Does Environmental and Social Disclosure Affect Firm-Level Innovation? Evidence from Around the World

Abstract

Complaints from institutional investors suggest that insufficient disclosure of non-financial environmental and social (E&S) policies leads to information frictions. Using the staggered introduction of 79 country-level regulations that mandate disclosure, I document that disclosing financially immaterial E&S information has material effects on firms’ investment and financing decisions. Firms domiciled in countries that mandate E&S transparency increase R&D expenditures and patenting activity after changes to disclosure. However, fixed capital investment, which is less sensitive to information frictions, does not change. This reduction in information frictions alleviates capital rationing, especially from institutional investors, resulting in increased reliance on external equity and more innovation for equity-dependent firms. It also improves shareholders’ monitoring abilities, incentivizing managers to invest in innovation. These findings coincide with investors’ complaints and suggest that the sole reliance on financial materiality disclosure standards leads to E&S-related information frictions in capital markets.