Market Reaction to Mandatory Nonfinancial Disclosure

Abstract

We examine the equity market reaction to events associated with the passage of a directive in the European Union (EU) mandating increased nonfinancial disclosure. These disclosures relate to firms’ environmental, social, and governance (ESG) performance, and would be applicable to firms listed on EU exchanges or with significant operations in the EU. We predict and find (i) an on average negative market reaction; (ii) a less negative market reaction for firms having higher pre-directive nonfinancial performance; and (iii) a less negative reaction for firms having higher pre-directive nonfinancial disclosure levels. Results are accentuated for firms having the most material ESG issues, as well as investors anticipating proprietary and political costs as a result of the mandated disclosures. Overall, the results are consistent with the equity market perceiving that this disclosure regulation of nonfinancial information would lead to net costs (benefits) for firms with weak (strong) nonfinancial performance and disclosure.

Keywords: event study; ESG reporting; international; nonfinancial disclosure; sustainability; environmental; social responsibility; governance

JEL Classification: M4, G14, G15, G18