Businesses had better get ready for “the California effect.”
Eric Orts, a Wharton professor of legal studies and business ethics, predicts that sweeping new climate disclosure bills signed into law earlier this month in the Golden State will set the standard for the rest of the nation. The state’s ability to influence other jurisdictions through its long history of enacting stricter environmental regulations has come to be known as the California effect.
“If you want to do business in California and you’re a big company, you’re going to have to conform to the California standards,” he said. “We may have some legal challenges, but the general sense is that it’s going to withstand legal challenge and it will become de facto the law in the United States.”
Setting a New Standard for Corporate Climate Responsibility
The landmark legislation requires large corporations operating in the state to be more transparent about their contributions to climate change and their climate-related financial risks. One law mandates that firms with more than $500 million in annual revenue disclose their climate-related financial risks and how they are managing them. The other mandates companies with more than $1 billion in annual revenue to report both direct and indirect greenhouse gas emissions. That encompasses about 5,300 companies, according to The Washington Post.
“You might have some lobbying about what’s good or what’s bad, but it’s going to be an overall improvement of the information we get.”— Eric Orts
Orts said the laws are important for several reasons: They include both publicly traded and private companies without burdening small businesses; they standardize carbon emissions reporting, which should help reduce greenwashing; and they mesh with similar laws developed by the European Union.
“One of the things you see here in the climate space is that Congress has pretty much been stuck in the mud for the last several decades on this issue,” Orts said. “Developments like you see in California and in Europe may then add pressure for the [federal] government to actually step in here.”
Going Beyond the SEC Climate Disclosure Rule
California’s laws, which take effect in 2026, will also phase in the reporting of Scope 3 emissions, which are greenhouse gases created outside the company by entities up and down its value chain, from suppliers to customers. The Securities and Exchange Commission (SEC) is expected to vote later this month on a Climate Change Disclosure Rule that does not include private companies and likely will not include Scope 3 emissions.
“In a way, I think the California statute is more exciting because it’s broader than the [SEC’s proposed regulation],” Orts said.
The professor acknowledged that measuring the upstream and downstream impact of energy-related activities is a difficult task for companies because there is no single set of standards. But California’s laws will help refine the process and provide transparency.
“It’s not easy to know what the exact amount is, but what we will start to see when this comes online is the indirect footprint of an oil company is a hell of a lot larger than the impact of another kind of company that’s doing supply or services or something like that,” he said.
“In a way, I think the California statute is more exciting because it’s broader than the [SEC’s proposed regulation].”— Eric Orts
California Braced for Legal Challenges
Orts said it’s likely that the laws will be challenged. The business community offered mixed support for the bills, which failed last year. Big players including Google, Apple, Patagonia, IKEA, Microsoft, Adobe, and Salesforce supported the current legislation, while the state’s chamber of commerce and the powerful Western States Petroleum Association opposed it.
But Orts also thinks the laws will survive any claim that the state of California doesn’t have a right to impose its climate standards on anyone else. California has the fifth-largest economy in the world, so it holds considerable sway in business matters. Over the years, it has set higher-than-national standards for a host of concerns, from vehicle emissions to product warnings about dangerous chemicals. Orts pointed out that the U.S. Supreme Court recently upheld the constitutionality of a California law restricting the sale of pork from pigs subjected to cruel treatment.
“You might have some lobbying about what’s good or what’s bad, but it’s going to be an overall improvement of the information we get,” he said about the climate disclosure rules. “It’s not only investors that care, it’s consumers, it’s the government, and it’s everyday citizens. They’re going to want to know what’s the climate profile of the different companies that they do business with.”