Highlights
- Mandatory ESG disclosure regulations significantly improved stock liquidity across 65 countries, with stronger effects when enforced by governments.
- The liquidity benefits were more pronounced in firms with weaker pre-existing information environments and when full compliance was mandated without voluntary explanatory options.
- The findings support adopting comprehensive, well-enforced ESG disclosure standards globally to enhance transparency, market efficiency, and informed investment decisions.
Environmental, social, and governance (ESG) considerations have gained increasing significance in investment decision-making processes. Despite this heightened importance, investors often express concerns regarding the sufficiency and quality of firm-level ESG disclosures, which are crucial for making informed investment decisions.
In response, several countries have implemented mandatory ESG disclosure regulations aimed at compelling firms to provide high-quality information on ESG-related issues. These regulations may require disclosures either alongside traditional financial reporting or through specialised standalone reports. Beyond national initiatives, there are ongoing global efforts to develop, harmonise, and eventually establish international ESG disclosure standards.
The research compiled a novel dataset on mandatory ESG disclosure regulations across different countries and examined their impact on firm-level stock liquidity. The focus on stock liquidity stems from two primary considerations. First, liquidity is a first-order stock characteristic that is important for investors, firms, and regulators because it affects real and financial outcomes. Second, market liquidity has been shown to be very responsive to corporate disclosures, and it may be one of the capital-market outcomes that is best understood. Additionally, the lack of standardised reporting structures and guidance on ESG disclosures complicates their effectiveness.
The empirical analysis utilised a panel dataset comprising 136,269 firm-year observations covering 17,680 firms across 65 countries from 2002 to 2020.
The empirical analysis utilised a panel dataset comprising 136,269 firm-year observations covering 17,680 firms across 65 countries from 2002 to 2020. The researchers identified 38 countries that introduced ESG disclosure mandates during the sample period. Twenty-five countries implemented comprehensive mandatory ESG disclosure all at once, while the remaining 13 countries introduced E, S, and G disclosure one by one.
The findings demonstrated consistent evidence that the introduction of ESG disclosure mandates positively affected stock liquidity, with effects that were both statistically and economically significant.
These liquidity improvements persisted even when excluding countries that never adopted ESG disclosure rules, or those that implemented environmental, social, or governance regulations at different times. The analysis also accounted for heterogeneity in treatment effects and timing, reinforcing the robustness of the results.
To differentiate the effects of mandatory disclosures from voluntary initiatives, the study excluded countries that introduced voluntary ESG disclosures before formal mandates and examined whether firms from countries with voluntary disclosure practices experienced different liquidity effects. The results indicated that the liquidity benefits were more pronounced in countries where ESG disclosure mandates were enforced by governments rather than stock exchanges. Furthermore, the improvements in liquidity were approximately 50% stronger in countries where firms could not evade full compliance through a “comply-or-explain” approach.
The study also acknowledged potential confounding factors, such as the timing of ESG mandates coinciding with broader societal debates or ESG incidents. These external developments could influence liquidity independently of the regulations themselves, suggesting that the observed improvements might partly reflect underlying societal shifts rather than the mandates alone.
An important dimension of the analysis involved examining how variation in voluntary disclosure behaviours affected the impact of mandates. Firms which already issued sustainability reports before mandates or provided earnings guidance experienced less significant increases in liquidity. This suggests that firms with more active voluntary disclosure practices or better information environments might derive smaller incremental benefits from new regulations, possibly due to their existing transparency levels.
Overall, the research concluded that mandatory ESG disclosure regulations exert a positive influence on stock liquidity, almost three times more strongly when these regulations are implemented by government authorities rather than stock exchanges, and when compliance is enforced without reliance on voluntary explanatory mechanisms. Firms operating within weaker information environments benefited more from the mandates, indicating that such regulations help improve the corporate information environment more broadly.
The results provide a compelling argument for regulatory bodies in countries that have yet to adopt mandatory ESG disclosure standards to consider implementing such regulations.
The results provide a compelling argument for regulatory bodies in countries that have yet to adopt mandatory ESG disclosure standards to consider implementing such regulations. The study demonstrates a significant, positive association between mandatory ESG disclosures and stock liquidity, emphasising that well-designed, enforced, and comprehensive regulations can foster a more transparent and efficient market environment.
These insights reinforce the rationale for adopting mandatory ESG disclosure standards worldwide, aiming to enhance corporate transparency and facilitate better-informed investment decisions.
Keywords: Sustainability reporting, ESG reporting, nonfinancial information, stock liquidity
* Learn more from the full research article here: https://doi.org/10.1111/1475-679X.12548
