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Study Indicates that Firm Size Plays a Role in Drilling Safety

A recent study analyzed correlations between the size of a drilling company and compliance with environmental regulations and found that the size of the firm does matter.

The 2018 study titled, “The Effect of Firm Size on Fracking Safety”, published in the journal Resource and Energy Economics, analyzed the effect of the size of drilling companies in Pennsylvania on compliance with environmental regulations and determined that larger firms have better records in this area.

In the study, researchers used inspection data of gas wells in Pennsylvania from 2008 through 2012, the employee count of each drilling firm, and brand value to gauge the size of firms committing violations, and determine if larger firms comply with environmental regulations more than smaller firms. More specifically, the study uses three dimensions of liability (legal, regulatory, and brand) to measure potential losses from noncompliance.

· Legal liability can be understood as “potential costs from lawsuits or fines” from violations;

· Regulatory liability can be understood as “increased regulatory burdens” that occur from violations, and,

· Brand liability can be understood as “potential losses to the value that a firm derives from being viewed positively (or negatively) by the public.”

The researchers note that unconventional natural gas extraction, or ‘fracking’, has become safer since its rise to prominence in Appalachia in the late 2000s. In an effort to hold drillers liable for potential environmental issues, the state requires projects to be bonded, in other words insured, so that the finances needed for remediation would already be secured. Even with this compliance mechanism, smaller firms continued to commit violations.

Since its rise, the industry has evolved from independent operators doing the majority of drilling in the Commonwealth to major, publicly traded companies taking the lead. The study assumes, and then empirically shows, that as firm sizes grow, there are increased legal, regulatory, and brand liabilities that come with non-compliance, thus driving larger firms to become compliant to the point of over-compliance. That is, larger firms with larger assets have more to lose from noncompliance in every dimension of liability analyzed for this study.

The mechanisms that drive compliance within large firms do not translate to smaller firms, as their financial situations are not comparable. For example, though a project may require bonding before operations begin, a smaller firm may not be required to provide the bond upfront, thus leaving no financial incentive for complying with environmental regulations. Furthermore, if a small firm was to be fined for noncompliance, and the fine is more than the company’s worth, it may simply file for bankruptcy, which then protects it from such financial burden. Additionally, smaller firms are not as susceptible or sensitive to the other dimensions of liability, particularly brand liability, as they often do not interface with customers, and thus have small brand values.

Larger firms, on the other hand, are highly sensitive to all three dimensions of liability, according to the study. Though all three liabilities are linked, there is an especially strong link between legal and regulatory liability and their consequences. Though larger firms may be able to afford fines that they incur, such noncompliance could also bring the industry to the forefront of regulators who are more aware of the existence of a large firm, and who could then enact new regulations up to the point of a complete ban on the industry. In that way, the consequences are not just to the firm in violation, but to the industry in whole.

Additionally, larger firms that have powerful brand values and consumer awareness have much more to lose than smaller firms if the public’s perception were to change. Examples of this can be seen in previous disasters, such as British Petroleum’s Deepwater Horizon incident. After the spill, BP suffered from a 25 percent loss in sales at BP-branded gasoline stations, and its removal from Interbrand’s 100 most valuable brands list, according to the study.

In short, the study does find that as firm sizes increase, so does their compliance with environmental regulations. The reasons for this are directly related to the liability that each firm holds, and the impacts that those liabilities have on the individual firm. As the study was conducted using data from Pennsylvania, the information is a direct representation of the reality of the industry in the Commonwealth.

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