Sustainability Reporting out of a Prisoner's Dilemma

Abstract

Listed firms increasingly strive for a sustainable appearance, which has made sustainability reporting very popular in recent years. This would be completely rational if sustainability reporting could enhance shareholder value. This paper investigates from a theoretical perspective which conditions are sufficient for the individual and collective rationality of sustainability reporting. The analysis leads to the conclusion that, due to the competition between firms, sustainability reporting generates a separation equilibrium as long as the reporting costs are proportional to the reported level and the marginal costs of reporting differ with the true level of sustainability. Although it might be preferable, a pooling equilibrium with no sustainability reporting cannot be sustained, which is a result of the so-called prisoner's dilemma that firms find themselves caught within. The most important practical implication of the model is a call for external auditing with high assurance levels to ensure an efficient separation of highly and weakly sustainable firms.

Keywords: Sustainability Reporting, Game Theory, Signaling Theory, Prisoner’s Dilemma

JEL Classification: D52, D53, D82, M14, M49