a proposed model of the relationship between environmental management accounting and firm...

A Proposed Model of the Relationship between Environmental Management Accounting and Firm Performance

Sayedeh Parastoo Saeidi1, Saudah Sofian

Faculty of Management, Universiti Teknologi Malaysia, Skudai, 81310, Johor Bahru, Malaysia

Abstract The aim of this paper is to propose a model of the relationship between Environmental

Management Accounting (EMA) and firm performance through reviewing the related literature. One of the more significant findings to emerge from this review is that the majority of previous studies in environmental management area have only focused on non-monetary environmental management practices such as EMSs, quality control systems, and ISO 14001; and very few empirical studies focused particularly on accounting aspects of environmental management practices such as EMA. Moreover, the experimental findings are quite controversial, and there is no universal agreement about the actual impact of EMA on firm performance. This is because while the positive relationship between EMA and firm performance has been obtained in most studies, some studies have still found a negative or neutral relationship. The third obvious finding is that most studies on environmental management practices have been carried out in developed countries based on European and US data. However, far little attention has been paid to such studies in developing countries. Review of the related literature on EMA and performance leads us to establish another conclusion, which is that the majority of studies have focused only on the monetary aspects of firm performance as a measurement of overall performance, and non-monetary aspects have been disregarded. Taken together, the lack of study on EMA in developing countries, lack of a comprehensive approach to firm performance, and inconclusiveness among findings create enough ground for future empirical study on EMA and firm performance. Accordingly, based on the suggested association of these factors, this paper proposes a model that links EMA to both financial and non-financial performance for the empirical research which is carrying out by the authors in Malaysia as a developing country.

Key Words _ Environmental Management Accounting; Financial performance; Non-financial performance.

1. Introduction

Since firm performance is widely considered a major organizational goal, environmental management has become an issue of great concern for industry and administration. Much recent study has attempted to examine the relationship between environmental management and firm performance and while many found positive relationship [1-4], others did not [5-7].

From a different perspective, literature shows that while the majority of environmental management practices have focused only on ethical and non-monetary aspects of environmental management such as corporate social responsibility, disclosing environmental activities information, or different ISO certifications [8-12], little attention has been paid to monetary or accounting aspects of environmental management practices practically as well as academically.

Since the company's success in raising performance is based on correct strategic decisions, and complete monetary and non-monetary information is the basis for correct decisions, it could be concluded that the cost of incomplete information would reduce the quality of decision-making and hence the firms performance evaluation [13]. Unfortunately, a main component of a firms total costs are known as environmental costs and these have always remained “hidden” from managers’ eyes [14]. This may be explained by the fact that many firms as still using weak conventional management accounting systems. These weaknesses have been largely focused on identifying the environment-related costs [15]; producing cost centres to allocate identified environmental costs to the right places;

1 Corresponding author, Email address: [email protected]

A Proposed Model of the Relationship between Environmental Management Accounting and Firm Performance Sayedeh Parastoo Saeidi, Saudah Sofian

International Journal of Information Processing and Management(IJIPM) Volume 5, Number 3, August 2014

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and finally, weakness in establishing proper communication between accounting and other departments, especially production departments [14].

Experience has shown that while environmental managers who have a great deal of knowledge about the environmental impact of the organizations activities have no entry permits into the companies financial subsystems. On the other hand, accountants or controllers who have a lot of top down financial information on hand often have little knowledge about the actual physical flow of materials and energy through production, the related environmental impacts and the environmental relevance of corporate activities. Subsequently, key decision-makers are seldom able to link physical information to monetary information properly in making decisions, often resulting in low quality decisions [16]. Consequently, the outputs of these decisions based on incomplete cost information do not have an effective impact on organizational performance.

Environmental Management Accounting (EMA) as a new tool in management accounting which tries to overcome these limitations and weaknesses through merging environmental management (physical) department with management accounting (monetary) departments [17]. In fact, EMA incorporates cost accounting information with material flow balances data. This comprehensive information provides decision makers with a clear picture of joint environmental and economic outcomes of firm’s activities leading to more strategic and effective decisions [18, 19].

Therefore, managers in the area of environmental management should be advised and encouraged to employ EMA. It is possible by providing them more additional experimental evidence of the potential uses and benefits of EMA on firm performance. Until now, the majority of studies on EMA have focused only on calculating the firm’s environmental cost at a given point in time as in case studies [14, 20]; and only a few studies with inconclusive findings tried to link EMA to firm performance [21, 22]. However, none of them adequately covered firm performance in detail. This is because they considered only some limited dimensions of firm performance, unaware of the fact that there is actually no strict dividing line between a firm’s financial and non-financial performance, and measuring and improving overall firm performance should be based on both monetary and non-monetary aspects of performance [23-25]. Accordingly, this study aims to fulfil the existing gap in EMA studies through proposing a model which serves as a guide for future empirical investigation into the relationship between EMA and firm performance in a developing country. It is worth noting that in this model, firm performance is considered a combination of both financial and non-financial aspects.

2. Environmental Management Accounting

Sustainability accounting can be manifested in organisations through the development of conventional accounting systems. It is possible by focusing on both monetary and physical resources, along with other organizational resources [26]. EMA is a prime example of recent innovations in management accounting and is representative of these new developments.

According to the United Nations Division for Sustainable Development (UN DSD) [27], two types of information are considered under EMA: physical and monetary information. Physical information includes data on the use, flow and final destiny of energy, water, materials and waste; and monetary information includes environment-related costs, earnings and savings. Accordingly, EMA is broadly defined by UN DSD [28] as “identification, collection, analysis and use of two types of monetary and physical information for internal decision making”. Schaltegger & Burritt [29], Burritt [30], and Graff et al. [31] emphasised the flow of environmental expenditures of EMA as opposed to Jasch [14] who contended that the main areas of environmental information systems are objective units of energy, water and material flow rather than monetary information.

In contrast to UN DSD, Bennett and James [32] presented a description which includes both monetary and non-monetary information regarding environmental and fiscal efficiency, with durable business objectives in mind. In the same view, Bennett et al. [33] and Deegan [34] also described EMA as a method that creates, analyses, and utilizes both non-monetary and monetary information to enhance the fiscal and environmental efficiency of an organization. Therefore, it could be concluded


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that EMA provides policy makers with non-monetary as well as monetary information with which to evaluate the company’s environmental impact [28, 33, 35].

From a different view of point, Bennett et al. [36] insisted that EMA provides a secure connection between environmental management and organization accounting. Is it through supplements to existing environmental management, or supplements to conventional management accounting, through reinvention of conventional management accounting and environmental management, or through the introduction of a new system that reflects a change in management philosophy towards concern for the environment as ongoing issues for business. Taken together, according to UNDSD [28] and Jasch [37], the most important task of EMA is to make sure that all relevant and significant costs have been considered when making business decisions.

Despite giving definitions of EMA, a few researches reported that environmental management activities, coupled with EMA have an affirmative impact on company achievement. Nevertheless, there are no noticeable similarities in researchers’ findings on this subject and this relationship is still open to the question of whether environmental management practices improve the performance of the firm.

3. EMA and firm performance

From recent surveys it is clear that companies today are demonstrating an increased willingness to address environmental and social responsibility issues and to adopt voluntary environmental practices to reduce their negative operational impact on the environment and enhance administrative control [38]. Therefore, they adopt different environmental management practices that affect their structure, responsibilities, procedures, processes and resources for better performance [39, 40]. A study carried out by Kirk [41] shows that the main reward of environmental management is advanced social reputation and improved public relationship. Some other scholars [42-44] also confirmed Kisk’s claim that paying attention to environmental management practices could further enhance corporate image enabling the introduction of environmentally-friendly commodities into the market and the performance of commercial actions with fewer detrimental effects on the surrounding atmosphere.

Finally, it could be concluded that superior organizational reputation and enhanced association with interested parties are part of the rewards that firms can realize by adopting environmental management practices. Likewise, Adams and Zutshi [45] claimed that enhancement in corporate image could come about due to the commissioning of environmentally-friendly products into the market and carrying out institutional operations with reduced hazardous impacts on atmospheric ecology and achieving a greater degree of customer satisfaction. Many scholars have reported that a greater degree of customer satisfaction increases the firm reputation [46-48] and subsequently, an improved corporate image has a positive impact on economic performance [49-51]. This view is supported by Anderson et al. [52, 53] who writes improved financial performance is one of the consequences of a high level of customer satisfaction.

In addition to creating value for consumers through producing and supplying environmentally friendly products, firms should also be open an honest about their financial performance through the proper reflection of environmental costs in their cost accounting system. Therefore, some scholars [14, 20] have focused in particular on identifying firms’ environmental costs through EMA and its various potential benefits or disadvantages in terms of firm performance. In most cases, authors have claimed that more accurate environmental cost information through EMA is accompanied by three advantages. First, firms will have a better and more accurate picture of their real financial performance [19]. Second, complete cost information will enable managers to make better strategic decisions [54]; and third, discovering all the hidden environmental costs through EMA paints a frightening picture of the true costs for firms which motivates them to find and innovate new ways and strategies to control and reduce environmental costs and the impact of their activities [55]. Therefore, EMA has become a deliberate issue within the recent aggressive situations for businesses [35] and a number of researchers have tried to understand and explain the affiliation between EMA and different firm performance indicators such as eco-efficiency (profitability), differentiation and innovation, market performance (customer satisfaction and reputation), and competitive advantage. However, different research efforts


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have produced different research findings. This is because some authors have reported a positive link, while others did not suggest a positive association.

3.1. EMA and Efficiency

In terms of efficiency, which is divided to profitability and productivity, Burritt & Saka [22] claim that EMA enables companies to shift manufacturing procedures and the utilization of products towards durability. Jasch [14] also reports that EMA lessens environmental effects, the risk of firm activities and increases environmental security. Burritt & Saka [22] discovered that eco-efficiency data is an important indicator which should be incorporated into EMA applications as well as incorporate green information. Likewise, Hart [56] found that preventing effluent could allow the company to save control costs, input, and power usage. Preventing effluent can also allow companies to recycle unused or waste materials in the process of manufacturing. In another study, Jasch [21] claimed that businesses that implement EMA could reduce expenditure by yielding to demand pressures for more manufacturing efficiency and lower excessive effluent, material, and energy utilization. In his analysis of identifying, assessing and allocating environmental and material flow costs, Jasch [54] revealed that by EMA managers are able to identify opportunities for cost savings.

In the measurement of inputs and outputs in physical terms such as kilograms, the focus is often placed on practical procedures, which is referred to as productivity as it is another aspect of efficiency [57]. Therefore, the creation of waste is seen as a symbol of inefficiency [58]. In his study, Jasch [14] reported that EMA raises resource productivity. In another major study, Nishitani [59] found that coupled with attaining green objectives, it is pertinent that environmental management practices decrease expenditure through an enhancement of productivity, and increase sales through a rise in the need of green friendly clients. However, through the adoption of a proactive green approach, in particular EMA, companies could get rid of environmentally dangerous manufacturing procedures, revamp current manufacturing systems to lower life cycle effects, and build fresh commodities with lower life cycle expenses [55] and obtain higher levels of productivity. This view is supported by Elsayed & Paton [60] who wrote that environmental management accounting practices have the strongest effect on green policy in the maturity phase of the company life cycle. In a similar study by Masanet-Llodra [61] increased efficiency in the use of raw materials, operating materials, and energy in non-product output also constitute a main component of environmental costs.

In conclusion, eco-efficiency means manufacturing and supplying commodities while at the same time lowering environmental effects, material use and reducing expenditure [22, 62]. In seeking to achieve sustainable eco-efficiency, organisations have been advised to improve and develop new products and manufacturing processes to reduce their use of resources and the environmental damage caused by their activities.

3.2. EMA and Innovation

Organisations today are required to be innovative in terms of environmental issues as evidence shows that in the growing competitive market, companies with greater emphasis on a business model based on innovation have faster operating margin growth and higher sales growth [63, 64]. Innovation in environmental management area has been mostly conceptualised as product and process innovations. Several attempts have been made to identify the association between EMA and innovation. A recent study based on 588 German companies set out to determine the impact of environmental management practices on green innovations by Rennings et al. [65]. A weak positive impact of ISO 14001 and EMAS was reported only on green product innovation. These findings are consistent with those of US Environmental Protection, Agency (USEPA) [66], and Hansen & Mowen [67] who found that the implementation of EMA could result to product innovation in an organization.

In an empirical study, Ferreira, et al [55] aimed to investigate if EMA leads to improvement within firms. The results of their study indicated that implementation of EMA doesn’t have a positive relationship with product creativity, but the adoption of EMA facilitates the procedure of improvement. In this way EMA has a positive and significant effect on process innovation. This finding is in line with


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the researcher’s opinion that EMA adoption most often leads to the recognition of opportunities, such as advancement in manufacturing procedures [35, 67, 68] and reduction of expenses of manufacturing process [69].

In a complementary study, Chang [70] emphasized that environmental product innovation mediates the positive interconnection between the firm’s environmental ethics and competitive edge. This view is supported by Mario [71] who found that new products produced through innovation lead to competitive edge. This is because the main aim of innovation is meeting consumer expectations, which is the main interest of stakeholders and the main source of revenue for the organization. Therefore, some scholars attempted to answer the question of whether the use of EMA actually leads to customer satisfaction and to enhancement of the reputation of the organization

3.3. EMA, Customer Satisfaction and Corporate Reputation

Customer satisfaction is a measure of how products and services supplied by a company meet or surpass customer expectations [72]. Many firms use satisfaction ratings as an important indicator of performance evaluation [73]. Therefore, it could be claimed that higher levels of performance are positively affected by higher levels of customer satisfaction [74, 75]. On the other hand, corporate reputation is a reflection of the degree to which the public is satisfied that firms are meeting their expectations with their products and services [76].

Since today’s consumers demand more durable and eco-friendly commodities [42], firms have a new reason to be concerned about their customers environmental demands and expectations. As reported by Csutora & Palma [77], environmental expenditure uncovered by EMA has a positive indirect linkage to increasing market share through innovating new environmentally friendly products according to consumer desires. Another report by Staniskis & Stasiskiene [78] indicated that businesses are supported through the adoption of EMA to lower production expenditure, charge competitive rates with good quality brands and also to reduce the use of natural resources. Improved pricing [42] and product superiority [79, 80] may lead to a higher degree of consumer satisfaction. Thus, Schneider et al. [81] and Simon et al. [82] and Troilo et al. [83] emphasized that firms with whose customers are satisfied with their ongoing efforts to offer better services and products have higher levels of business and market efficiencies. Based on this evidence, therefore, it could be concluded that organizations that offer better environmental ideas will most likely be seen as possessing a high degree of environmental integrity on behalf of its customers [42, 84, 85]. The increased integrity consequently results in better community endorsement and greater customer authenticity through mediating environmental approach such as EMA [86]. Literature shows that it is mostly accepted that customer satisfaction and reputation are the main components of competitive advantage [87], especially in corporate environmental responsibility.

3.4. EMA and Competitive Advantage

Claver et al. [1] suggest that competitive edge comes from an improved product reputation and an enhanced integrity in business association due to the implementation of eco-friendly administration operations. This claim was supported by Lindell & Karagozoglu [88]; Yang et al. [89]; Ambec & Lanoie [90]; Hart [91]; Porter & Vander [92]; and Trung and Kumar [93] who reported that obtained improvement as a result of environmental management practices may lead to an enhancement in competitive advantage and consequently, profitability.

Chang [70], Yang et al. [89], Dunk [42], Burritt et al. [94], and Wolters & Jasch [95] claimed that if companies perceive EMA as an important tool that supports environmental managers in decision making, they are likely to increase their competitive advantages. This is because EMA assists businesses to match blueprint and features of their product output with the needs of the customers which leads to reputation and finally to competitive advantage [42].


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4. Conclusion and Proposed Model

Reviewing the related literature revealed four gaps among previous studies in the field of environmental management issues. First, the majority of previous studies in the environmental management area have focused only on non-monetary environmental management practices such as EMSs, quality control systems, and ISO 14001; and very few empirical studies focused particularly on accounting aspects of environmental management practices such as EMA [55, 96]. Comprehensive and complete cost accounting information including environmental costs plays a critical role in improved managerial decision making processes and outcomes. Therefore, further study to add substantially to firms’ understanding of the real nature of EMA, as well as to increase managers’ knowledge about their EMA involvement’s level would be necessary.

Second, it is noteworthy that most studies on environmental management practices have been carried out in developed countries based on European and US data. However, far too little attention has been paid to such studies in developing countries [97, 98]. Therefore, based on Oeyono et al. [99] who claim that exposing environmental responsibility programs is advantageous for organizations in developing countries, more studies on EMA are needed in developing countries, especially in Malaysia where green sustainability is part of the 2020 development plan. An additional factor in the context of Malaysia is importance of the Environmental Quality Act of 1974 which assesses the environmental impact of firms’ activities [98]. Moreover, to date, little evidence has been found associating EMA with firm performance in Malaysian firms. Therefore, Malaysia as the best option has been selected for future empirical research.

Third, while a positive relationship between environmental management practices including EMA and firm performance has prevailed in most studies in this field, results still remain inconclusive and there is no agreement on this [96, 100]. It is because some found no positive relationship [5-7]. Such inconclusiveness, therefore, creates a proper ground for further investigation in environmental management field [25] especially regarding the role of EMA on changes in firm performance that would be of great help in increasing mangers’ knowledge about the potential effects of EMA on firm performance. Relying on these recommendations and given the scarcity of this kind of study in Malaysia, in addition to measure the level of EMA, future empirical research will try to fill in the existing gap by examining the relationship between EMA and firm performance in Malaysian companies.

Fourth, while measuring and improving firm performance should be based on both monetary and non-monetary aspects of performance, and there are no strict dividing lines between financial and non-financial variables in evaluating overall firm performance [25, 101] the majority of scholars have focused only on financial aspects of performance in the link between environmental management practices and firm performance; and only a few studies in this field have jointly considered firm performance as a financial and non-financial concept [5, 25, 87]. Moreover, those researches that have covered both financial and non-financial performance have been carried out on common environmental management practices such as TQM, quality control systems, Life cycle analysis, and ISO 14001, and no single study exists which specifically covers EMA and its relationship with both firm financial and non-financial performance [19, 96, 102-104]. Accordingly, future empirical research will attempt to give a comprehensive picture of firm performance through considering both financial and non-financial performance in examining the relationship between EMA and firm performance. It is worth noting that non-financial performance in the proposed model has been divided into five indicators including product innovation, process innovation, customer satisfaction, reputation, and competitive advantage. Accordingly, the following hypotheses will be tested:

H1) Firms with EMA achieve higher level of financial performance. H2) Firms with EMA achieve higher level of non-financial performance.

H2a) Firms with EMA application achieve higher level of product innovation. H2b) Firms with EMA application achieve higher level of process innovation. H2c) Firms with EMA application achieve higher level of customer satisfaction. H2d) Firms with EMA application achieve higher level of reputation. H2e) Firms with EMA application achieve higher level of competitive advantage.


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Figure 1. Research Model

It is worth noting that the empirical study based on this proposed model is carrying out by the authors in Malaysia as the only developing country with an explicit timeline to achieve developed nation status by the year 2020. The only firms which are included in the study are 295 companies in the industrial product sector and 157 companies in the consumer products sector - a total of 452 listed companies in 2013. These sectors have been chosen because the activities undertaken by the manufacturing and consumer product industries have the most negative impact on the environment [94, 105]. The survey approach is using for gathering data. Management accountants and financial managers are respondents because they are directly involved in the management of organizational affairs and have first-hand knowledge of organizational improvement processes and cost accounting information.

The findings from the future empirical study will make several contributions. First, the findings will extend EMA literature by providing a comprehensive view of firm performance through considering non-financial performance as well as financial. It could served as a base for future studies on EMA in Malaysia. The findings further will assist in scholars’ better understanding of the role of EMA in firm performance and will provide a new understanding of the underlying concept and nature of EMA for Malaysian managers.

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a proposed model of the relationship between environmental management accounting and firm...

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