By Jody Grewal, University of Toronto, Edward J. Riedl, Boston University and George Serafeim, Harvard Business School


Over the past decade, many jurisdictions around the world have enacted regulation requiring companies to disclose information about their performance, policies and risks, relating to environmental, social, and governance matters, or non-financial information.

The goal is to provide investors and other stakeholders with a more comprehensive picture of firm performance than financial information alone can provide.

Despite this growing regulatory trend, little is known about how equity investors, which represent an important audience for these disclosures, perceive the associated costs and benefits.

We study the largest mandatory non-financial disclosure regulation to date – Directive 2014/95/EU, which passed in 2014 and affected some 6,000 companies in the European Union – to examine equity investor expectations about the costs and benefits of future disclosures, deriving three primary insights relevant to policy makers and practitioners.

Economic significance

We find that the announcement of mandated non-financial disclosures was economically significant, generating a reaction from investors – as measured by abnormal trading-day returns.

This suggests that equity investors expect non-financial disclosure regulations to have real cash flow and/or cost-of-capital implications for affected companies and that they don’t view the regulation as simply a compliance exercise with little material effect on business.

To isolate the market reaction attributable to the regulation and remove equity-market changes attributable to non-regulation factors, we define the abnormal return as the difference between the observed stock returns for firms affected by the regulation with that of similar but unaffected firms matched by country, sector, market capitalisation, and price-to-book ratio.

The average negative market reaction is 0.79% of market value (or US$79m on average) across our sample events, matching our prediction based on the expectation that equilibrium conditions will constrain firm choices, resulting in costs exceeding benefits for firms affected by the disclosure mandate.

Impact on weaker firms

While investors generally expect the directive’s costs to outweigh its benefits, we find that the costs are concentrated in firms having weaker pre-directive ESG performance and disclosure.

Investors expect market and non-market participants to rely more on ESG information following mandated disclosure, increasing the impact of ESG issues on firm values when the regulation comes into effect. Investors also anticipate higher expected costs for weak firms to maintain poor ESG performance or to shift to improved performance.

These revised expectations will cause investors to further price ESG differences across firms with strong versus poor ratings of ESG performance. Similarly, anticipating increased ESG disclosures, investors will price expected proprietary and/or political costs of disclosure, beyond the expected informational and monitoring benefits of disclosure.

Our findings are consistent with these predictions. Specifically, we document that the market reaction is less negative for firms with higher pre-directive ESG performance and disclosure. This suggests that investors use pre-existing signals of non-financial disclosure and performance to assess the costs and benefits of future actions that companies take in relation to their non-financial performance and mandated nonfinancial disclosure. To put it another way: investors perceive net costs for firms with weak pre-regulation ESG performance and disclosure versus net benefits for firms with strong pre-regulation disclosure and performance.

This indicates that the announcement of mandatory non-financial disclosure regulations forces firms with poor ESG performance to internalise negative effects imposed on society, such as pollution, adverse impacts on health or poor workplace practices.

Competitive dynamics

We find that the regulation affects expectations of competitive dynamics – investors expect firms with strong pre-regulation ESG performance to have a competitive advantage, because weak ESG firms will either incur higher costs to practice business as usual (for example, through penalties) or to improve their ESG performance.

Furthermore, investors expect mandated non-financial disclosure to be costly for firms forced to reveal information that will harm their competitiveness or those expected to be targets for political action.


Overall, we conclude that the equity market perceives that this regulation mandating the provision of non-financial information leads to net costs (benefits) for firms with weak (strong) non-financial performance and disclosure. Our findings have policy implications, as they suggest that non-financial disclosure regulation affects investor perceptions of the competitive landscape of affected firms, and generates concerns around the proprietary and political costs of disclosure.

Our results also provide managerial insights by documenting that investor responses to mandated non-financial reporting are more pronounced for firms with the most financially material ESG issues (defined as above-average risk exposure to ESG issues relative to peer firms). In other words, as ESG issues become more relevant for a firm’s valuation, the contribution of ESG performance to the observed market reaction increases. This suggests that managers should identify the most material ESG issues and focus their efforts on transparency and performance relating to them.

The full paper can be found here.



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