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To disclose or not to disclose

The case for disclosing greenhouse gas emissions

Home / Hermes EOS Blog / To disclose or not to disclose – The case for disclosing greenhouse gas emissions

Companies nowadays are required to publish various kinds of information. While the disclosure of financial information in annual reports is mandatory and regulated, the publication of environmental, social and governance (ESG) information is usually undertaken on a voluntary basis. Information on greenhouse gas emissions (GHG), for example, is part of ESG information which responsible institutional investors increasingly view as important.

Risk management
This type of environmental information allows long-term investors to assess the potential risks stemming from newly introduced climate change legislation. For us as stewards of a group of large institutional investors, and in turn millions of pensioners and beneficiaries, the level of transparency of companies regarding ESG metrics is crucial. We are, among other environmental topics, engaging with companies on their level of transparency regarding GHG emissions and welcome when companies reveal these through the annual questionnaire by the CDP initiative, formerly known as the Carbon Disclosure Project.

Financial advantage?
My co-author Stefanie Kleimeier and I investigate in a study whether companies which voluntarily report their GHG emissions through one specific public channel, a reporting framework widely accepted by many institutional investors, have an advantage in financial markets by paying lower interest rates on their outstanding bank loans than others.

The rationale for this argument is that capital providers such as banks might be willing to issue loans with lower interest rates to companies that are more transparent about potential environmental liabilities and emit relatively fewer GHG emissions. In contrast, companies choosing not to disclose their emissions through CDP might have to pay an environmental risk premium on their bank loans, because they publish less information and thus appear to be riskier than their voluntarily disclosing peers.

We used data from the CDP, of which Hermes Investment Management is a supporting member, to test this theory.

Findings
Three striking results emerged.

First of all, companies that receive the CDP questionnaire pay lower interest rates on their outstanding bank debt. However, this finding could be due to the selection process. Because not all listed companies receive the CDP questionnaire, those that do tend to be the largest companies in terms of market cap and because of those characteristics pay lower interest rates per se, irrespective of whether they disclose their GHG emissions or not.

Secondly, the public disclosers, those companies invited to participate in the survey and opting to reveal their emission levels publicly, pay significantly lower interest rates (see Figure 1). In addition, we found that companies that choose not to disclose or that decline to participate in the CDP questionnaire – the non-responders or decliners – pay significantly higher interest rates[1].

Cost of Debt for Different Companies

Source: Kleimeier and Viehs (2016, p 30), available here.

Our third finding concerns the absolute emission levels that the companies disclose. Significantly, we found that companies which emit relatively more GHG emissions have to pay significantly higher interest rates. On average, those emitting more have to pay up to $2.5 million more in interest. Of course, these results are specific to our sample and just average effects – however, they point to a clear relation between the decision of companies to voluntarily disclose GHG emissions and the interest rates they have to pay in their outstanding bank loans.

Implications 
This has important implications for companies, investors and regulators alike. For one, companies – even the largest – can save substantial amounts of money by starting to disclose their GHG emission levels. Meanwhile regulators faced with the question of how GHG emissions should be regulated are provided with robust evidence that the financial markets are already indirectly incentivising companies to disclose their emissions and emit fewer of these.

Lastly, institutional investors also benefit from these results because they are provided with comforting evidence that engagement on more transparency with respect to GHG emissions is valued by capital providers and companies alike.

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[1] The interest rate is measured in basis points above a certain standardised benchmark rate in order to filter out any market movements and geographic effects. We call this interest rate the spread in basis points above a certain benchmark.

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    Michael Viehs Dr Michael Viehs is responsible for intelligent proxy voting in Germany, corporate engagements on environmental, social, and governance issues and for conducting research on sustainability and responsible investing with a focus on consumer goods and retail, mining, oil and gas, pharmaceuticals and utilities. Before his appointment at Hermes EOS, Michael was research director at the Smith School of Enterprise and the Environment at the University of Oxford and visiting assistant professor at the School of Business and Economics at Maastricht University in the Netherlands. Michael is a visiting research associate at the University of Oxford and a research affiliate with the European Centre for Corporate Engagement. He presented his research at several top academic and industry conferences in Germany, the Netherlands, Sweden, Spain, the UK, the US and South Africa. Michael holds a BSc in International Business Economics, an MSc in International Business and a PhD in Finance from Maastricht University.
    Read all articles by Michael Viehs

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