277116                                 Report to
                                       U.S. Environmental
                                       Protection Agency
                                       August 1983
Benefits to Industry
of Environmental Auditing
                  /L Arthur D. Little, Inc.
                     Center for Environmental Assurance
                     EPA No. EPA-230-08-83'005

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                                                                                    27796
                                       NOTICE

             This report has been prepared by Arthur D. Little, Inc., under contract
             No. 68-01-6160 for the Regulatory Reform Staff, Office of Policy and
             Resource Management, U.S. Environmental Protection Agency. The
             report reflects the findings  and conclusions of the author and  not
             necessarily those of EPA or any other government entity.
A Arthur D. Little, Inc.

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                    BENEFITS  TO INDUSTRY
               OF ENVIRONMENTAL AUDITING
ABSTRACT
    This paper identifies the principal objectives of environmental audit programs,
identifies the major parties affected by the establishment of an auditing program,
and, based on these, outlines some performance measures which can be used to assess
the benefits of environmental auditing to industry. Some performance measures will
lead to quantifiable results, others to qualitative impacts. Some benefits will  stem
from the direct influence of the audit program; others will flow only indirectly. While
the perceived benefits of environmental auditing vary both among companies and
among individuals within a corporation, the most significant benefits to industry of
environmental auditing fall into two broad categories: increased environmental  man-
agement effectiveness and a feeling of increased comfort or security.

INTRODUCTION

    As companies have developed environmental auditing programs in recent years,
more information has become available for those interested in developing an auditing
capability. Although a growing body of literature describes what environmental
auditing is and how it is used in the private sector, little has been written describing
its benefits. Environmental auditing may benefit EPA, industry, the general public,
labor, and other groups, as well as the environment. The scope of this paper, however,
is limited to the  potential  benefits to industry of environmental  auditing.

    Generally speaking, a benefit can be defined as something that aids or promotes
well-being, or otherwise contributes to an improvement in condition. Implicit in this
definition is a judgment of "well-being" that, although  somewhat constrained by
cultural norms, basically rests in the experience of an individual. For the purposes of
this analysis, we  define benefits more specifically to include those aspects and outputs
of voluntary private-sector environmental auditing that significantly and positively
contribute to the achievement of corporate objectives.

    The achievement of corporate objectives is based on contributions and activities
at many levels and can be measured in many ways. In general, however, corporate
objectives relate  in some way to maintaining or improving the long-term competitive
viability of the firm. Within the scope of benefits to industry, three important issues
influence the description of environmental auditing benefits:

       How to characterize environmental auditing benefits? Benefits can be
        limited  to those derived specifically and  solely from environmental
        auditing, or expanded  to include  all those benefits of environmental
        management to which environmental auditing contributes.
/L Arthur D. Little, Inc.

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        What defines environmental auditing? There is not, as yet, a universally
         accepted definition of environmental auditing; therefore, what one com-
         pany perceives as a benefit of environmental auditing,  another may
         categorize as a benefit of its environmental compliance management
         (and not auditing) programs.

        Whose perspective? Different companies undertake the development of
         an environmental auditing program for different reasons; as a result,
         what is perceived as a benefit by individuals in one company may not at
         all be perceived as a benefit by those in another company. Moreover, the
         perception of some attribute or outcome of the audit program as a benefit
         varies from person to person within a corporation. The views of the plant
         manager are generally very different from those of the corporate envi-
         ronmental staff or top management.

     For the purposes of this analysis, we answer the first question by  limiting
 benefits to those for which environmental auditing is the principal source or to which
 auditing significantly contributes. Responding to the second question, we define
 environmental auditing as a methodical examination involving analyses, tests,  and
 confirmations of facility procedures and practices leading to a verification of their
 compliance with legal requirements, internal policies, and/or accepted practices. With
 regard  to the third question posed above, because many different perspectives of
 environmental auditing currently exist in the private sector, the scope of this study is
 intentionally broad to  encompass these many different views.

     While the perceived benefits of environmental auditing vary both among com-
 panies and among different individuals within a corporation, most of the more widely
 acknowledged benefits do fall into two basic  categories: increased environmental
 management effectiveness and a feeling of increased comfort or security that the
 company's potential exposure to regulatory compliance problems is being reduced. In
 order to explore these two categories in some depth, the sections that follow present a
 context for analysis of environmental auditing benefits; identify the range of environ-
 mental audit program effects which may be perceived as benefits; identify the parties
 affected by  the audit program; and identify the  measures which may be used to
 evaluate audit program effects.
/L Arthur D. Little, Inc.

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CONTEXT FOR THE BENEFITS ANALYSIS

    The benefits to industry of environmental auditing are as wide and varied as the
objectives of audit programs. In order to provide a context for defining the benefits to
industry of environmental auditing, it is useful to examine the techniques that have
been used in other types of benefit analyses and assess the inherent limitations of
those techniques as they apply to this study.

Link to Cost/Benefit Analyses

    Cost/benefit analysis has been used in a variety of forms and levels of sophis-
tication in both the public and private sectors. Formal cost/benefit analysis in the
public arena is a technique designed to promote regulatory and investment decisions
which provide net benefits to a society as a whole. In this case, it is important to define
the society  carefully  in order to include all significant effects of the decision  or
investment. Some effects will be benefits, others  will be costs on the whole, and
different individuals may view the same effect as  benefits or costs.

     Formal cost/benefit analyses generally use aggregate measures of welfare, i.e.,
the sum of a society's well-being. The most common measures  include GNP  or
consumer surplus as the basic economic monetary measure of benefits (or costs). The
general benefits analysis proceeds in several steps: categorization of all identifiable
effects of a given activity; conversion of these effects into benefits; conversion of the
implicit value of these benefits into a common set of units or metrics (generally
dollars); discounting future benefits (or costs); and summing everything in terms of
present value.

     Less formal cost/benefit analyses often crop up as a result of procedures set forth
in statutes or legal precedents which require, without much specificity, that benefits
must outweigh or be commensurate with costs. This informal setting for benefits
reflects a more pragmatic, less analytic connotation and leaves the process of balanc-
ing to the decision maker's judgment.

     In the private sector, a form of cost/benefit analysis is used in investment
decisions. Conventional discounted cash flow (DCF) or return on investment (ROD
analyses, with target or hurdle levels, are an analog to formal cost/benefit analysis in
the public arena.
/fl Arthur D. Little, Inc.

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Inherent Limitations of Benefits Analyses

     While various forms of cost/benefit analysis have been used in both the public
and private sectors, there are a number of inherent limitations of such analyses which
we believe are particularly  important in this study  of environmental auditing
benefits.

       Questions of Definition

        When the framework on which benefits are being identified and eval-
        uated shifts from society to other organizations, such as corporations,
        several questions of definition arise. What is the collection of individuals
        whose well-being is affected by the procedure, in this case voluntary
        environmental auditing? What responsibilities for others are assumed
        by decision makers in weighing the costs and benefits of an action or,
        pragmatically, whose well-being is considered at what levels? Who pro-
        vides information for the decision makers?

       Reliance on Individual  Judgment

        In the absence of conventional aggregate measures of well-being within
        a single corporation,  benefits depend entirely on individual judgments
        and will reflect on the corporate organization hierarchy. This reliance on
        individual judgment, which  is generally the case with the benefits of
        environmental auditing, greatly increases the inherent difficulty of the
        benefits analysis.

       Qualitative Nature of Audit Benefits

        Many of the effects and benefits associated with voluntary private-sector
        environmental auditing are difficult, if not impossible, to quantify.  It is
        no easy task to determine the value of an increased feeling of comfort or
        security a corporate officer may feel as a result of having implemented
        an environmental auditing program. Nevertheless, just because some-
        thing is not measurable does not mean that it has no benefit.

     Despite  these limitations, it is possible to identify  the potential  benefits to
 industry  of environmental auditing. While environmental auditing does not fit into
 the conventional financial analysis framework, the potential benefits of voluntary
 environmental auditing can be identified by an approach embodying parts of analogs
 to the formal benefits analysis process. Quantification of these potential benefits is a
 much more difficult and subjective task that is beyond the scope of this initial study.
A Arthur EX Little, Inc.

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IDENTIFICATION OF AUDIT PROGRAM EFFECTS

    Corporations undertake environmental auditing programs for a variety of rea-
sons, ranging from providing assurance to top management that systems are in place
and operating effectively to assessing the hazards and risks to which the company is
exposed. Table 1 lists commonly found audit program objectives. Generally speaking,
environmental audit programs differ by the driving force behind the program, by the
role the audit program plays in the corporation's overall approach to environmental
management, by the degree of compliance verification, and by the level of
involvement of different functions within the organization. As a consequence of these
differences, a variety of audit program objectives are commonly found. It is important
to recognize that these objectives are often competing and conflicting in terms of the
role of the audit team, the audit methodology, and the type of audit reporting
required; thus, it is  highly unlikely that all, or even most, would be found as objec-
tives of any given audit program.

    It is important to distinguish  among the  objectives, benefits, and effects of
environmental auditing. An objective of an audit program is an end toward which
effort is directed over a period of time.  A benefit (to a  company) of auditing is
something resulting from achieving the objective which imputes a higher value to the
corporation. In short, companies work toward achieving audit program objectives so
that they can gain the resulting value or benefit. In a benefits analysis, it is common
practice to assume that all or part of the objectives have been accomplished; thus, for
the purposes of this study, the audit program objectives listed in Table 1 are con-
sidered as audit program  effects. While audit program effects can be perceived as
either costs or benefits, Table 1 does not include those environmental audit program
effects (e.g., human resources required) which are generally categorized as costs.

    This distinction is important because the objectives of audit programs are com-
monly used in industry as  the benefits, per se. For example, a typical audit program
objective is to identify and document compliance  status. The benefit  is really not
identification and documentation of compliance status, but rather may be increased
environmental management effectiveness as measured by such things as an improved
compliance record, reduced occupational hazards, fewer legal actions brought against
the company, etc. In this example, identification and documentation of compliance
status are an effect of implementing the audit program, not the benefit.
  Arthur D. Little, Inc.

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                                       TABLE 1

                              PRINCIPAL OBJECTIVES OF
                        ENVIRONMENTAL AUDITING PROGRAM
    Identification and documentation of compliance status, including:
     Compliance discrepancies;
     Differences or shortcomings at individual facilities; and
     Patterns of deficiencies that may emerge over time.
    Improvement in overall environmental performance at the operating facilities as a result of:
     Providing an incentive not to allow problems to happen again;
     Reducing or containing problems that can interfere with normal business  activity; and
     Providing an incentive to clean up/improve housekeeping before an upcoming audit.
    Assistance to facility management in:
     Understanding and interpreting regulatory requirements, company policies and guidelines,
       and (perhaps) good practices;
     Identifying compliance problems;
     Defining cost-effective measures that should be taken to achieve compliance; and
     Putting potential problems before a "committee of experts."
    An increase in the overall level of environmental awareness as a result of:
     Demonstrating top management commitment to environmental compliance;
     Increasing the environmental awareness at the facility;
     The training accrued to the audit team; and
     Involving employees  in environmental, health, and safety issues.
/k Arthur D. Little, Inc.

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                                 TABLE 1 (Continued)

                             PRINCIPAL OBJECTIVES OF
                       ENVIRONMENTAL AUDITING PROGRAMS
   Acceleration of the overall development of environmental management and control systems as
    a result of:
     Auditing those systems that are "auditable";
     Defining the  status of those activities that are not yet in a position to be audited;
     Identifying important lessons learned and modifying systems and/or sharing information as
       appropriate;
     Encouraging formulation of more formal procedures and standards for measuring environ-
       mental performance; and
     Developing a data base of information on environmental performance which can be used in
       other management functions.

   Improvement of the environmental risk management system as a result of:
     Identifying conditions that may have an adverse impact on the company;
     Assessing the risks associated with the hazardous  conditions identified; and
     Determining  what actions are  necessary to control  those risks.

   Corporate protection  from potential liabilities as a result of:
     Being able  to demonstrate due  diligence/evidence of the corporate environmental
       commitment;
     Soliciting an independent (third-party) opinion;
     Documenting evidence demonstrating that the company is complying with regulations; and
     Developing improved relations with regulators.

   Development of a basis for optimizing resources as a  result of:
     Identifying current and anticipated costs and recommending ways to reduce those costs;
     Identifying potential longer-term savings which can  be accrued; and
     Identifying potential opportunities to reduce waste generation.
A Arthur D. Little, Inc.

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MEASURES FOR BENEFITS

     In converting the effects listed in Table 1 to benefits, it is useful to repeat the
statement made above that companies work toward achieving objectives so that they
can gain  the resulting value or benefit. Audit program effects become benefits by
applying some form of performance measure to the effect. Application of performance
measures implies that the effects have  to be measurable and worth measuring.

     A benefit  of auditing has been defined as an aspect or output of voluntary
private-sector auditing that contributes significantly and positively to the
achievement of corporate objectives. It is important to recognize that the principal
corporate objectives tend to be described in very broad terms such as competitive
position, market share, growth, stock price, etc. In most companies, these measures
are driven largely by non-environmental factors; thus, environmental auditing,  in
most instances, does not influence these measures significantly. Nevertheless, a
number of specific measures  some quantifiable and some non-quantifiable  can
be applied to the audit program  effects listed in Table 1.

     Thus, in order  to identify the potential benefits  to industry of environmental
auditing, we can look at various measures of corporate well-being. Table 2 provides
some examples of measures which might be used to evaluate audit program effects.
The table distinguishes between those measures commonly considered to be directly
influenced by  the audit program and  those  not directly influenced. In addition,
Table 2 categorizes each  measure as being either generally quantifiable or generally
non-quantifiable. As discussed above, Table 2  does not include some common quan-
tifiable measures of corporate performance (e.g., return on investment) or individual
performance (e.g., compensation) because these are not generally affected signifi-
cantly by environmental audit programs. That is, activities, actions, and programs
other than environmental auditing are  likely to significantly influence or drive the
performance measured. Table 3 shows how the effects listed in Table 1 correspond to
the different direct measures (both quantifiable and non-quantifiable) listed in Table
2.
/ti Arthur Di Little, Inc.

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                                  TABLE 2

                 EXAMPLE MEASURES WHICH MAY POSSIBLY BE USED
                     TO EVALUATE AUDIT PROGRAM EFFECTS
Directly Influenced by Audit Program
Improved compliance record
Reduced legal actions brought against
company and/or individuals
Reduced fines
Improved incident/accident statistics
Reduced volume of environmental
hazards
Improved worker health
Improved reputation
Favorable publicity
Improved regulatory relations
Indirectly Influenced by Audit Program
Decrease in business interruptions by identifying
problems that could affect production
Increased worker productivity from reduced
environmental risks
Reduced insurance rate
Increased involvement in day-to-day
environmental activities
Increased job satisfaction
Knowledge of job performance measures
Feeling supported by management
Generally
Quantifiable
V
V
V
V
V
V




V
V
V




Generally
Not Quantifiable






V
V
V




V
V
V
V
/t Arthur D. Little, Inc.

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                                           TABLE 3

                          APPLICATION OF PERFORMANCE MEASURES
                                 TO AUDIT PROGRAM EFFECTS
                    Measure
          Effect
 Generally
Quantifiable
                                                 8

                                                 I
                                                 8
                                                 o
                                                 I
                                                 E
  o
  tS
 1
 i
l
I
c  8
8*
IS
 v>
"5  +
ll
                       Generally
                   Non-Quantifiable
cc
"O >
ll
a 
   Identification and documentation of
   compliance status
   Improvement in overall environmental
   performance at the operating facilities
  Assistance to facility management
  An increase in the overall level of
  environmental awareness
  Acceleration of the overall development
  of environmental management and
  control systems
   Improvement of the environmental risk
   management system
  Corporate protection from potential
  liabilities
  Development of a basis for optimizing
  resources
  X    - Generally applicable
  S     = Situations!
  D    = Generally not applicable
/tv Arthur D. Little, Inc.
                                             10

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IDENTIFICATION OF PARTIES AFFECTED

     In order to evaluate the benefits to industry of environmental auditing, we need
to identify the key parties affected by the establishment of an auditing program. By
"industry," we essentially mean "a company," and we can think of a company both as
a corporate entity and as a collection of individuals. An example of a benefit to the
corporate entity might be improved company reputation. On the other hand, a. benefit
to a senior officer might be  a feeling of increased  comfort or security. The key
individuals potentially benefited by an environmental audit program are  listed
below.

        Stockholders
        Board members
        Corporate officers
        Corporate environmental  management
        Legal department
        Manufacturing manager
        Plant manager
        Plant environmental  staff
        Line supervisors
        Hourly workers

     Others who might be added to the list include customers, neighbors, and other
 members of the general public who may potentially benefit from an environmental
 auditing program.

     Ultimately, the benefits to a company of environmental auditing are defined by a
 combination of the corporate benefits and the net sum of the benefits to the various
 individuals. Again, however, each of the individuals listed above has  a different
 measure of value, so, for example, what is perceived as a benefit to a corporate officer
 is generally different  from what a plant  manager  would call a benefit.  Table 4
 outlines which of the measures commonly applied directly to environmental audit
 programs are most likely to be perceived by which individuals as potential benefits.
 Table 5 provides a similar analysis for a sample of measures which are, as a rule, not
 applied directly to audit programs.
                                      11

/^ Arthur DL Little, Inc.

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                                          TABLE 4


                 MEASURES DIRECTLY INFLUENCED BY THE AUDIT PROGRAM
              Parties Affected
         Measures
                                            *
s>
I
&
                                                          
                                                          Ui
                                                                &
                                                                     I
                                                                     e
i
                                   I
                                        i


  Quantifiable
  Improved compliance record
  Reduced number of legal actions
  Reduced fines
  Improved incident/accident statistics
  Reduced volume of environmental hazards
  Improved worker health
  Not Quantifiable
  Improved reputation
  Favorable publicity
  Improved regulatory relationships
  X    = Generally applicable

  S    = Situations!

  D    = Generally not applicable
/k. Arthur D. Little. Inc.
                                            12

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                                          TABLE 5

               MEASURES NOT DIRECTLY INFLUENCED BY THE AUDIT PROGRAM
              Parties Affected
       Measures
                                             E
                                             s
                                                          1
u
it
OS
                                                                      8.

                                                                               UJ
2
S
i

I
  Quantifiable
  Decrease in business interruptions
  Increased worker productivity resulting
  from reduced environmental risk
  Reduced insurance rate
  Not Quantifiable
  Increased involvement in day-to-day
  activities
  Increased job satisfaction
  Knowledge of job performance measures
  Feeling supported by management
  X    = Generally applicable
  S    = Situational
  D    = Generally not applicable
A Arthur DlUttle, Inc.
                                             13

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BENEFITS OF AUDITING

    Several patterns emerge from this analysis of audit program effects and the
performance measures which might be used to evaluate those effects. First, as Table 3
shows, the performance measures which most naturally apply to the various program
effects are generally quantifiable  (e.g., improved  compliance record, improved
incident/accident statistics, etc.). Second, as Table  4 shows, individuals who are
higher up in the organization (e.g.,  corporate officers and Board members) tend to
evaluate the audit program by measures which are generally non-quantifiable (e.g.,
improved reputation or favorable publicity). The quantifiable measures likely to be of
significant importance to top management (e.g., reduced number of legal actions) are
not commonly influenced directly by the audit program.  As a result of these two
patterns, we can conclude that operational managers such as the corporate environ-
mental manager or plant manager generally view the benefits  of auditing in ways
that may be quantifiable, while top management views the benefits in more sub-
jective ways. Thus,  the most significant benefits  to industry of environmental
auditing can be  classified into two broad categories:  increased environmental man-
agement effectiveness and a feeling of increased comfort or security. Table 6 shows
which audit program effects contribute to achieving these two categories of benefits.

Principal Categories of Benefits

1. Increased Environmental Management Effectiveness

    A significant number of the audit program effects listed in Table 1 contribute
toward increasing the overall environmental management effectiveness of the corpo-
ration. This  increased effectiveness results from identifying and reducing  "blind
spots" that may exist, clarifying issues that might otherwise be interpreted  differ-
ently at different facilities, and developing a more uniform approach to managing
environmental activities  through sharing information and learning from other
facilities.

    As shown in Table 3, increased environmental management effectiveness can, to
some  extent, be quantitatively measured over time. Some basic measures include an
improved compliance record, improved incident/accident statistics, and some index of
the volume and size of legal actions. However, there are likely to be significant
limitations to using such measures to evaluate management  effectiveness. Some
measures of improved environmental management effectiveness, such as an improved
reputation or favorable publicity, are generally not quantifiable.
                                     14

  Arthur D. Little, Inc.

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                                     TABLE 6




                    CLASSIFICATION OF AUDIT PROGRAM BENEFITS
^*****^^^ Principal Categories
^"""""--^of Benefits
Audit Program Effects ^"""*">>^^
Identification and documentation
of compliance status
Improvement in overall environmental
performance at the operating facilities
Assistance to facility management
An increase in the overall level of
environmental awareness
Acceleration of the overall
development of environmental
management and control systems
Improvement of the environmental
risk management system
Corporate protection from potential
liabilities
Development of a basis for optimizing
resources
Increased
Environmental
Management
Effectiveness








Feeling of
Increased
Comfort








             Primary



             Secondary
/ti Arthur D. Little, Inc.
                                       15

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2. Feeling of Increased Comfort or Security

     Many environmental auditing programs are established at the request of top
management for the purpose of identifying and documenting the compliance status of
individual facilities. The primary benefit of such programs is to provide top manage-
ment with a sense of increased comfort or  security that the company's potential
exposure to  regulatory compliance problems is being reduced. This benefit is com-
monly perceived more by those who feel liability (e.g., top management) than by those
who feel risk  (e.g., plant management). The feeling of comfort is generally non-
quantifiable and stems from the knowledge that operations are consistent with good
practice, that control systems are in place and operating, and that legal and ethical
responsibilities are being met.

Link to the  Overall Environmental Management System

     As mentioned at the beginning of this paper, the benefits analyzed are those for
which environmental auditing is the principal source or to which auditing signifi-
cantly contributes. Environmental auditing is universally recognized as one compo-
nent of the  overall corporate environmental management system, and there is an
inherent difficulty in trying to measure the  benefits of one component of a system.
Many of the objectives audit programs strive to meet  are also objectives of other
environmental management activities. As a result, the benefits of increased comfort
or security are driven by a variety of efforts, of which environmental auditing is a
very important one.
                                      16

A Arthur D. Little, Inc.

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CONCLUSIONS

    While the benefits of environmental management in general and environmental
auditing in particular are difficult to assess, this paper has focused on showing that
there are ways to begin to explicitly categorize what those benefits are and who they
are perceived by.

    The benefits to industry of environmental auditing are as wide and varied as the
underlying reasons for which companies develop environmental auditing programs.
While the perceived benefits of environmental auditing vary both among companies
and among different individuals within a corporation, it is nevertheless possible to
identify  and to  a  limited extent measure  the benefits of auditing.

    The benefits to industry of environmental auditing basically fall into two broad
categories: increased environmental  management effectiveness and a feeling of
increased comfort or  security. The role of environmental auditing in achieving these
benefits is extremely difficult to measure because many other factors typically con-
tribute to their achievement. Nevertheless, we have found that however difficult the
benefits are to quantify, those companies with established environmental audit pro-
grams feel strongly  that the benefits are substantial.  As  a result, the number of
companies with  environmental  audit programs continues to increase.
                                      17

   Arthur D. Little, Inc.

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