A Theoretical Framework for ESG Reporting to Investors

46 Pages Posted: 11 Oct 2021 Last revised: 2 Dec 2021

See all articles by Henry L. Friedman

Henry L. Friedman

University of California, Los Angeles (UCLA) - Anderson School of Management

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department

Irina Luneva

New York University (NYU) - Leonard N. Stern School of Business

Date Written: September 28, 2021

Abstract

We provide a theoretical framework for reporting of firms' environmental, social, and governance (ESG) activities to investors. In our model, investors receive an ESG report and use it to price the firm. Because the manager is interested in the firm's price, disclosing an ESG report provides effort and greenwashing incentives. We analyze the impact of different reporting characteristics on the firm's price, cash flows, and ESG performance. In particular, we investigate the consequences of whether the report captures ESG inputs or outcomes, how the report aggregates different ESG dimensions, and the manager's tradeoffs regarding ESG efforts and reporting bias. We find that, for example, an ESG report that weights efforts by their impact on the firm's cash flows tends to have a stronger price reaction than an ESG report that focuses on the ESG impact per se. ESG reports aligned with investors' aggregate preferences provide stronger incentives and lead to higher cash flows and ESG than reports that focus on either ESG or cash flow effects individually. Additionally, in the presence of informative financial reporting, ESG reports that focus on ESG impacts lead to the same cash flow and better ESG results than reports focusing on cash flow impacts alone.

Keywords: ESG reporting, ESG valuation, real effects

JEL Classification: G11, G23, G34, M14, M40

Suggested Citation

Friedman, Henry L. and Heinle, Mirko Stanislav and Luneva, Irina, A Theoretical Framework for ESG Reporting to Investors (September 28, 2021). Available at SSRN: https://ssrn.com/abstract=3932689 or http://dx.doi.org/10.2139/ssrn.3932689

Henry L. Friedman (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Irina Luneva

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Office 10-88
New York, NY 10012-1106
United States

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