes:

enforcement, monitoring, and rulemaking (see examples in appendix I).

For enforcement, financial report information could help determine a

firm’s compliance with the financial assurance requirements in environ-

mental laws and could be used to assess firm-specific compliance costs and

penalties imposed through enforcement actions (see examples #1−4). For

monitoring, financial report information could be used to validate the

accuracy of a firm’s self-reported data and to ensure compliance with the

financial requirements in environmental statutes (see examples #5−6). For

rulemaking, it could be valuable in cost–benefit analyses of significant rule

proposals (see examples #7−8). Additionally, federal regulations govern-

ing EPA activities often refer to specific accounting metrics, which suggests

that accounting information is relevant to the EPA (see section 4.4). De-

spite these anecdotes, there is a notable absence of empirical evidence on

how the EPA acquires and uses financial report information for regulatory

purposes. Our study aims to fill this gap.2

1See https://www.epa.gov/planandbudget/budget (accessed on April 10, 2023).

2Different from existing literature (e.g., Bozanic et al. [2017], Fox and

Wilson [2023], Guo and Tian [2023], Li et al. [2023], Holzman, Marshall, and Schmidt

[2024], Iselin et al. [2024]), our study focuses on the EPA rather than regulators with a

primary interest in firm financials, for example, the Internal Revenue Service (IRS), the

Securities and Exchange Commission (SEC), and the Federal Reserve (the Fed).

on the epa’s radar 1851

We adopt an empirical approach similar to those used in prior studies

(e.g., Bozanic et al. [2017], Li et al. [2023]) and track the EPA’s direct

access to financial reports in the SEC’s EDGAR system. Specifically, we use

the timing and frequency with which the EPA retrieves each firm’s SEC

filings to measure the timing and intensity of its acquisition of firm-level

accounting information (hereafter “EPA downloads”). Conceptually, this

measure serves as a proxy for the (unobservable) efforts of EPA employees

to acquire and use financial report information.

We begin by documenting the EPA’s reliance on corporate financial re-

ports. We observe that the EPA retrieved 53,716 copies of SEC filings from

the EDGAR system between January 2003 and June 2017, averaging 3,705

downloads per year. When categorized by SEC filing type, the majority of

these downloads are Form 10-K (42%), Form 8-K (22%), and Form 10-Q

(16%). The sectors with the highest frequencies of EPA downloads are Oil

and Gas (19%), Utilities (13%), and Chemicals (12%), consistent with their

high pollution levels. Further analysis of the EPA’s downloads of 8-K top-

ics reveals several specific areas of interest: voluntary disclosures of major

events (37%), operating performance and financial condition (36%), ma-

terial contracts (18%), and corporate governance and executives (16%).

These descriptive statistics confirm that (1) the EPA actively seeks firm-

level accounting information, and (2) there is substantial variation in its

information-acquisition behavior.

In the main analyses, our identification strategy relies on an event-study

design that relates the timing of EPA downloads to the timing of its regu-

latory events (e.g., Fox and Wilson [2023], Guo and Tian [2024]). Specif-

ically, we track the monthly downloads of SEC filings and then link the

timing and frequency of these downloads to specific types of EPA regula-

tory activities: enforcement, monitoring, and rulemaking. This allows us to

examine whether and how the EPA’s information acquisition aligns with its

regulatory events.

First, we investigate the EPA’s use of financial reports during the enforce-

ment process. Following the timeframe outlined in the EPA’s enforcement

guideline, we divide the enforcement process into four stages: (1) viola-

tion discovery, (2) case investigation, (3) case resolution, and (4) case re-

view (see figure 1). Our findings reveal a significant increase in both the

probability and frequency of EPA downloads during the enforcement pro-

cess. Notably, these increases are observed only during the investigation

stage, as opposed to the discovery, resolution, and review stages. In terms

of economic magnitude, the probability of nonzero EPA downloads rises

by 12% over an average eight-month investigation period, broadly consis-

tent with the fact that around 35% of all enforcement cases in our sample

have at least one EPA download related to enforcement investigation. To

glean deeper insights into the role of financial reports in EPA enforcement,

we conduct cross-sectional tests based on case characteristics. Our analy-

sis indicates an elevated likelihood and frequency of EPA downloads dur-

ing the investigation stage for cases subject to environmental statutes with