The Effects of Mandatory ESG Disclosure around the World

Zacharias Sautner is Professor of Finance at Frankfurt School of Finance & Management. This post is based on a recent paper by Prof. Sautner; Philipp Krueger, Associate Professor of Finance at the University of Geneva; Dragon Yongjun Tang, Professor of Finance at The University of Hong Kong Business School; and Rui Zhong, Senior Lecturer in Finance at the University of Western Australia Business School.

ESG considerations have become increasingly important for investment decisions by institutional investors. Yet, institutional investors frequently complain that the availability and quality of firm-level ESG disclosures are insufficient to make informed investment decisions. In response to the gap between the demand for ESG information by investors and the supply of information by firms, several countries have initiated mandatory ESG disclosure regulations to force firms to properly disclose information on ESG issues in traditional financial disclosures or in specialized standalone reports (e.g., in sustainability, citizenship, or CSR reports).

Though the primary purpose of mandatory ESG disclosure rules is to enhance the supply of ESG information, it is unclear whether such regulations actually improve the ESG information environment. Even more importantly, it remains largely unexplored whether any ESG-related mandatory disclosure requirements are associated with beneficial real outcomes.

In our paper, which is available here, we make significant progress in addressing these questions by constructing a novel international dataset of country-level mandatory ESG disclosure regulations between 2000 and 2017. Our dataset allows us to evaluate the informational and real effects of mandatory ESG disclosure around the world, as we identify 25 countries that introduced mandates for firms to disclose ESG information during the sample period, including Australia (2003), China (2008), South Africa (2010), or the United Kingdom (2013).

Before examining how firm-level outcomes are affected by mandatory ESG disclosure requirements, we demonstrate that the introduction of such disclosure rules is related to important country-level variables. Two findings stand out in light of the current ESG debate: the adoption of mandatory ESG regulation is more likely in countries with common law origins and in countries with higher per capita carbon emissions. The finding that common law countries have a stronger propensity to enact disclosure regulations relates prior evidence showing that firm-level ESG performance is generally higher in civil law countries. Consequently, the gap between the supply of and demand for ESG information is possibly larger in common law countries, which implies a greater need for mandating ESG disclosure in such countries. The finding that countries with higher per capita emissions are more likely to introduce mandatory ESG disclosures may reflect that such disclosures are in part a disciplinary tool through which countries hope to reduce their firms’ carbon footprints.

We then examine the impact of mandatory ESG disclosure on ESG reports filed in the databases of the Global Reporting Initiative (GRI) and of Asset4 ESG (now Refinitiv ESG). Across the full sample, the percentage of firms that file ESG reports in the GRI or Asset4 database increases by 2.9 percentage points (pp) after ESG disclosure is made mandatory, a large increase relative to the unconditional frequency of 8.6%. Somewhat surprisingly, mandatory disclosure on average does not increase the quality of the filed ESG reports, which we measure based on whether an ESG report’s content adheres with the GRI Sustainability Reporting Standards.

Importantly, these average treatment effects mask substantial heterogeneity across firms. Notably, firms with lower ESG qualities (measured using ESG ratings) are much more likely to file ESG reports after mandatory disclosure is introduced, and such firms also exhibit significant improvements in their ESG reporting quality. These effects are plausible as firms with better ESG qualities may have a higher propensity to voluntarily disclose ESG information—they are in turn less affected by mandatory disclosure requirements. Our findings suggests that mandatory ESG disclosure is most effective among firms where ESG-related concerns as well as information demands by investors are largest.

It remains unclear to what extent these effects of ESG disclosure regulation translate into a better overall information environment. Hence, we consider how mandatory ESG disclosure affects the information set that key market participants use when evaluating firms. It is difficult to directly observe this information set and/or the resulting investor beliefs. However, analysts’ earnings per share (EPS) forecasts have been shown to constitute a data source that allows us to capture such informational effects. We demonstrate that the accuracy of EPS forecasts significantly increases, and the dispersion of analysts’ EPS forecasts significantly declines, after mandatory ESG disclosure is introduced. These results indicate beneficial informational effects resulting from mandatory ESG disclosure.

A natural question that follows from these effects is whether and how real outcomes are affected. In a first step, we examine whether mandatory ESG disclosure reduces the probability of negative ESG events. Mandatory ESG regulation should make it less likely that firms can hide ESG incidents ex post, which in turn should have ex ante disciplinary effects on firm management and should reduce the likelihood of ESG incidents. We demonstrate that both the amount of ESG incidents and its significance decrease after mandatory ESG disclosure is introduced. This suggests that mandatory ESG disclosure exerts positive real effects by reducing ESG incidents.

In a second step, we study the effect of ESG disclosure regulation on stock price crash risk. We consider crash risk for two non-mutually exclusive reasons. First, negative ESG incidents likely represent crash risk type of events, and the decline in ESG incidents after mandatory ESG disclosure regulation may in turn also decrease crash risk. Second, crash risk has been shown to be related to the accumulation of bad news. Specifically, when accumulated bad ESG news reaches a tipping point and are released to the market all at once, such batch-releases can result in sharp stock price declines. Since mandatory disclosure regulations accelerates ESG information disclosure through ESG reports, crash risk may decline after the enactment of mandatory disclosure. Consistent with these mechanisms being at play, the likelihood of stock price crash risk decreases after mandatory ESG disclosure is introduced.

The complete paper is available for download here.

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