The Financially Material Effects of Mandatory Non-Financial Disclosure

Abstract

Complaints from institutional investors suggest that principles-based disclosure regimes that rely on financial materiality standards produce insufficient non-financial environmental and social (E&S) information. Using the staggered introduction of 40 country-level regulations that mandate disclosure, I document that reporting E&S information alleviates capital rationing from institutional investors. This reduction in capital rationing has material effects on firms’ investment and financing decisions. Disclosing firms raise more external equity and shift their investment mix towards long-term innovative projects. Although these effects following improvements to non-financial disclosure are similar to those following improvements in financial disclosure, the mechanism behind these effects is unique. Evidence indicates these results are due to a clientele effect from institutions with E&S preferences rather than a reduction in overall information asymmetry. Taken together, these results suggest that jurisdictions that rely solely on financial materiality disclosure standards create non-financial information frictions with material effects on investors and firm decision-making.

Keywords: Innovation; R&D; CSR; ESG; Sustainability; Disclosure; Information asymmetry

JEL Classification: D82, G32, G38, O32, Q56