Environmental Liabilities, Bond Ratings, and Bond Yields

Abstract

We examine the relationship that exists among bond ratings, bond yields, and various estimates of a firm's contingent environmental remediation liability using a sample of new bond issues. Our results indicate that the largest external EPA-based estimates of the firm's environmental obligations are significantly associated with a firm's bond rating, providing relevant incremental information beyond that supplied by the environmental accruals presented in the financial statements. Furthermore, while the accrued environmental liability is shown to have a direct association with the bond yield, the external EPA-based estimates provide an indirect relationship with the bond yield through their influence on the bond rating. These results contribute to the extant literature by empirically clarifying the role of various environmental liability estimates in establishing a firm's bond rating and further indicating their connection with the pricing of corporate debt.