Strict ESG reporting requirements reduce the risk of negative ESG incidents and decrease the probability of stock price crashes by 18%, researchers have concluded.
The findings were presented in a study on whether mandatory disclosure rules are associated with beneficial real outcomes for companies, and improvements in the quality and availability of ESG data.
The study found that ESG controversies declined both in magnitude and severity after mandatory ESG disclosure regulations were introduced. Researchers suggested that this could be due to regulations making it “less likely that firms can hide ESG incidents”, which in turn reduced managerial misconduct on ESG issues.
As a result of this dynamic, the probability of stock price crashes – which can occur as a result of major ESG controversies or through the accumulation of bad ESG news – declined by 18% with the enactment of mandatory disclosure, said the researchers. Reporting firms may also “face less litigation, lower fines or fewer sanctions – all of which can reduce the risk of stock price crashes,” they added.
Mandatory disclosure was found to be linked with “better overall information environment” for market participants. According to an analysis of earnings per share (EPS) forecasts from financial analysts, the introduction of mandatory disclosures not only improved the accuracy of EPS forecasts, but also resulted in higher convergence among forecasts.
The study, authored by academics in Europe, Hong Kong and Australia, was based on a global dataset of country-level mandatory ESG disclosure regulations between 2000 and 2017. Researchers identified a total of 25 countries with ESG reporting mandates during the sample period, including Australia, China, South Africa and the UK.
The study was published as part of the Finance Working Paper Series from the European Corporate Governance Institute, a non-profit research association for academics, legislators and practitioners.
It comes as leading regulators appear poised to back more progressive ESG disclosure policies. In the US, the SEC and the Federal Reserve has announced a number of regulatory initiatives focusing on climate risks, sustainability disclosures and “ESG-related misconduct”, while global regulatory body IOSCO has established an expert group to oversee prospective new international standards on sustainability reporting.