On Wednesday the Securities and Exchange Commission (SEC) voted to adopt its long-awaited climate-related disclosure rule, thus injecting itself into climate-related government regulation initiatives. These reporting requirements will require companies to foot an exceptionally large compliance bill and submit disclosures that will provide investors relatively little information relevant to the performance of their stocks.
The rule will force companies to report their direct greenhouse gas emissions (which the Environmental Protection Agency categorizes as Scope 1 emissions), the indirect emissions they create from their purchase of electricity as well as heating and cooling at their facilities (Scope 2).
The good news is that the rule does not require firms to also report Scope 3 emissions, which result from entities not owned or controlled by the reporting organization, but that the organization indirectly affects in its value chain. Scope 3 disclosures would have required firms to provide information on the economic activity of the full supply chain of a firm — a prohibitive task riddled with a large set of assumptions.
The bad news is that the rule still requires firms to assess risks that are largely aggregate risks and which don’t affect their own profits in any material way. We can all agree that if the climate changes, then most businesses will suffer consequences. But to ask each firm to assess the material impact of climate risks on its “business strategy, operations, and financial conditions” would require firms to become experts in how and when such risks will manifest. This is beyond the scope of firms to assess and beyond the scope of the SEC to require.
Disclosure requirements will increase the operating costs of all public corporations. The SEC’s own estimate is that companies will incur higher direct costs of $6.37 billion a year to comply with the rule. These costs will ultimately be borne by their workers (via lower wages), by their customers (through higher prices) and by the shareholders (through reduced stock prices).
But the aggregate effect on the U.S. economy will be much larger. One analysis by Matthew Winden, an economist at the University of Wisconsin Whitewater, estimated that this rule will reduce aggregate output in the U.S. economy by $25 billion each year and result in 200,000 fewer jobs by the later part of the decade.
My own research has shown that complex regulations increase the cost of financing for firms. If costs increase for firms to be publicly traded, fewer firms will IPO and startups will remain private longer to avoid regulatory burden. Given the myriad advantages of firms becoming publicly traded — most notably their access to deep capital markets, which makes it much easier to grow — barriers to incorporation reduce long-term growth.
Computing a firm’s Scope 1 and 2 emissions is costly. Smaller public corporations, due to higher compliance costs, will scale back some operations, possibly reduce employee payrolls, and increase the costs of goods at a time when high inflation is still afflicting American consumers.
Besides the high costs, it remains unclear what the benefits of this exercise will be. There is no reason to think that investors will find these numbers useful unless the SEC or some other government entity has plans to use them for future regulations or taxes. Given the complexity of supply chains, every firm will undoubtedly strive to make assumptions that will allow them to minimize reported numbers. The result will likely be a costly exercise in futility.
The SEC’s emission reporting rules go beyond the ostensible reason for the SEC’s existence, which is to encourage capital formation and maintain fair, orderly, and efficient markets by encouraging the provision of useful information about publicly traded firms for interested investors. These rules do neither one of these tasks, absent more intrusive rules regarding greenhouse gas emissions.
If the SEC feels compelled to regulate the impact that publicly traded firms have on greenhouse gas emissions, then it should also do its utmost to help companies lower overall compliance costs. As it currently stands, the benefits to investors are far outweighed by the costs.
Indraneel Chakraborty is professor and chair of the department of finance at The University of Miami.
