Abstract
We examine the equity market reaction to events associated with the passage of a directive in the European Union (EU) mandating increased nonfinancial disclosure. These disclosures relate to firms’ environmental, social, and governance (ESG) performance, and would be applicable to firms listed on EU exchanges or with significant operations in the EU. We predict and find (i) an average negative market reaction of –0.79% across all firms, (ii) a less negative market reaction for firms having higher predirective nonfinancial performance, and (iii) a less negative reaction for firms having higher predirective nonfinancial disclosure levels. In addition, results are accentuated for firms having the most material ESG issues, as well as investors anticipating proprietary and political costs as a result of the mandated disclosures. Finally, we find that the negative market reaction is concentrated in firms with weak preregulation ESG performance and disclosure, which exhibit an average return of –1.54%; in contrast, firms with strong preregulation disclosure and performance exhibit an average positive return of 0.52%. Overall, the results are consistent with the equity market perceiving net costs (benefits) for firms with weak (strong) nonfinancial performance and disclosure around key events surrounding the mandatory disclosure regulation of nonfinancial information. This paper was accepted by Shiva Rajgopal, accounting.
Highlights
This study investigates the equity market reaction to events associated with the adoption of mandatory nonfinancial disclosure
This paper examines the equity market reaction to events associated with the passage of a directive in the European Union (EU) mandating increased nonfinancial disclosure, which affected firms listed on EU exchanges or having significant operations in the EU
We document on overall positive market reaction for those firms exhibiting strong nonfinancial performance and disclosure before the regulation, suggesting considerable heterogeneity in the market response to these events. These cross-sectional findings are robust to a variety of analyses, including: (i) alternative matching algorithms, such as replacing the country-sector matching with a more restrictive country-industry matching; (ii) excluding firms domiciled in the US, the country having the largest percentage of our sample observations; (iii) including only EU firms; and (iv) including the percentage of shares held by socially responsible investment (SRI) funds
Summary
This study investigates the equity market reaction to events associated with the adoption of mandatory nonfinancial disclosure. We find a more positive stock price reaction for firms having high levels of shareholder ownership from institutional asset owners such as pension funds and insurance companies We interpret this result as consistent with greater demand for this nonfinancial information by this type of investor, as prior research documents such asset owners among the strongest proponents of mandatory nonfinancial disclosure (Serafeim 2015). We document on overall positive market reaction for those firms exhibiting strong nonfinancial performance and disclosure before the regulation, suggesting considerable heterogeneity in the market response to these events These cross-sectional findings are robust to a variety of analyses, including: (i) alternative matching algorithms, such as replacing the country-sector matching with a more restrictive country-industry matching; (ii) excluding firms domiciled in the US, the country having the largest percentage of our sample observations; (iii) including only EU firms; and (iv) including the percentage of shares held by socially responsible investment (SRI) funds.
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