Nonfinancial Risk Disclosure & The Costs of Private Ordering

Abstract

In 2016, the Securities and Exchange Commission (SEC) considered for the first time whether financial disclosure reform should address sustainability matters and other sources of nonfinancial risk. The resulting debate over these issues raises fundamental questions about how well the federal disclosure regime addresses emerging risks and about how well private ordering, through shareholder engagement, the work of private standard-setters, and corporate voluntary disclosure, can fill the gaps. This Article argues that the current model of nonfinancial risk disclosure, based largely on private ordering, is ineffective and undermines the SEC’s mission to protect investors, facilitate capital formation, and promote fair, orderly, and efficient markets. This conclusion rests on evidence that the current state of sustainability disclosure is inadequate for investment analysis and that these deficiencies are largely problems of comparability and quality that cannot readily be addressed by private ordering. This Article also highlights the costs of agency inaction to investors and to public companies, which have been largely ignored in the debate over the future of financial reporting. It concludes by proposing avenues for disclosure reform.

Keywords: securities, disclosure, private ordering, risk, sustainability, ESG, nonfinancial, market efficiency

JEL Classification: K22