Environmental and Accounting Regulation: Lessons from The EU ETS

Abstract

Environmental regulation potentially has a relevant role in reducing the negative effects of the firms' economic activities on the environment and thus in improving firms' environmental performance. However, environmental regulation can impose binding reduction targets of pollution, which can negatively affect firms' financial performance. Additionally, the institutional framework of the environmental regulation potentially affects the representation of firms' environmental perfomance in their financial statements. Against this background, the purpose of this paper is two-fold. First, it aims to investigate the effectiveness of the European Union Emissions Trading Scheme (EU ETS) in promoting companies' environmental and financial performance. Second, it aims to investigate how EU ETS affects the representation of environmental performance inside firms' financial statements. To reach our aim, we follow two main stages of analysis. First, with descriptive statistics and archival data analysis, we investigate the effects of the EU ETS institutional framework on firms' environmental and financial performance. Secondly, we develop a comparative analysis of the IAS/IFRS and Italian accounting standards concerning the recording of emission allowances. Our findings show that the EU ETS is a flexible regulation, which is effective at improving firms' environmental performance and at safeguarding firms' financial performance. Additionally, we find that under IAS/IFRS and Italian accounting standards, the environmental performance is included in the financial statements by recognizing the cost for polluting on an accrual basis.