Environmental Liability Information and Bond Ratings

Abstract

This research examines whether analysts' credit ratings of new bond issues reflect environmental liability information provided by the Environmental Protection Agency. Because environmental obligations provide no future economic benefits, we expect a negative relation between credit ratings and proxies for off-balance-sheet environmental obligations. To test this relation, we utilize a bond rating prediction model with a sample of new bond issues over the period 1990-1992. Our environmental liability estimates vary in size according to assumptions concerning the allocation of costs across responsible parties. Results indicate that environmental information is a significant negative factor in explaining bond ratings and increases the model's classification accuracy. Based on the overall analysis, the larger monetary measures of the firm's environmental liability are more consistent with bond rating analysts' assessment of the obligation. The general results are reinforced by additional analysis utilizing a model of bond rating changes over the period 1986-1997. This analysis indicates being named a potentially responsible party on additional environmental Superfund sites is associated with deterioration in a firm's credit rating when the firm has not previously been associated with a large number of these sites. This research establishes the value relevance of environmental information in debt markets and adds to prior studies that examine equity market effects.