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Disclosures and The Firm

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Climate change is one of the key challenges of our times. In the PWC’s 21st CEO Survey, climate change and environmental damage is rated amongst the top concerns for CEOs globally (pwc, 2018). Climate change is now widely referred to as a ‘super wicked problem’ due to its social complexity and the diversity of its causes, consequences, and constituent factors (Lazarus, 2009). Floods, hurricanes, tornadoes, droughts and other extreme weather events are on the rise in frequency and severity – causing huge financial impacts on economies. In 2017 for example, Hurricane Harvey and Hurricane Irma are estimated to have caused damages estimated at US$125bn and US$50bn respectively in the United States (NHC, 2018). In Kenya we have witnessed increasing severity of droughts, floods and water shortage that in attributable to climate change. In the Kenya National Adaptation Plan 2015-2030, climate change is acknowledged as having adverse impacts on our country’s economic development and threatening the realisation of our Vision 2030 goals of creating a competitive and prosperous nation with a high quality of life. Kenya’s economy is highly dependent on natural resources, meaning that recurring droughts, erratic rainfall patterns and floods will continue to negatively impact livelihoods and community assets. (KNAP 2016)

Investors and shareholders worldwide have voiced concerns over the absence of forward-looking assessments by organisations on how vulnerable they are to the effects of climate change and actions that the organisations are taking to mitigate these risks (TCFD 2018). Adequate climate related financial disclosures are necessary to provide investors, lenders, and insurance underwriters to appropriately assess and price climate-related risks and opportunities. Climate-related financial and non-financial information disclosure is a critical first step in channelling resources towards sustainable development (Burnett & Schellhorn, 2016).

Context of the study

Kenya is one of the parties who have ratified the Paris Agreement on Climate Change and is committed to pursuing a low-carbon development pathway. The Climate Change Act 2016 was passed in May 2016. The government has also set up institutional frameworks such as NEMA and National Climate Change Council and intends to establish a climate fund. These are signals to the market that there is a heightened focus on tackling climate change and organizations need to align their strategies and reporting appropriately.

Research work on climate change disclosures in Kenya is still in embryonic stage with focus thus far mainly on relationship between voluntary disclosures (Maina, 2014), financial disclosures (Oyugi, 2007), mandatory disclosures (Gakeri, 2014) and corporate social responsibility reporting (Wakesho, 2013). Odhiambo, (2015) did a study on effects of social and environmental reporting on financial performance using census method and regression analysis. Kalunda, (2007) examined corporate social reporting practices among firms listed at the NSE in year 2006.

This study focuses determining on level of climate related financial disclosures by companies listed in the Nairobi Stock exchange as an indicator of their readiness to tackling the climate change and to further assess the relationship between the level of climate related disclosures and value of the firm.

Research problem

There have been numerous research work and recommendations on climate related disclosures, but these have been mainly done in Europe and North America (Berthelot & Robert, 2011; SASB 2017; Deloitte 2011). Various frameworks have been developed to address the disclosure problem but in as much as they target organizations across, the globe, limited inputs have been gotten from Africa and developing countries in general (TCFD 2017).

In Kenya, there are few studies relating to climate change disclosures. The research done in Kenya have focussed on relationship between environmental reporting and performance, carbon trading, enterprise risk management and on climate change science and agriculture. Other studies have researched on corporate social disclosures for firms listed in the NSE (Wachira 2017). This study is specific to climate change related disclosures by Kenyan firms listed in the NSE. The study does a content analysis of their annual financial statements and investor reports in company websites to determine the quantity of climate related disclosures as an indicator of the level of readiness and to draw a relationship between climate related disclosures and value of the firm.

Research Questions

This study aims to answer the following questions:

  • What is the extent of existing climate related disclosures amongst companies listed in the NSE?
  • What is the relationship between climate related disclosures and value of the firm amongst companies listed at the NSE?

Research Objectives

To determine the level of climate related disclosures in the annual financial statements and investor reports in websites of companies listed at the NSE to appreciate the current disclosure gap.

To determine if there exists a relationship between level of climate related disclosures and value of the firm (measured by market capitalization).

Value of the study

This study raises awareness to the climate change challenge that organisations and communities face today and to increase the academic literature on this topical issue.

This study will be useful to organizations as it will spur them to action to not only think about climate change risks and opportunities but also align their actions and resources accordingly.

This study will be useful to the regulators as by tracking the climate related disclosures, they will be able to gauge traction on the fight on climate change and make informed policy decisions on matters such as providing guidelines for mandatory disclosure.

This research will also be useful for standard setting bodies such as Institute of Certified Public Accountants of Kenya (ICPAK) to consider avenues for standardising corporate reporting on climate-related disclosures.


Theoretical Framework

According to Najah & Cotter (2012), two broad theoretical perspectives have been used in most studies relating to financial and non-financial disclosures by companies. These are socio-political theories (legitimacy theory and stakeholder theory) and economic-based disclosure theories (signalling and voluntary disclosure theories). For this study the underpinning theories are legitimacy theory, stakeholder theory, signalling theory, agency theory and the efficient market hypothesis. These theories are explained below:

Legitimacy Theory

Legitimacy theory posits that for a corporation to continue to exist it must act in congruence with society’s values and norms. That organisations seek to establish congruence between the social values associated with or implied by their activities and the norms of acceptable behaviour in the larger social system of which they are part. (Dowling & Pfeffer, 1975). Organisations make social and environmental disclosures to enhance their legitimacy in the eyes of its “conferring publics” and reduce their exposure to the socio-political environment (O’Donovan, 2000). Patten (1991) expounds on this thought by stating that the disclosure should be driven by public-pressure variables rather than profitability. Legitimacy theory concentrates on the concept of a social contract, implying that a company’s survival is dependent on the extent to which the company operates within the bounds and norms of society (Brown & Deegan, 1998; Guthrie & Parker, 1989). In a research on social and environmental disclosures of BHP Ltd, Deegan, Rankin and Tobin (2002), took the view that management release positive social and environmental information in response to unfavourable media attention to further lend support to legitimation motives for a company’s social and environmental disclosures (Deegan, Rankin & Tobin, 2002).

Stakeholder Theory

According to stakeholder theory, organisations are considered part of a social system consisting of several groups working together to achieve the system targets (Cotter, Lokman & Najah, 2011). Freeman and McVea, (2001) states that firms have stakeholders who are affected either positively or negatively, and whose rights are either infringed or respected by corporate actions. Under stakeholder theory, if organisations are to continue to exist within a given environment, management decisions must be taken with due consideration of stakeholders’ interests and welfare (Cotter et al., 2011). Organisations are keen to fulfil expectations of given stakeholders whom they see as “powerful” and able to affect the operations of the firm (Deegan, 2009; Ullmann, 1985). Stakeholders include not just shareholders, but also creditors, employees, customers, suppliers, and the communities at large – management should consider all those affected by business decisions (Antonelli et al., 2016). Leuz and Wysocki (2016) assert that organisations should make disclosures to investors, consumers, contracting parties, regulators and government agencies, or the general public (Leuz & Wysocki, 2016).

Signalling Theory

Signalling theory posits that the most profitable companies provide the market with more and better information. The manner in which information is communicated by one party, or interpreted by another is called signalling (Bini, Danielli & Giunta, 2010). Adverse selection or information asymmetry occurs when one party in an economic transaction possesses some information that the other party does not have. Akerlof (1970), Spence (1973), and Rothschild and Stiglitz (1976) are credited with the foundation research in information asymmetry theory. Nobel Prize winner George Akerlof highlights the issue of information asymmetry in his ‘market of lemons’ analogy (Akerlof 1970) – that sellers have more knowledge about quality of the merchandise than the buyers. He argued that in many markets the buyer uses some market statistic to measure the value of a class of goods. Thus, the buyer sees the average of the whole market while the seller has more intimate knowledge of a specific item giving the seller an incentive to sell goods of less than the average market quality (Auronen,2003). Spence (1973) refers to a similar mechanism when workers “sell” their labor to firms and have private information about their skills, while Rothschild and Stiglitz (1976) analyses the insurance market in which private information is instead on the side of the buyer who is better aware of her health condition or driving skills than the insurer.

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