The Value Relevance of the Recognition of Soil Remediation Costs And Liabilities: Evidence from Japan

Abstract

This is the first paper to examine the value relevance of soil contamination risk, and the recognition of site clean-up costs and liabilities on the financial statements of Japanese firms. Soil contamination is one of the primary environmental issues confronting Japan in terms of the massive clean-up costs involved. Although Japanese firms are not required to clean-up compulsory unlike US, many firms implement site clean-up activities voluntarily. These actions are against common perception “clean-up doesn’t pay”. Our research provides the evidence that “site clean-up pays” under conditions of accounting recognition. We estimate firm’s soil contamination risk using Pollutant Release and Transfer Register data and examine the relation between the risk and corporate market values. Next, we investigate the impact of corporate activity aimed at preventing soil contamination risk. We also examine whether the recognition of site clean-up costs and liabilities in the firm’s financial statements alleviate the purported negative impact of soil contamination risk on market value. Our market value analysis generates three main findings. First, firm’s soil contamination risk has a negative impact on market value. Second, corporate activity regarding the prevention of soil contamination risk has a positive impact on market value. Finally, the recognition of site clean-up costs and liabilities on financial statements helps alleviate the purported negative impact of soil contamination risk on market value. An important consideration is that we revealed these findings under the unique regulatory environment operating in Japan, one mainly based on corporate voluntary action. This suggests that the market values firm’s clean-up not from any compulsory requirement, but rather from the perspective of voluntary prevention activity, and that the recognition of clean-up costs and liabilities substantially offset any downward valuation from soil contamination risk. We thus assert that the stigma of soil contamination exists, and that prevention of pollution and the recognition of site clean-up costs and liabilities help reduce the stigma for firms and that “clean-up pays.”