Corporate Governance,Social Responsibility

The Dark Side of Voluntary Carbon Disclosure

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greenwashing

Companies disclosing their carbon footprints often shrink their own environmental impact but end up outsourcing the responsibility to their upstream suppliers

By Putro Harnowo, Senior Content Manager, China Business Knowledge @ CUHK

The past couple of years have seen regulators worldwide cracking down on companies making unsubstantiated or seemingly climate-friendly claims. Such practice in reality is more common than expected, as the Google Cloud Sustainability Survey 2023 reports nearly 60% of executives confessed to exaggerating or misrepresenting their sustainability initiatives.

Therefore, when the U.S. Securities and Exchange Commission proposed new rules last year requiring companies to spill the tea on their climate-related information, many fear it could catch companies off guard. The main concern is the potential mandate of Scope 3 emissions disclosures, which includes reporting greenhouse gas emissions from external suppliers, leaving nothing to hide in the value chain.

“One easy way for companies to say that they are focusing on reducing carbon footprints is to disclose how much emissions in their own facilities, establishments, and manufacturing factories.”

Prof. Wu Jing

“One easy way for companies to say that they are focusing on reducing carbon footprints is to disclose how much emissions in their own facilities, establishments, and manufacturing factories,” says Wu Jing, Associate Professor in the Department of Decisions, Operations and Technology at The Chinese University of Hong Kong (CUHK) Business School.

“Disclosing Scope 1 emissions, which is the company’s internal emissions, in the sustainability report is currently voluntary, but there are some components that the companies can outsource to their upstream suppliers, and they are not obliged to disclose those.”

To understand whether the companies outsource their emissions to third parties, Prof. Wu and his doctoral student, Shi Yilin, as well as Prof. Christopher Tang of the UCLA Anderson School of Management conducted comprehensive cross-border research. Their paper, Are Firms Voluntarily Disclosing Emissions Greener?, reveals some interesting insights that question conventional wisdom.

carbon-disclosure
The study finds that disclosing firms are either outsourcing their emissions to upstream suppliers knowingly via greenwashing or unknowingly due to their lack of information.

The firms that voluntarily disclose their emissions were found to generate less internal emissions, or Scope 1 emissions, but more external emissions from their upstream suppliers, or Scope 3 emissions. In fact, the combined Scope 1 and 3 emissions of disclosing firms tend to be higher than those of non-disclosing firms.

This suggests that disclosing firms are either outsourcing their emissions to upstream suppliers knowingly via greenwashing or unknowingly due to their lack of information about climate disclosure. The study challenges the assumption that voluntary carbon disclosures lead to reduced emissions and highlights the importance of comprehensive emission reduction strategies that address both in-house and external emissions.

Going Beyond Surface Level

To come up with these findings, the researchers analysed a dataset obtained from carbon footprints data provider, S&P Trucost, from 2002 to 2020. The company’s environmentally extended input-output model is widely used for estimating carbon emissions, including Scope 1 and Scope 3, for firms that do and do not disclose their data.

On top of that, the researchers used several tests ensuring the robustness of their methods, including the coarsened exact matching method to match firms with voluntary disclosures with similar control firms that did not disclose emissions voluntarily. The researchers addressed the potential systematic estimation bias and investigated the dynamic change of carbon emissions after the first disclosure year. The researchers also examine firm-level mechanisms – while disclosing firms making more green hirings for their own operations, they have more transactions with upstream suppliers.

greenwashing

Scope 2 emissions, which come from the generation of purchased heat, steam, and electricity, were not included in the study as most of companies have limited control over these factors.

Overall, the researchers found that Scope 1 and Scope 3 emissions among companies declined steadily over time, likely due to technological advancements, renewable energy adoption, and climate regulations. Meanwhile, Scope 2 emissions showed minimal change over time and represented a small proportion compared to the other two scopes.

The data also revealed that firms disclosing carbon emissions steadily increased from 2002 to 2015, but following the adoption of the Paris Agreement in 2015, a surprising increase occurred. This increase could be reflected in Trucost expanding their sample size, estimating emissions for around 7,000 firms since 2016 compared to 2,184 in the previous year.

Prof. Wu and the team then explored emissions disclosures across years, industries and geographic locations. Combining Trucost and WorldScope data, which provides public firms’ financial attributes globally, the researchers gathered a final sample of 92,059 firm-year observations from 13,169 unique firms across more than 90 economies from 2002 to 2020.

The transportation industry was found to have the highest proportion of disclosing firms, followed by the paper and printing industry, and then the chemicals and petroleum industry. This is expected, given the significant direct emissions from these sectors and the public demand for transparency. When considering the breakdown of firms by geographical location, European firms are the most likely to disclose their carbon emissions.

“We found that the U.S. and the Asia Pacific firms tend to shift their emissions to upstream suppliers,” says Prof. Wu. “One group of companies that we did not see such increases is the European firms, as they actually decrease their emissions without increasing their Scope 3 emissions.”

Moving On the Right Track?

greenwashing

The study further investigated the implications of mandatory environmental reporting regulations by different governments and found this requirement tends to encourage firms to reduce their Scope 1 emissions, especially for disclosing firms. Among disclosing firms, strong regulations can entice them to reduce their internal emissions by 24 percent. Interestingly, mandatory reporting regulations can also discourage disclosing firms from increasing their Scope 3 emissions, or at least not exacerbate carbon outsourcing in the supply chains.

As a result, it appears that mandatory regulations tend to nudge disclosing firms to reduce their total emissions along the supply chain, not only their internal emissions. This indicates that mandatory environmental reporting regulations can be an effective policy tool to encourage firms to reduce their carbon emissions and improve their environmental performance.

Prof. Wu suggests that government intervention, mandatory reporting regulations, and comprehensive emissions management can work together to address the challenges posed by greenhouse gas emissions. By adopting a comprehensive policy package that includes these tools, policymakers can encourage firms to reduce their carbon emissions.

Companies should also adopt comprehensive emission reduction strategies that address both in-house and outsourced emissions. For example, managers can consider adopting cleaner production technologies, reducing energy consumption, and improving supply chain management.

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“When thinking about carbon emissions, many don’t have a holistic view of how the product is being set these days,” says Prof. Wu. “Many companies actually don’t produce their own products internally, but rather through original equipment manufacturers, including for electric vehicle, electronic, and smartphone products.”

“We need to think about the supply chain perspective to complete the whole cycle because the easiest way to do greenwashing right now is through the supply chain,” Prof. Wu adds.