The real effects of mandated information on social responsibility in financial reports: Evidence from mine-safety records

https://doi.org/10.1016/j.jacceco.2017.08.001Get rights and content

Highlights

  • Results illustrate that including information on social responsibility in financial reports can have real effects.

  • Dodd–Frank's requirement to include mine-safety records in financial reports improves safety but reduces productivity.

  • Market reactions and changes in ownership suggest that MSD increases awareness of mine safety.

  • Novel data on citations, injuries, and labor productivity allows identification of real effects.

  • Information available elsewhere allows identification of the incremental effect of financial report inclusion.

Abstract

We examine the real effects of mandatory social-responsibility disclosures, which require SEC-registered mine owners to include their mine-safety records in their financial reports. These safety records are already publicly available elsewhere, which allows us to isolate and estimate the incremental real effects of including this information in financial reports. Comparing mines owned by SEC-registered issuers with mines that are not, we document that including safety records in financial reports decreases mining-related citations and injuries, and reduces labor productivity. Evidence from stock-market reactions and mutual-fund holdings suggests that increased awareness of safety issues is a likely explanation for the observed real effects.

Introduction

In the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (hereafter, the “Dodd–Frank Act”), policymakers made an unprecedented move towards using securities regulation to address issues unrelated to the Securities and Exchange Commission's (SEC) core mission of protecting investors and maintaining the fair and efficient functioning of financial markets (Lynn, 2011). Section 1503 of the Dodd–Frank Act requires SEC-registered firms to include information regarding mine-safety performance in their financial reports. In this paper, we examine the real effects (i.e., changes in mining-related citations, injuries, and labor productivity) of the mandatory inclusion of mine-safety disclosures in the financial reports (“MSD”) of the 151 SEC-registered firms whose ownership of a U.S. mine make them subject to Section 1503 of the Dodd–Frank legislation. A key feature of our setting is that the information provided through MSD is already publicly available on the Mine Safety and Health Administration's (MSHA) website; this allows us to isolate and estimate the magnitude of the incremental real effects of including information in financial reports.

Section 1503 of the Dodd–Frank Act requires reporting citations for violations of mine-safety regulations both periodically in mine owners’ financial reports (i.e., Forms 10K and 10Q) and immediately upon the receipt of an imminent danger order (IDO) through a Form 8K filing. MSD advocates make the implicit argument that including this information in financial reports has implications that such information does not have when only disclosed on the MSHA website. However, it is unclear whether the information included in MSD is news to investors or other interested parties. One reason the inclusion of safety information in financial reports could have an incremental effect is because financial reports broadcast the information to a wide range of interested parties, thereby increasing awareness of firms’ safety records.

If MSD increases awareness of firms’ safety records, then political costs, reputational concerns, and/or activism by investors or other parties could provide an incentive for managers to improve mine safety. For example, if managers anticipate that the revelation of poor safety performance will have a negative effect on firm value, they may invest more in safety to limit such effects. Investors may react negatively to poor safety performance either because of the future cash flow consequences or because of their non-cash-flow-based preferences. Cash flow effects could occur, for example, through fines, mine closures, or other costs imposed by activists. Non-cash-flow-based preferences could also lead investors to require higher returns for financing the operations of firms engaging in activities that conflict with those preferences, such as maintaining relatively unsafe working conditions (e.g., Fama and French, 2007, Friedman and Heinle, 2016). If MSD increases the implications of safety issues for firm value, then MSD will give managers an incentive to alter resource allocation decisions to improve safety. It is also possible that MSD could affect managers’ safety-investment decisions through channels other than firm value, such as, for example, negative reputational costs arising from the public revelation that a manager operates a firm with poor safety conditions.

Using data obtained from the MSHA, we first assess the effect of MSD on the incidence rate of citations for violations of mine-safety regulations. For these analyses, we employ a difference-in-differences (“DiD”) design that compares changes in citations issued to mines owned by SEC registrants (“MSD mines”) with those issued to mines owned by non-SEC registrants (“non-MSD mines”) around the effective date of Dodd–Frank. We control for flexible time trends and static, mine-level differences by including both year and mine fixed effects. We document a decrease in citations per inspection hour of approximately 11% for MSD mines relative to non-MSD mines. Our evidence suggests this reduction in citations is attributable to an increase in compliance with mine safety regulations rather than a change in inspector behavior.

Next, we analyze the effect of MSD on injury rates. An implicit assumption of MSD, which focuses almost exclusively on the reporting of citations for safety violations, is that a decrease in citations will translate into a reduction in injuries. However, the link between compliance with mine safety regulations and actual safety improvements is debatable (e.g., Ruffennach, 2002, Gowrisankaran et al., 2015). Consistent with a meaningful improvement in safety, we document a 13% decrease in injuries for MSD mines relative to non-MSD mines. For the average firm, this 13% reduction translates into approximately 0.2 fewer injuries annually per 100 full-time employees (the equivalent of 200,000 mine-hours worked).

While the above results suggest that MSD has substantial benefits, it is unlikely that the observed safety improvements are costless. Gowrisankaran et al. (2015) posit that mines produce a joint output of safety and mineral production, which suggests that an increase in safety could lead to lower mineral production per hour worked. We examine this tradeoff by testing whether productivity in coal mines, where we have measures of production and labor quantities, changes around the adoption of MSD. Using a DiD research design, we find evidence of a significant reduction in labor productivity following the implementation of MSD. The observed decline translates into increased labor costs of approximately 0.9% of total revenue.

A critical assumption of our identification strategy is that the trends in mine safety and productivity for MSD and non-MSD mines would have been the same in the absence of MSD (i.e., the parallel-trends assumption). We assess the validity of this assumption by mapping out the counterfactual treatment effect of MSD in the pre-MSD period (from 2002 to 2009). This analysis shows that the trends for MSD and non-MSD mines are similar. Even given similar pre-treatment trends, other factors, such as public outrage over a mining disaster, which differentially affect MSD and non-MSD mines, could potentially confound our inferences. To address this possibility, we first demonstrate that there is no difference in the reactions of MSD and non-MSD mines to another major regulatory event (the 2006 MINER Act) that pertains to all mines and was triggered by events similar to those that led to MSD.

To provide evidence that an increased public awareness of safety issues is a likely explanation for the observed real effects, we assess whether more attention is paid to safety after MSD. First, we provide descriptive evidence of an increase in media and analyst coverage. Second, we compare short-window stock returns and changes in mutual fund holdings around IDO disclosures before and after MSD. We find a 155 (140) basis point more negative average (median) market reaction when a safety citation is reported in an 8K filing and disclosed on the MSHA's website, compared to the period when such citations are disclosed only on the website. These market reactions are most negative for firms operating primarily in the mining industry, where safety violations likely have the greatest implications for firm value.

For mutual fund holdings, in the pre-MSD period, we find a significant reduction in ownership in the quarter following an IDO announcement, indicating that some sophisticated investors were aware of, and responded to, IDO website disclosures prior to MSD. In the post-MSD period, the reduction in ownership when the safety information is also disseminated through an 8K is significantly larger, which suggests that mutual fund managers care more about safety issues when other parties’ awareness of these issues increases. These effects are particularly pronounced for funds with explicitly stated preferences for socially responsible investment.

Our paper contributes to the existing literature by documenting the magnitude of the real effects of including information on social responsibility in financial reports. Prior research shows accounting disclosures can have real effects because: (i) disclosure reduces information asymmetry and agency costs (e.g., Biddle and Hilary, 2006; Biddle et al., 2009; McNichols and Stubben, 2008), (ii) accounting numbers are used in contracts and regulation (e.g., Holthausen and Leftwich, 1983), and (iii) managers learn new information from their own disclosures and the disclosures of peers (e.g., Shroff, 2017). There is also a literature that shows that disclosure through channels other than financial reports can have real effects (Jin and Leslie, 2003, Chuk, 2013). Our paper contributes to this prior work primarily because mine-safety records are already publicly available outside of a firm's financial reports, which allows us to isolate and estimate the incremental effect of including information in financial reports as opposed to the effects of disclosing information not previously publicly released elsewhere.

Understanding the real effects of regulations requiring information on social responsibility in financial reports is increasingly important given the recent trend towards employing such policies (Leuz and Wysocki, 2016). U.S. policymakers are currently considering implementing similar reporting requirements for political contributions, conflict minerals from the Democratic Republic of the Congo, and, more broadly, the standards issued by the Sustainability Accounting Standards Board. The European Union (EU) also recently mandated disclosures related to firms’ environmental, social, and governance performance (Grewal et al., 2015). Although our relatively narrow focus on the mining industry and MSD regulation could limit the generalizability of our findings, our study nonetheless provides direct evidence on the real effects of mandating the inclusion of information on social responsibility in financial reports—a feature that is common to all of the aforementioned initiatives.

Section snippets

Institutional background

The mining industry is both an economically important and historically unsafe sector of the U.S. economy. In 2014, the mining industry contributed $225.1 billion to GDP and nearly two million jobs to the U.S. economy (NMA, 2014). Since 1900, more than 100,000 workers have died and many more have been injured in U.S. mines (MSHA, 2014). Although mining is no longer among the ten most dangerous jobs in the U.S. (based on fatalities), it remains one of the most heavily regulated sectors in terms

Reasons MSD could have real effects

If the inclusion of safety information in financial reports increases public awareness of safety records, MSD could have real effects through managers’ rational anticipation of its implications for cash flows, discount rates, and/or their own reputation.4 MSD could affect cash flows by exposing a firm to heightened political costs, reputational concerns, and activism by

Real effects of MSD

In our analyses of the real effects of MSD, we focus on changes in safety citations, mining-related injuries, and labor productivity around the enactment of MSD.

MSD filings and awareness of safety violations

The potential explanations (discussed in Section 3) for why MSD could create an incentive for managers to improve safety depend on increased public awareness of firms’ safety records. Most of these explanations are also consistent with greater or more timely security price implications of safety issues. To substantiate whether more attention is paid to safety after MSD, we provide descriptive evidence on who uses MSD filings and compare short-window stock returns and changes in mutual fund

Conclusion

Increasingly, policy makers are using securities regulations to address issues beyond the SEC's core mission of protecting investors and maintaining the fair and efficient functioning of financial markets. We examine the effectiveness of these policies in the context of mandatory inclusion of mine-safety records in SEC-registered firms’ financial reports. The safety information included in financial reports was already publicly available on the MSHA's website—this feature of the setting allows

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    We are grateful to Jake Thornock for providing data on the identity of 8K downloaders. We appreciate helpful comments from John Core (editor), Nemit Shroff (referee), Wayne Guay (discussant), Stephen Glaeser (discussant), Dan Alexander, Salman Arif, Mary Billings, Terrence Blackburne, Donal Byard, Alan Crane, Kevin Crotty, Vivian Fang, Christian Hansen, Eva Labro, Christian Leuz, Patricia Naranjo, Karen Nelson, Valeri Nikolaev, Jiri Novak, Yuan Zhang, and workshop participants at: Bristol University, the University of Chicago, Chinese University of Hong Kong, University of California Berkeley, UCSD, Emory University, University of Exeter, the 2016 FARS Midyear Meeting, the 2015 HKUST Research Symposium, the 2016 Journal of Accounting and Economics Conference, LSE, University of Missouri, New York University, UNC-Chapel Hill, University of Notre Dame, Rice University, Rotterdam University, Tilburg University, Washington University, the 2016 Wharton Spring Accounting Conference, and the SEC Conference on Financial Market Regulation. We also thank Chelsea Zeller for excellent research assistance. Christensen, Liu and Maffett gratefully acknowledge financial support from The University of Chicago Booth School of Business. Floyd gratefully acknowledges funding from Rice University Jones Graduate School of Business, UCSD, and PRIME. This work is supported by the Centel Foundation/Robert P. Reuss Research Fund at the University of Chicago Booth School of Business.

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