The BP Oil Spill: Shareholder Wealth Effects and Environmental Disclosures

• Published date: 01 March 2017
• Author: Dana Wallace,Frank Heflin
• DOI: http://doi.org/10.1111/jbfa.12244
• Date: 01 March 2017

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 44(3) & (4), 337–374, March/April 2017, 0306-686X

doi: 10.1111/jbfa.12244

The BP Oil Spill: Shareholder Wealth

Effects and Environmental Disclosures

Frank Heflin and Dana Wallace∗

Abstract: We use the BP oil spill to provide new evidence regarding the consequences of,

and motivations for, environmental disclosures. We find that among oil and gas firms drilling in

US waters, those with greater environmental disclosure suffered smaller negative shareholder

wealth effects following the spill. This suggests that shareholders believed firms with more

environmental disclosures were better prepared to address future environmental regulations

and less likely to experience similar environmental incidents. We also document an increase

in environmental disclosure, specifically disclosures of disaster readiness plans, in the year

following the spill. Firms with poorer past environmental performance were more likely to

increase disaster readiness plan disclosures. The increased disclosure by the poor pre-spill

environmental performers is not entirely window dressing, as their post-spill environmental

performance improved. The totality of our evidence is most consistent with the voluntary

disclosure theory of environmental disclosure.

Keywords: environmental disclosure, environmental performance, stock returns

1. INTRODUCTION

On April 20, 2010, the Deepwater Horizon oil rig exploded roughly 40 miles off

the coast of Louisiana in the Gulf of Mexico. The rig was owned and operated by

Transocean Ltd. and leased to BP, PLC (BP, hereafter).1In this paper, we investigate

(1) whether oil and gas firms’ pre-spill environmental disclosures affected the magni-

tude of any spill-induced shareholder wealth changes, (2) whether oil and gas firms

changed their environmental disclosures in response to the BP spill, and (3) whether

firms’ pre-spill level of environmental performance affects cross-sectional variation in

environmental disclosure changes in response to the spill.2

∗The first author is from the J.M. Tull School of Accounting, University of Georgia, Athens, USA. The

second author is from the Kenneth G. Dixon School of Accounting, University of Central Florida, Orlando,

USA. The authors would like to thank the editor (Andy Stark), an anonymous reviewer, and workshop

participants at New York University, Florida State University, the University of Central Florida, the JBFA

Conference, the American Accounting Association FARS Conference, the American Accounting Association

Annual Meeting, and the International CSEAR UK Conference for helpful comments and suggestions.

(Paper received May 2015, revised revision accepted February 2017).

Address for correspondence: Frank Heflin, J.M. Tull School of Accounting, Terry College of Business,

The University of Georgia, Brooks Hall, 310 Herty Drive, Athens, GA 30306, USA.

e-mail: frank.heflin@uga.edu

1 The explosion caused 11 deaths and 17 injuries. BP did not own or operate the well, but owned the

drilling rights and was, therefore, largely the sole firm held responsible for cleanup efforts.

2 Henceforth, when we refer to oil and gas firms, we mean oil and gas firms other than BP.

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338 HEFLIN AND WALLACE

As a result of a corporate disaster, such as the BP spill, same-industry firms’ stock

prices can be affected by changes in investors’ assessments of the probability of

(1) increased government regulation and (2) similar disasters involving other firms.

Disclosures by oil and gas firms, statements in trade publications, and prior research

on corporate disasters (e.g., Bowen et al., 1983; and Hill and Schneeweis, 1983)

suggest it is likely that the BP spill created the potential for increased regulatory

and expected future disaster costs for the oil and gas industry.3We first document

a negative shareholder wealth effect for oil and gas firms operating in US waters. Our

results contrast with Patten and Nance (1998) (the only other oil-spill event study,

to our knowledge), who find positive shareholder wealth effects for oil and gas firms

following the Exxon Valdez oil spill.4However, our results are consistent with research

on the shareholder wealth effects of environmental incidents in other industries.

We next investigate the effect of environmental disclosure on the shareholder

wealth effects of the spill. A similar question, albeit in a different industry, is

addressed by Blacconiere and Patten (1994), who conclude that firms with superior

environmental disclosures suffered less negative stock market reactions to the Union

Carbide chemical leak at Bhopal, India. However, Blacconiere and Patten’s (1994)

evidence (regarding the effect of environmental disclosure) is weak and their study

(like ours) represents only one incident in a single industry, and those industries are

very different.5The BP spill offers a relatively unique opportunity to assess whether

the inferences in Blacconiere and Patten (1994) are specific to that particular incident

(the Union Carbide leak), are specific to the chemical industry, or can be generalized

to other settings. Given the centrality of disclosure to accounting research (Healy

and Palepu, 2001; and Verrecchia, 2001), we believe this issue is worth revisiting in

a different setting.

Two broad perspectives regarding voluntary disclosure strategies – voluntary dis-

closure theory and legitimacy theory (Merkl-Davies and Brennan, 2007; and Clarkson

et al., 2008) – guide our first analysis.6Voluntary disclosure theory assumes manage-

ment’s voluntary disclosures provide relevant information aimed at improving investor

decision making. When applied to environmental disclosure, this theory predicts

better environmental performers make more extensive environmental disclosures to

distinguish themselves from poorer environmental performers. This suggests firms

with better pre-spill environmental disclosures will suffer smaller shareholder wealth

declines in response to the spill because investors expect smaller incremental costs for

these firms to adapt to new oil and gas regulations and a lesser chance of a future

environmental disaster. Legitimacy theory research assumes management’s voluntary

disclosures represent an attempt to manipulate and manage the impression conveyed

to users of accounting information. Applied to environmental disclosure, legitimacy

3 As we explain in our motivation section, the spill eventually garnered the attention of multiple govern-

mental regulatory agencies, including the Environmental Protection Agency (EPA), the US Department of

the Interior, and the Minerals Management Service (MMS) (Rascoe, 2010; US Department of the Interior,

2010b).

4 Patten and Nance (1998) attribute this result to increases in US wholesale and retail gasoline prices

following the Exxon spill, which likely benefitted investors of other oil and gas firms. In contrast, the BP

spill had no discernible effect on oil and gas prices (see Section 4).

5 For example, the demand for some of its primary products are more price inelastic (e.g., heating oil and

transportation fuel) (Krichene, 2002).

6 Voluntary disclosure theory is sometimes referred to as the incremental information perspective and

legitimacy theory is sometimes referred to as the impression management or socio-political perspective.

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theory implies poorer environmental performers provide more environmental disclo-

sures than better performers to create the impression of environmental concern. This

perspective suggests that firms with more extensive environmental disclosures are no

better or even less well prepared to adopt new regulations and prevent future disasters

and so will experience zero or even more negative share price reactions.7Following

prior research (Blacconiere and Patten, 1994), we construct an environmental disclo-

sure rating score from various 10-K environmental disclosures. We find that oil and gas

firms (operating in US waters) with more environmental disclosures suffered smaller

shareholder wealth losses, consistent with voluntary disclosure theory. This evidence

suggests that investors believe firms with more expansive environmental disclosures

are better prepared to handle future potential regulatory and disaster costs.

Next, we examine whether the threat of potential regulation and disaster costs

prompts changes in environmental disclosures in annual 10-K filings in the year

following the BP spill. Evidence in Bergman and Roychowdhury (2008) suggests firms

increase their voluntary disclosures (specifically management forecasts) in response

to negative changes in investor sentiment. We extend this theory to environmental

disasters. We hypothesize that the BP spill negatively impacted investor sentiment

regarding environmental issues and that oil and gas firms responded by increasing

environmental disclosures. We find that both firms with and without US offshore

operations increased their disclosures about disaster plans and disaster readiness.

However, we find no changes in disclosures about environmental capital expenditures,

environmental liabilities, environmental litigation, or environmental regulations. Our

results differ from Patten (1992), foremost in that Patten (1992) does not study

disclosures of disaster readiness plans. Patten (1992) studies disclosure changes

in response to the Exxon Valdez oil spill and finds an increase in a composite

environmental disclosure score. We do not find increases in disclosure of some of

the components of Patten’s (1992) composite environmental disclosure score (there

is not complete overlap between Patten’s (1992) components and ours, and Patten

(1992) does not analyze the components of his composite score).

Finally, we address whether firms’ disclosure changes are related to their past

environmental performance. Prior research provides results supporting both a positive

(e.g., Al-Tuwaijri et al., 2004; and Clarkson et al., 2008) and negative (Patten, 2002;

Cho and Patten, 2007; and Cho et al., 2012) relation between environmental disclosure

and environmental performance. One possibility is that managers of those firms who

are stronger environmental performers increase environmental disclosures to inform

investors about their preparedness and ability to handle future regulatory costs (i.e.,

a positive relation). Alternatively, poorer environmental performers may face greater

benefits from increasing environmental disclosure following the spill because they may

have more to gain during a time of high regulatory and public scrutiny (i.e., a negative

relation). We find that firms with poorer past environmental performance (i.e., more

7 If investors cannot see through poor performers’ disclosure ploy, it is possible that these high disclosers

will suffer smaller share price declines than their better performing, but lower disclosing, competitors.

The environmental accounting literature finds evidence in support of both voluntary disclosure theory

and legitimacy theory. However, for a number of reasons we explain in our motivation section, we follow

most prior research on price reactions to environmental news in interpreting the results of our tests.

Specifically, we interpret muted negative stock price reactions to the spill for firms with more extensive

environmental disclosures as suggesting investors view such firms as better prepared to deal with future

regulatory and disaster costs, consistent with voluntary disclosure theory. See our motivation section for

more detail regarding prior research on voluntary disclosure theory and legitimacy theory.

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