A recent policy innovation is the use of securities regulations to solve social challenges. It started with mine-labor-safety and conflict-minerals disclosures in the 2010 Dodd-Frank Act and continues today with the Securities and Exchange Commission (SEC) proposal to mandate climate change disclosures. The ostensive goal is to protect investors but, most likely, the real objective is to affect social change on issues where more traditional policy instruments lack sufficient political support in Congress.
No doubt, the safety of miners, the financing of wars through international mineral trade, and global warming are important issues worthy of the government’s attention. The question, though, is whether disclosure mandated through securities regulation and enforced by the SEC is the best policy instrument. In a recent piece, I argue that it is not and that expanding its use, as the SEC is currently considering, could have unintended consequences that are hard to reverse once problems become apparent. Perhaps it is time to apply the principle of “first, do no harm” that is taught to all healthcare professionals and broadly translates into the idea that, given an existing problem, it may be better to do nothing than to risk causing more harm than good.
In the spirit of this principle, before we mandate more ESG disclosures through securities regulation, I maintain that proponents of mandatory ESG disclosure must provide evidence (or at least arguments) in support of three propositions. First, the changes in corporate behavior that a disclosure mandate will cause are beneficial to society. Second, the SEC is a suitable agency to oversee the enforcement of ESG disclosure rules. Third, even if the effects are desirable and the SEC is the agency best suited to oversee a reporting mandate, proponents still must substantiate that transparency regulation is less costly than alternative, more traditional policy instruments such as taxes, subsidies, and penalties. In my view, proponents of a reporting mandate have not yet provided convincing arguments, let alone evidence, on these three key issues.
Real Effects Will Occur but Are They Desirable?
There is ample evidence that disclosure mandates often change corporate behavior – one of the few points that most accounting academics agree on. However, the existence of real effects does not imply that such changes benefit society. Forcing public firms that operate mines to disclose their mine safety records in SEC filings appears to increase mine safety at affected mines (see Christensen et al. 2017). Forcing public firms to disclose their efforts to ensure their product does not include minerals that finance conflicts in and around the Democratic Republic of the Congo appears to make them alter their supply chain (see Baik et al. 2022). What is less clear are the long-term consequences of these policies. It is likely that firms subject to the disclosure regulation (i.e., SEC registrants) will be less likely to operate mines that are inherently less safe or buy minerals from areas with high conflict risk, leaving these operations to firms that are not registered with the SEC (e.g., private U.S. firms or non-U.S. firms). There is little evidence that U.S. private firms or non-U.S. firms (e.g., Chinese or Russian mining firms operating in African conflict areas) perform better on social issues than SEC registrants (even in the absence of a disclosure mandate).
Is the SEC a Suitable Agency to Enforce an ESG-Disclosure Mandate?
Implementing disclosure rules (or reporting standards) at the SEC often becomes political. Prominent examples include the expensing of employee stock options in the early 2000s and, more recently, the reporting standard for leasing. However, the debates on ESG reporting standards are likely to be much more controversial than financial reporting because the users of ESG information are much more diverse than the users of financial reporting. For instance, my mother, a retired caretaker for people with mental handicaps, does not care about whether we expense employee stock options or capitalize leases on the balance sheet. She does care about ESG issues such as climate change, child labor, and the plight of the 90 million people who call the Democratic Republic of the Congo home and have endured unimaginable suffering for decades due to violent conflict that may be partly financed by mineral extraction.
Conflict mineral disclosures is a good example to make this point more generally. In response to a 2017 SEC call for comment letters regarding all aspects of the conflict-minerals-disclosure rule, 80 percent of comment-letter writers were untraditional respondents (individuals, NGOs, student organizations, religions groups, and think tanks). Their arguments are often unconventional, centering on opposition to the conflict in general rather than the efficacy of the disclosure rule. The SEC seems ill equipped to deal with such issues, and it will likely be difficult for the SEC to manage its agenda after a reporting mandate. More concerning, expanding the SEC’s role to include addressing broad social problems could crowd out the SEC’s traditional role of protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital formation.
Is Securities Regulation the Most Effective Policy Instrument?
Even if mandatory CSR reporting leads to genuine, positive change in society and the politics involved in setting standards are managed well, proponents of a mandate still must make the case that CSR reporting is a cost-efficient way to address the problem. In the case of climate change, a tax on CO2 emissions is likely more effective as it could apply to both SEC registrants and non-SEC registrants and would not require a broad (and potentially unsophisticated) stakeholder group to impose the right amount of costs on emissions. . For the same reasons, in the case of conflict minerals, a due diligence requirement enforced by U.S. Customs and Border Protection would likely be more effective. Since most proponents of mandatory disclosure related to climate change and conflict minerals argued for traditional policy interventions prior to arguing for disclosures rules, they probably realize it is not the best way to address these issues, just the approach with the least political resistance.
In my view, an ESG-disclosure mandate effectuated through securities regulation is premature. Implementing it without sufficient evidence (or even sound conceptual arguments) risks doing more harm than good.
Baik, B., Even-Tov, O., Han, R. and Park, D., 2022. The real effects of conflict minerals disclosures. Available at SSRN 3908233.
Christensen, H. B., E. Floyd, L. Y. Liu, M. Maffett. 2017. The real effects of mandated information on social responsibility in financial reports: Evidence from mine-safety records. Journal of Accounting and Economics, Volume 64, Issues 2–3,2017, Pages 284-304.
This paper comes to us from Professor Hans B. Christensen at the University of Chicago’s Booth School of Business. It is based on his recent paper, “Is Corporate Transparency the Solution to Political Failure on our Greatest Problems? A Discussion of Darendeli, Fiechter, Hitz, and Lehmann,” available here.