Readable, Short and Focused: How ESG Disclosures Should Be

ESG DISCLOSURES CAN BE VALUEENHANCING, BUT IT IS IMPORTANT TO UNDERSTAND THAT NOT ONLY WHAT YOU DISCLOSE, BUT ALSO HOW YOU DO THAT WILL HAVE AN IMPACT ON INVESTORS

The number of firms that release non-financial information is growing, and so is the debate about the effectiveness of these reports. Some critics argue that these Environmental, Social and Governance (ESG) reports are often simply boilerplate and are not useful for making investment decisions.
 
On the contrary, ESG disclosure is informative, and it is definitely value-enhancing because it does correlate to value, according to a study by two Bocconi professors. “Do Firms Speak ESG and Do Investors Listen? Information content and market effects of mandatory non-financial disclosures” uses machine learning technique to identify the thematic contents of ESG disclosures and evaluate their market effects.
 
Ariela Caglio (Associate Professor at Bocconi’s Department of Accounting), Francesco Grossetti (Assistant Professor, Department of Accounting) and Gaia Melloni (Department of Accounting and Control, University of Lausanne) focused on the materiality of ESG information of integrated reports issued in South Africa, where they have been mandatory since 2010.
 
“Regulators are often criticized for failing to mandate sufficient disclosure regarding firms' non-financial dimensions. Therefore, it is important to document whether non-financial disclosures convey information that is useful to investors,” said Caglio. “We found that investors incorporate some specific ESG topics, mainly linked to the Governance dimension, in their decisions, as shown by the related incremental market effects in terms of firm value as well as stock liquidity.”
 
A second study found called “Informational Content and Assurance of Textual Disclosures: Evidence on Integrated Reporting” by Caglio, Melloni and Paolo Perego found that both the textual attributes and the external assurance of integrated reports matter.  “You can see more pronounced market effects and higher economic benefits when companies issue reports that are readable, short, and focused,” said Caglio.
 
At the same time, investors attach value to assurance, a document provided by a competent third-party that draws an independent conclusion on the accuracy of an ESG report’s information. “Assurance acts as a credibility-enhancing mechanism and can moderate or in some cases offset a market impact from low-quality textual attributes,” said Caglio. “Assurance acts as a credibility enhancing mechanism for financial analysts.”
 
The takeaway for companies is that their ESG disclosures can be value-enhancing, but it is important to understand that not only what you disclose, but also how you do that will have an impact on investors.

by Jennifer Clark