Social Washing or Credible Communication?

Investor demand for information about firms’ environmental, social, and governance (ESG) commitments has prompted substantial corporate disclosure of their ESG activities. However, these disclosures often raise questions of “social washing,” where firms make unsubstantiated claims or misrepresent their company as more socially responsible than it is.

In a recent study, we consider social washing related to diversity, equity, and inclusion (DEI). Beginning in 2020, the Securities and Exchange Commission (SEC) required publicly-traded firms to include under Item 1 “Business” of their 10-K filings a description of the registrant’s human capital resources, including the number of persons employed by the registrant and any human capital measures or objectives that the registrant focuses on in managing the business. In particular, firms must disclose “a description of the registrant’s human capital resources to the extent such disclosures would be material to an understanding of the registrant’s business.” One of the most commonly listed considerations is corporations’ commitment to DEI. Given this focus, we analyze whether these DEI commitments represent social washing or credible communication.

One reason firms might use these newly required disclosures to engage in social washing is the substantial scrutiny they face after recent social and civil unrest. In such an environment, corporations have been put in the spotlight to see how they will respond, and any failure to announce commitments to DEI can turn consumers and investors against them. However, these commitments can be costly and may not be aligned with shareholders’ desire to maximize value, prompting some firms to make DEI-related claims on paper without supporting them in practice – especially when the new DEI-related disclosures in the 10-K are essentially qualitative and hard to verify.

Yet numerous studies document that social washing can frustrate employees and diminish a firm’s value. Others suggest that damage to a firm’s reputation can make it harder to retain and attract employees and customers, do business with suppliers, or raise capital from investors. Given these significant costs, one might expect firms to credibly communicate their true actions to improve their performance on DEI, and corporations like Disney and Coca-Cola have, in fact, made material changes to their operations.

Using a sample of 2,221 annual financial statement disclosures in 2020, we first find that over 80 percent of companies commit to DEI in their new human capital disclosures. We then provide evidence that these disclosures credibly communicate DEI commitments across two different tests: (1) employees at firms with more extensive DEI disclosures rate the firms higher on DEI and report higher satisfaction overall (per, and (2) firms with more extensive DEI disclosures have higher employee productivity. These results suggest that the DEI disclosures in the 10-K filings reflect firms’ genuine commitment to DEI.

We also shed light on whether the disclosures provide useful information to the market. We find that investors do not respond to the DEI disclosures on average, but they do respond positively to the disclosures by smaller firms, which generally have lower visibility and information transparency. These findings suggest that DEI disclosures provide important information to investors when the market has limited prior information on a firm’s DEI commitments and activities.

Our study provides evidence that the SEC’s new human capital disclosure mandate helps enhance corporate transparency related to DEI commitments. Disclosures of DEI information in annual financial statements appear to reflect credible communication rather than social washing. Our results also help inform the SEC as it evaluates additional requirements for these human capital disclosures. Several SEC commissioners and U.S. senators have called for the disclosure of quantitative information, and our additional analysis shows that investors find this information new and useful. Lastly, our results demonstrate the importance of corporate commitment to DEI for employees and society.

This post comes to us from professors Nathan C. Goldman at North Carolina State University and Yuan Zhang at the University of Texas at Dallas. It is based on their recent paper, “Social Washing or Credible Communication? An Analysis of Corporate Disclosures of Diversity, Equity, and Inclusion in 10-K Filings,” available here.