The debate on whether environmental, social and governance (ESG) reporting should be mandatory is ongoing and of growing importance for regulators. Different institutions are working on new mandatory ESG disclosures. For example, the European Union passed the Corporate Sustainability Reporting Directive (CSRD) in 2014 and is now preparing to adopt the European Sustainability Reporting Standards (ESRS), which include sector- and SMEs-specific standards and are expected to affect over fifty thousand EU-based companies (EY [2022]). Similarly, the Securities and Exchange Commission (SEC) is working on a mandatory risk disclosure directed at listed firms in the U.S. However, whether these types of ESG disclosure mandates can address ESG issues without being detrimental to corporate performance is unclear.
Despite the abundant research on the effects of ESG disclosures (Christensen et al. [2021]), we lack a clear understanding of the consequences that mandatory ESG disclosure has on firms’ corporate performance and whether it is a cost-effective approach (Christensen [2022]). Prior research reports mixed results on the effect of ESG-related reporting on firm value or performance. Previous results differ from negative effects with respect to profitability (Chen et al. [2018]; Fiechter et al. [2022]), labor productivity (Christensen et al. [2017]) and market reaction (Grewal et al. [2018]) to positive associations with respect to firm value (Plumlee et al. [2015]) and Tobin’s Q (Ioannou and Serafeim [2019]) to no impact with respect to firm value (Cho et al. [2015]). In this paper, we examine the corporate performance effects of mandatory ESG reporting at the firm level using variation in ESG reporting resulting from the size criteria used in the Swedish setting.
To address the question, we focus on private Swedish firms, which were required to issue annual ESG reports from the financial year of 2017 onward. The Swedish setting is suitable to study this question because while the European Union Directive 2014/95 on non-financial reporting targeted a restricted group of large and listed firms, Sweden’s adoption of the Directive targeted a broader set of firms (Arsredovisningslag [1995:1554]). In Sweden, mandatory ESG reporting applies to firms that, for the last two financial years, have met two of the following three criteria:
- on average, they have more than 250 employees
- they report total assets exceeding SEK 175 million (≈ USD 21 million)
- they report net sales larger than SEK 350 million (≈ USD 42 million)
This standard is independent of the firm’s listing status. The annual ESG reports must include information on several dimensions: environmental, social and employee matters, respect for human rights, anti-corruption and diversity on the board of directors. Related to these ESG dimensions, firms must state their business model, policies and procedures in place to address the different ESG matters and the outcomes of such policies, risks associated with the different dimensions and the ways in which the firm is managing these risks, and the key performance indicators most relevant to the firm.
The effect of mandating firms to report ESG information on corporate performance ex ante is not clear. On the one hand, mandated firms can access larger supply chains by lowering the disclosure costs and ESG-related reputational risks of corporate customers and becoming a better supplier-customer match in terms of ESG (Dai et al. [2021]; Darendeli et al. [2022]). In addition, a mandate for ESG information creates demand for such information and increases its value. This fact, together with the increased comparability of information, reduces processing costs for capital providers such as banks and suppliers and incentivizes them to take ESG information into account when making decisions. In this case, mandated firms could benefit from improved financing conditions (Leuz and Schrand [2009]; Minnis and Shroff [2017]).
On the other hand, although the mandate would reduce the costs of producing the information by generating a larger market for such information, firms must still bear the direct costs of disclosing ESG information. Moreover, disclosing more information can create additional proprietary costs for firms (Dedman and Lennox [2009]; Bernard [2016]; Bernard et al. [2018]; Gassen and Muhn [2018]). This situation can be aggravated in the case of ESG information because it is more closely linked to the firm’s core operations and activities (Christensen et al. [2021]). In addition, firms can be subject to reputational costs from ESG disclosures. In the case of reporting ESG information, firms establish a reputational commitment that creates a risk through an ex post shaming effect (Christensen [2022]).
To examine whether mandatory ESG reporting has a negative or positive impact on the corporate performance of private Swedish firms, we obtain data on firms’ financial information from the Serrano database. To identify firms’ listing status, we use the Nordic Compass database and complement it with Bureau van Dijk’s Orbis. We exclude from our sample those firms that are owned by public administration, inactive, operating in the financial or insurance sector, publicly quoted, Swedish subsidiaries (which are not subject to the disclosure requirements) and micro-firms. The final sample consists of close to 150,000 firms that yield over 1.1 million firm-year observations for the period 1999-2020. Additionally, we perform a balancing process that requires all firms in our sample to appear in the sample at least 3 years before and after adoption.
Using a difference-in-differences approach, we observe that after the ESG mandate becomes effective, mandated firms experience an average increase of 1.2-1.6% in their return on assets (ROA) compared to firms not subject to the mandate. In other words, this increase translates into approximately 120 thousand SEK (≈ 14.4 thousand USD), on average, in terms of EBITDA and net income. These results are robust to an array of sensitivity tests regarding our research design choices. Additionally, we replicate our main findings using different matched samples, alternative measures of corporate performance and an alternative regression discontinuity design.
We explain this positive effect through two non-mutually exclusive channels: a supply chain channel and a financing channel. The rationale behind the supply chain channel is that large corporate customers are also required to disclose ESG information annually after 2017. This requirement creates a preference for corporate customers to contract with suppliers who have ESG information readily available (Dai et al. [2021]; Darendeli et al. [2022]). ESG transparent suppliers decrease the cost of producing ESG information for the corporate customer, and the latter is able to partially transfer reputational risks from the disclosures to the suppliers. In relation to the financing channel, we argue that the ESG reporting mandate reduces the costs of processing the information, and it creates demand for such information. This situation incentivizes stakeholders, such as capital providers, to incorporate ESG information into their decisions (e.g., debt pricing and lending decisions), ultimately allowing mandated firms to enjoy improved financing conditions.
We test the supply chain channel by comparing firms in business-to-business (B2B) industries to firms in business-to-consumer (B2C) industries, firms following a differentiation strategy to firms following cost leadership, and firms in a highly competitive environment to firms in a low competition environment. We find mixed evidence. The effect of mandatory ESG reporting on corporate performance seems not to be concentrated in B2B or B2C industries. On the other hand, we find that firms adopting a differentiation strategy and firms operating in a highly competitive environment report larger impacts of mandatory ESG reporting on corporate performance. However, we do find that when it comes to ESG reporting, firms in B2B industries (high competition environments) are more likely to report ESG information than firms in B2C industries (low competition environment). To test the financing channel, we analyze the effect of the ESG reporting mandate on the interest rate and the value of pledged collateral assets to firms’ total assets. We find that after the mandate becomes effective, treated firms exhibit a decrease in the interest rate and pledged assets.
Additionally, we extend our analyses by documenting the reporting behavior of firms around the ESG mandate for a random sample of 250 treated and control firms. Before ESG reporting was mandatory, only 4.91% (0.41%) of treated (control) firms disclosed ESG information. However, after the ESG mandate became effective, 45.34% (1.08%) of treated (control) firms disclosed ESG information. These values suggest that non-compliance costs in our setting are moderate, and that firms will reach a full compliance scenario in the medium to long run rather than in the short run.
In summary, our research documents that mandatory ESG reporting improves corporate performance for the subset of mandated private Swedish firms. This positive effect is consistent with a supply chain channel and a financing channel where disclosing ESG information enlarges the opportunity set of mandated firms to enter larger supply chains and capital providers incorporate ESG information in their debt pricing decisions. Combined with prior research, our paper also highlights the importance of considering institutional features when developing policies and regulations. Specific characteristics in the institutional setting (e.g., cultural reception, level of enforcement, type of firms subject to the regulation, etc.) can alter the cost-benefit scheme for firms, which in turn can result in disparate impacts on firms. This is especially relevant for settings such as the European Union, where regulations must be adopted by member states whose institutional features show considerable heterogeneity (e.g., Fiechter et al. [2022]).
Sofia Martinez is a Ph.D. student in Accounting at the Stockholm School of Economics.
Antonio B. Vazquez is an Assistant Professor of Accounting at the Stockholm School of Economics.
