Estimating the Hidden Costs of Environmental Regulation

This paper examines whether accounting systems identify all the costs of environmental regulation. We estimate the relation between the “visible” cost of regulatory compliance, i.e., costs that are correctly classified in firms’ accounting systems, and “hidden” costs i.e., costs that are embedded in other accounts. We use plant-level data from 55 steel mills to estimate hidden costs, and we follow up with structured interviews of corporate-level managers and plant-level accountants. Empirical results show that a $1 increase in the visible cost of environmental regulation is associated with an increase in total cost (at the margin) of $10-11, of which $9-10 are hidden in other accounts. The findings suggest that inappropriate identification and accumulation of the costs of environmental compliance are likely to lead to distorted costs in firms subject to environmental regulation.