Review of Literature.

Environmental Disclosure.

A collection of data on initiatives to manage the environment from the past, present, and future is
known as environmental disclosure. There are several methods to communicate environmental
responsibilities, according to earlier research. These obligations may be detailed in sustainability
reports, environmental reports, or notes to financial statements.(STIE Malangkuçeçwara, 2020)

Since the 1980s, the disclosure of information by companies has been the focus of several studies
and discussions on corporate environmental disclosure (CED). Numerous research has looked at
the patterns and nature of corporate environmental disclosure, as well as the various explanations
that affect corporate environmental disclosure practices. An extensive body of research has
established that environmental disclosure is a significant trend that businesses employ for a number
of reasons (Tilt, 2001)(Jumaah Al-Waeli et al., 2021; Mohamed & Ibrahim, 2014).

In the initial stages, when corporations were starting to provide disclosure about their
environmental performances, it is possible that investors are not getting enough environmental
disclosure, which might be harmful to them and the securities market. (Harte & Owen , 1991)
stated, when environmental disclosure started to appear in annual reports in the 1970s, the
information was presented in a narrative format on around a half page and had insufficient
information regarding environmental performance.

Because of this, in some countries it is a legal requirement for the companies to disclose their
dealings with the environment. For example, in the USA it is mandatory for the corporations to
disclose information about their dealings with the environment in the present and in the future.
(Buhr & Freedman, 2001)

According to (Lodhia, 2001), environmental disclosures are not a normal or frequent event, rather,
they differ from country to country and industry to industry and are understood using various
theoretical frameworks. In order to provide an explanation for this study's objective this chapter
will analyze and evaluate earlier research in order to find any notable gaps in the corporate
environmental disclosure (CED) literature. Furthermore, it offers background information on
various theoretical frameworks and methodological decisions made in these studies.
Environmental Disclosure in Sri Lanka

Sri Lanka is one of a South Asia's developing economy. Corporate environmental disclosure is not
mandatory in Sri Lanka, such as in many other nations. Hence it could be understood that many
corporations in Sri Lanka adapt voluntary to disclose about their dealings with relation to
environment. Disclosures range from minimal to standard levels, in accordance with GRI G3
sustainability reporting criteria, which are regarded as an international standard for reporting on
sustainability (Jariya, 2015).

It can be stated that issues related with environmental disclosure reporting in Sri Lanka has not
been much of a concern till late. According to the comprehensive study performed by (Rajapakse,
2003) on Stakeholders' Demand for Green Reporting in Sri Lanka, and the findings revealed that
a large majority of stakeholders actively demand environmental disclosures from commercial
enterprises. The explanations they give include both environmental concerns and self-interest.
However, despite this raised need, financial reporting on social and environmental issues has not
significantly improved. Remarkably, the study findings indicated that the overall number of
stakeholders looking for environmental information in annual reports outnumbers those who do
not. Nonetheless, the majority of survey respondents believe that present environmental reporting
procedures in Sri Lanka are not materially relevant for making economic decisions.

In their study, (Rajeshwaran & Ranjani , 2014) explored into an examination of the extent and
drivers behind social and environmental disclosures among Sri Lankan listed companies. They
precisely selected a sample of 100 companies, representing a wide array of 20 distinct sectors, to
ensure comprehensive exposure. Employing a checklist developed in accordance with the Global
Reporting Initiative (GRI) guideline, they thoroughly scored the gathered data. Utilizing both
descriptive statistics and irregular testing, they examined the dataset. The results showed a
important trend, as there exists a notable scarcity in the practice of social and environmental
disclosures within the Sri Lankan listed companies.

In the study examining corporate sustainability reporting practices in Sri Lanka, (Senaratne &
Liyanagedara, 2012) thoroughly followed the guidelines set by the Global Reporting Initiative
(GRI). Among the 34 companies included in their analysis, 11 companies (representing 32% of the
sample) actively engaged in some form of social and environmental reporting. Remarkably, only
2 companies presented a comprehensive sustainable report, demonstrating a commitment to
transparency and accountability. Notably, the disclosure rate for environmental performance
indicators was a mere 12% out of the three performance indicators studied. These findings
underscore the need for greater emphasis on environmental reporting practices within Sri Lanka’s
corporate landscape.

Legitimacy Theory

According to the Theory of Legitimacy, organizations try to operate within the boundaries and
norms of the communities they serve. By doing so, they increase their perceived credibility. These
norms are dynamic and subject to change, requiring organizational adaptation. This concept is
consistent with the idea of a social contract, in which businesses maintain a mutual relationship
with their stakeholders (Ewan, 2022). According to legitimacy theory, larger organizations must
respond with more information in order to have a stronger influence on societal expectations since
they have more stakeholders than small businesses (Cowen, Ferreri, & Parker, 1987). An
organization can sustain its existence when it is recognized by the community that the
organization’s values align with the community’s own value system.

Stakeholder Theory

Stakeholders are all internal and external parties who have a relationship with a company and may
affect or be influenced by it, either directly or indirectly. The stakeholders are divided into two
categories as internal and external. Internal stakeholders are those within the company's
organizational structure, such as shareholders, workers, and senior management, who have a direct
effect on the company's goals (Ewan, 2022). External stakeholders, on the other hand, are people
or groups outside the company's structure who can influence or be impacted by the company's
policies and practices, such as suppliers, competitors, customers, and government bodies
(Muslichah, 2020). Researchers often utilize stakeholder theory to illustrate the importance of CSR
initiatives for companies. According to stakeholder theory, a company's actions are ethically
responsible to its stakeholders due to the connection between the two. Also, a company's operations
should benefit all stakeholders, not only its own profits. Disclosure of information in corporate
reports must consider stakeholder expectations.
A recent study indicates that the connection between a firm's view of sustainability reporting and
its financial performance is explained by various theories, such as legitimacy theory and
stakeholder theory (Aureli, Gigli, Medei, & Supino, 2019).

Environmental Performance & Financial Performance

There are two perspectives on environmental performance and financial performance, the
traditionalist view and the revisionist approach. The traditional approach preserves the view that
environmental performance and financial performance are different and distinct entities. It
highlights that a company's major purpose is financial success, which includes profitability,
revenue growth, and return on investment. Traditionalists frequently believe that economic
activities and regulations should be designed to maximize shareholder wealth and financial returns
(Patten, 2002)(Lu & Taylor, 2018a)

Revisionists challenge traditionalist approach thinking by combining environmental performance

and financial performance, implying that they are interrelated and mutually beneficial. Revisionists
think that strong economic performance, which takes into account social and environmental
factors, improves long-term financial success. This view supports a more holistic approach to
business strategy, demanding organizations adopt sustainable practices, corporate social
responsibility, and ethical governance, which can lead to better financial outcomes over time
(Porter & Van Der Linde, 1995)(Lu & Taylor, 2018b).

In a recent research study,(Davis et al., 2016) examined the interplay between a company's
corporate social responsibility activities and its tax avoidance practices. They observed that more
socially responsible businesses are likely to pay less in taxes. This decrease in tax payments results
in a rise in earnings, which improves the firm's financial performance. The study's findings indicate
an implicit positive association between a company's environmental performance and financial
performance. In summary, (Davis et al., 2016) argue that CSR actions assist society while also
improving a company's profitability and overall financial health by cutting tax obligations.
Environmental Disclosure and Financial Performance

Researchers are most interested in the influence of environmental disclosure on financial

performance. For instance,(Maqbool & Zameer, 2018) and (Mahrani & Soewarno, 2018)
investigated the effects of corporate social responsibility on a company's financial performance
and concluded that corporate social responsibility had a beneficial influence.

Legitimacy theory is a popular framework used by researchers to explain why businesses engage
in CSR activities. According to this view, firms attempt to build legitimacy by fully revealing their
social and environmental operations. CSR disclosures are signals from management that investors
might see as good indicators of the company's ability to achieve their expectations (STIE
Malangkuçeçwara, 2020).

A number of studies have been conducted in recent years to explore the influence of environmental
information disclosure on financial performance or profitability, but their conclusions have been
uncertain, causing disputes. Several studies have found a beneficial relationship between
environmental transparency and financial performance. (Al-Tuwaijri et al., 2005), discovered that
organizations with greater levels of environmental performance reveal more environmental
information, which has a positive relationship with their financial performance. (How &
Verhoeven, 2002) observed that firms engaging in proactive environmental disclosure practices
often experience enhanced profitability, likely due to improved corporate reputation and
operational efficiencies.

A study was conducted by (Jumaah Al-waeli et al., 2021) to examine the link between
environmental disclosures of Iraq industrial companies and their financial performance. The study
discovered that Iraq's environmental disclosure is particularly poor when compared to other
developing countries studied. Furthermore, it was shown that there was a positive correlation of
61.29% between financial performance and environmental disclosure. This shows that, while
environmental disclosure standards in Iraq are undeveloped, firms that do make such disclosures
are more likely to experience economic advantages.

On the other hand, some studies have found a negative correlation between environmental
disclosure and financial performance. (Shariful et al., 2009) revealed in the research conducted for
the companies in Thailand, Singapore and Malaysia that voluntarily disclosed environmental
disclosures in their financial statements, that wide environmental disclosures may be associated
with greater expenses and operational difficulties which may decrease profitability. They argue
that the efforts invested in environmental initiatives and reporting might be greater than the
monetary benefits for certain businesses.

These conflicting findings highlight the complexity of the relationship between environmental
disclosure and financial performance. The impact may vary depending on factors such as industry,
geographic location, company size, and the specific nature of the environmental initiatives
undertaken. Some companies might experience immediate financial benefits from improved
reputation and stakeholder relationships, while others might face short-term costs that obscure the
long-term gains.
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