Center for Advancing Accounting

Implications of Investor-Focused ESG Reporting...and Misreporting

• In Event: Impact of CSR and ESG on Valuation

Abstract

Firms and jurisdictions worldwide are adopting ESG reporting in various forms. To facilitate a better understanding of potential implications of ESG reporting, we develop a model in which a firm provides ESG and financial reports to investors. Investors price the firm's stock, and stock prices provide both real and reporting incentives to corporate management. We characterize how the introduction of ESG reporting affects corporate ESG efforts, expected cash flows, and misreporting. ESG reporting tends to encourage corporate ESG efforts, but can discourage such efforts when they have significantly negative cash flow implications. We show that for moderately negative cash flow implications, the firm's price can suffer from ESG reporting. Furthermore, we show that greenwashing and expected ESG performance can be substitutes or complements. Finally, we use comparative statics to show how changes in investor preferences (e.g., more investors caring about ESG) and ESG efforts' cash flow implications (e.g., related to penalties, subsidies, or physical and transition risk) affect market responses to financial and ESG reports, corporate misreporting, and ESG and cash flow outcomes.

Authors

• Henry L. Friedman, University of California, Los Angeles

• Mirko Stanislav Heinle, University of Pennsylvania

• Irina Luneva, University of Pennsylvania