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The practice of hydraulic fracturing, or fracking, has generated significant economic benefits for the United States and increased our energy security. But it has also ignited a fierce debate about safety and environmental impact. Can transparency into fracking practices reduce those negative effects? 

Christian Leuz, the Charles F. Pohl Distinguished Service Professor of Accounting and Finance at the University of Chicago Booth School of Business, has been studying these questions. At the recent Unpacking ESG event, he discussed his research on fracking, whether mandating certain disclosures might make the practice cleaner, and how this work fits into the broader debate about increased transparency in environmental, social, and governance (ESG) reporting. He was joined by Mili Fomicov, ’11, a researcher at the Centre for Climate Finance & Investment at Imperial College London.

The event was held at Chicago Booth’s new Robert Rothman, ’77, Campus in London and was a part of the ongoing Unpacking ESG event series hosted by the Rustandy Center for Social Sector Innovation and the George J. Stigler Center for the Study of the Economy and the State.

Here are some key takeaways from the event:

Sunlight Is the Best Disinfectant 
Leuz’s research into transparency and disclosure has primarily focused on capital markets. But, he said, he’s seen an increase in the use of targeted transparency—asking for more transparency on corporate activities such as food labels, healthcare, and other areas of consumer protection.

“I was asking myself, why do we see this expansion of disclosure regimes?” Leuz said. “One reason is the recognition and understanding—to which Chicago Booth has contributed a lot—that the traditional types of regulation that tell people what to do or what not to do can have significant unintended consequences.”

Transparency regimes, on the other hand, do not restrict activities. They are about shedding light on activities—which many view as less intrusive and more benign. It’s also politically expedient for policy makers and regulators. “There’s a famous quote from Supreme Court Justice Louis Brandeis that encapsulates this notion really well: sunlight is the best disinfectant,” Leuz said. “Studying when this is or isn’t true has become a theme of my research.”

The Controversy over Fracking
As an example, Leuz spoke about his recent work on hydraulic fracturing, or fracking, which involves drilling deep into the earth and pumping water, sand, and chemicals into the shale to release the oil or gas that’s trapped inside. The practice has seen considerable growth in recent years.

“On the one hand, fracking has been an amazing force in terms of energy security and has brought very large economic benefits to the US,” Leuz said. “On the other hand, it has been very controversial, triggering a debate over the environmental impact of fracking. In particular, there are concerns about the impact on water quality.”

As fracking activity escalated in the US, government regulation focused less on banning the practice and more on requiring fracking companies to disclose information such as the location of drilling, the resources used, and the composition of the fluids produced. This provided ideal conditions for research into the impact of reporting.

“What can sunlight do in this case?” Leuz said. “Does the disclosure mandate for these fracking companies reduce water pollution and environmental impact?”

The Impact of Transparency

When Leuz and his team investigated the environmental impact of fracking, they found evidence of harmful increases in the concentration of salts from fracking fluids. This led to a study that was published in Science in 2021. This was the first study to show the widespread impact of hydraulic fracturing on US surface waters.

More recently, they found meaningful reductions in concentrations after the introduction of disclosure regulation by the states.

“After the introduction of the disclosure mandate, you see less impact from fracking as measured by the salt concentrations,” he said. “There is a clear improvement in terms of the water quality.”

Next, Leuz and his team analyzed the factors leading to the improvement in water quality. They found that companies that faced more public pressure as a result of the disclosure mandate saw greater improvements. They concluded that targeted transparency works when it mobilizes public pressure.

“The bottom line is that disclosure regulation can be a tool to mitigate environmental externalities,” Leuz said. 

Defining the Goal

Pivoting to a broader view of environmental issues, Leuz said it is critical to identify the goal of ESG disclosure. Is it about providing investors with what they need to understand a company’s risks and opportunities? Or is it about driving environmental change through targeted transparency?

“These goals have very different implications in terms of what we should be reporting on,” he said. “If the goal is to report about risks and opportunities, then the focus of reporting is about the consequences for the corporation. But if your goal is to address externalities and to drive changes to address climate change, then focusing on risks to the corporation is not necessarily the right perspective.” Externalities, by definition, have little consequences for the firm.

Implications for Other Areas of Impact
Looking beyond the fracking example, Leuz pointed to studies on greenhouse gas emissions that found eight to 15 percent improvements in emissions after the introduction of disclosure mandates, consistent with what they saw in their fracking study. 

“In my mind, that’s pretty significant,” Leuz said, adding that these rules work in part through public pressure and in part through peer benchmarking. “Nobody wants to be the dirtiest kid on the block,” he said. “So again, transparency can work in the way Brandeis envisioned.”

But transparency also has limits. It is not always the best solution. “Would anybody suggest that we get rid of FAA inspections and rules and replace them with safety disclosure mandates?” Leuz asked. “Nobody would do that, obviously, and that shows that in certain areas disclosure is not sufficient. It can be a stepping stone in the right direction, but it is probably not enough.”

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