Week 3 - Regulation & standardisation of ESG disclosures Flashcards
3 benefits of standardisation of ESG disclosures + 3 reasons why potential benefits are hard to assess(Leuz and Wysocki, 2016)
- COMPARABILITY (over time and between similar organisations)
- COMPLETENESS (limited or no choice about what to report)
» companies not just reporting good news - UNDERSTANDABILITY
But potential benefits are hard to assess…
1. LIMITED EVIDENCE of causal effects of standardisation
» ie. don’t know if standardising ESG disclosures is actually useful
2. Scarce metrics for assessing the benefit
3. Hard to GENERALISE
- standardisation is diff. for each industry
When standards might fail to improve the usefulness of disclosures - 3 cons
- Co.s forced to report info that might not be very informative/relevant to their investors but is costly to the co.
- SASB tries to solve this by identifying the most salient (important) issues to the investors in each industry - Industry-specific standards like SASB are difficult to compare with other org.s in diff. industries
-
Standardised doesn’t necessarily mean they are correct
- could simply be wrong like Wirecard
- earnings management, manipulate within acct. rules
Also, ESG doesn’t have auditing unlike corporate financial reporting
Does mandating ESG disclosures have real ESG effects?
Mixed results
- much disclosure relates to POLICIES rather than outcomes (Serafeim, 2021)
- reporting alone is unlike to change the ESG activities
> > although TRANSPARENCY will hopefully cause companies to change to adopt good practices
mandating also forces companies to disclose info whether GOOD OR BAD
4 measurement issues with ESG disclosures (Unerman et al., 2018)
How might this affect sustainability decisions?
- MONETISATION is difficult where NO MARKET exists
- difficult to value externalities - difficult to estimate a ‘CONTROVERSIAL’ measure, that everyone agrees upon
- NUMERICAL VALUES may be viewed as more OBJECTIVE, even if they are based on questionable assumptions
- no range, a single point estimate may be more misleading (in actuality could be at the tail of distribution) - values of externalities determined by inter-subjective consensus-building
- not necessarily free from political bias
- measures may also change quickly, eg. gender pay, cultural differences, diff. definitions of man/woman
This may affect sustainability decisions…
1. we may RELY too much on disclosures as if they are objective and neutral
2. we may ASSUME there are GOOD ASSUMPTIONS underlying the numerical values, when there might not be
What 3 principles in financial reporting would benefit ESG accounting?
(Karthik Ramanna’s plea/FT article)
- prudence (& conditional conservatism)
- dual reporting
- matching (accrual acct. would better match ESG impact with expenses)
Arguments against standardisation of sustainability reporting (by the US commissioner)
- improperly equate sustainability standards with financial reporting standards…
- …b/c sust. standards are relatively new and can still be seen as controversial vs financial reporting standards which are universally agreed upon
4 examples of mandated disclosures
eg. of scope 3 emissions
- food retail: food wrappers after customers throw away
- entertainment and film production: transport of actors and extras at film set
- banking: financed emissions, employees’ travel, lunches
- GHG emissions
Gender and diversity
2. Gender pay gap (legal requirement in UK)
3. Pay ratio (UK and US requirements)
- investors care about this b/c of whether the biz model is sustainable
- pay might affect employee retention & hiring right talent -> subsequently affect firm value
4. Board diversity (UK and US listing requirements - FCA and NASDAQ respectively)
eg. state-based board gender diversity disclosure in California
Information asymmetry: Akerlof’s market for lemons (peaches are good)
1. How does this relate to ESG disclosures? What are the risks of poor quality reporting?
Basics:
- due to information asymmetry, buyers cannot distinguish between peaches & lemons (good car worth $1000 vs bad car worth $500), so will pay up to the expected value $750
- no one will sell a peach at $750
- everyone wants to sell a lemon for $750
- market collapses as lemons drive out peaches -> bad for consumers, cannot access peaches
If not mandated,
- companies only disclose voluntarily if benefits outweigh costs
-> not high quality, not credible, ie. the Akerlof situation
If mandated + STANDARDISATION,
- might engage in MISREPRESENTATION (earnings management equivalent for ESG)
- we expect this to be better than Not mandated but still…
1. possible inaccuracies - mistakes or trying to mislead
2. complicated
- COMPARABILITY ISSUES across diff. industries & standards b/c have to compare various issues like diversity, human rights, supply chain to determine if peach or lemon &…
- …all these might be CONTROVERSIAL measures (except GHG) &…
- …these elements/regulations can change over time during analysis
Through either voluntary or mandated disclosures, BAD FIRMS may send a signal that they are good
- would create value by satisfying stakeholders, higher liquidity, lower cost of capital
Information asymmetry: Akerlof’s market for lemons
2. What are the possible solutions?
Assurance/auditing for external OBJECTIVE VERIFICATION of the disclosures made
- What is Greenwashing?
- Potential consequence of greenwashing
- Greenwashing = misrepresentation through disclosures that a company’s actions are environmentally friendly
- in other words, lying - Cost to society of greenwashing is ALLOCATIVE INEFFICIENCIES
- investors cannot allocate their resources efficiently
2 reasons for not engaging in greenwashing
- Assurance (constraint) - still at early stage
- Reputation damage (cost)
2 types of Assurance for ESG disclosures + What is the difference from Financial audit?
*consulting/engineering firms offer assurance, eg. using various standards
- LIMITED ASSURANCE (currently this is mostly done; still better than nothing)
- uses Negative framing of opinion, ie. reporting that NO EVIDENCE has come to light to indicate that a disclosure is incorrect - REASONABLE ASSURANCE
- similar to a Financial audit, ensuring a true and fair view that disclosures are CORRECT
- uses Positive framing of opinion, LOOKING FOR something wrong
ESG assurance is mostly Limited assurance. Only 18% of S&P 500 companies are receiving independent auditor assurance over their ESG reports
eg. Alphabet, Nike, Coca-Cola
