The global impact of mandatory ESG disclosure on the cost of capital: a comparative analysis across legal regimes

Abstract

ESG reporting has become increasingly important for firms, investors, governments, and stakeholders due to heightened awareness of environmental and social issues, and investor demand for sustainable investments. While producing beneficial effects, ESG reporting has also presented challenges, primarily due to the lack of harmony in voluntary ESG disclosures, making it difficult for stakeholders to compare and assess corporate sustainability efforts effectively. Therefore, efforts around the world have been made by governments and other relevant organizations to regulate reporting, creating mandatory ESG reporting regulations.

Scholars have investigated whether mandatory ESG reporting regulations are beneficial or detrimental to firms. Benefits include reductions in greenwashing, improved risk management, and better stock liquidity. However, some studies have found adverse market reactions, making the impact of mandatory ESG reporting unclear. Firms may benefit from reduced information asymmetry, reputation effects, and a decrease in the risk of shareholder expropriation. On the other hand, mandatory ESG disclosure involves compliance costs that might impact profitability. Additionally, proprietary and political costs pose significant challenges to its effectiveness.

Attention in the literature has also been given to country and market-specific factors when examining the impact of mandatory ESG reporting. Differences are expected across legal regimes, namely common law and civil law. In common law countries, mandatory ESG reporting is expected to decrease the cost of equity due to prior lower levels of stakeholder protection and weaker information environments. Conversely, in civil law countries, it is anticipated to increase the cost of equity due to higher existing ESG performance levels, which may result in exposing "bad players" and greater compliance costs, thereby leading to negative market reactions.

This thesis tests the impact of mandatory ESG reporting on the cost of equity capital for firms, using a staggered difference-in-difference methodology to analyse data from 10 countries from 1998 to 2018. The main results indicate an average increase in the cost of equity following the introduction of mandatory ESG reporting, with comparative analysis revealing a decrease in common law countries and an increase in civil law countries. The conclusions emphasize the importance of considering legal and country-specific contexts when assessing the effects of ESG reporting on financial performance.