The effects of voluntary corporate ESG disclosures on market financial performance and regulatory policy

Overview and Background: In the United States, Europe and elsewhere in the world to a varying degree, environmental and societal consciousness, as applied to industry and business has been steadily increasing.  There are multiple reasons for this development, regulatory, legal penalties, and in general, greater consciousness about these matters in the society itself. Our research focuses on the voluntary participation of the corporate community in bringing this consciousness into corporate operating and financial practices in a pro-active manner.

Against this societal and corporate landscape, we posit the following issues.

1.  Environmental (E),Social(S),Governance(G) performance can help reduce stock portfolio risk by drawing attention to material but often overlooked investment issues related to corporate ESG activities.

2. Regulatory costs in these matters are very high and, uncontrolled, resulting in market inefficiencies.

3. The voluntary ESG activities of firms and their market reactions shed  light into whether the investment community is indeed actively supporting  “sustainability”

Data/Methods:

The research problem, involves the corporate ESG activities as measured by innovation as well as compliance in each ESG dimension, and how these, working through the vectors of corporate communication and social reputation against the backdrop of industry/firm characteristics impact financial measures commonly used in the market.  We look at beta, cost of capital, return on assets (ROA), cash flow characteristics and Tobin’s q and others.  The methodology involves applying various econometric models on a database of 2652 firms Kinder, Lydenberg and Domini (KLD) and Bloomberg professional databases, 2007-2013). We also test standard theories of risk vs. return and applied economic performativity theory, media agency theory and organization information theory.

Results/Expected Results

So far, we have found that 1. Firms with higher (better) ESG disclosures exhibit lower capital market risk, 2. Markets amplify the effects of positive disclosures and 3. But negative disclosure effects are neither amplified nor dampened.

Policy Implications:

1. Voluntary disclosures mange risks and lower regulatory costs, suggesting a balance between mandated and voluntary disclosures. 2 and 3 suggest that a more nuanced, optimal approach is better for both regulators and corporate communicators.