On March 21, 2022, the Security and Exchange Committee (SEC) proposed that all public firms disclose climate-change risk and greenhouse-gas (GHG) emission information in their financial statements. According to SEC Chair Gary Gensler, the proposal “would help issuers more efficiently and effectively disclose these risks and meet investor demand, as many issuers already seek to do.” Was he right? Would government-mandated GHG reporting meet investor demand and aid efficiency? After all, companies might not provide information voluntarily because the cost of producing and disseminating it, including the proprietary costs, exceeds the benefits to shareholders (Admati and Pfleiderer, 2000). In a new paper, we aim to determine whether investors perceive a net benefit from mandatory disclosure of GHG and climate-change risk information by examining the effect on stock prices of a series of events related to the likelihood of adopting these disclosure requirements.
The SEC proposal would impose costs on companies by expanding the definition of GHG emissions and requiring that outside experts give assurances that the disclosures were accurate (e.g., Peirce, 2022). All firms would have to disclose their scope-1 and scope-2 GHG emissions, and publicly-traded firms would also have to disclose scope-3 emissions if they publicize a scope-3 target or if scope-3 emissions are material.[1] To the extent that these measures fall under Regulation S-X, auditors would have to certify the internal controls that produced these numbers, and CEOs and CFOs would also have to certify the disclosed measures (SOX section 302). These are just some of the complex requirements that make the proposed rules so costly for companies.
In addition to reporting costs, climate-risk disclosures could create so-called proprietary costs by forcing companies to reveal sensitive information to rivals. For example, GHG emissions indicate fuel consumption, and disclosing them would allow competitors to gauge the efficiency of one another’s operations and manufacturing techniques. Competitors could also deduce operating growth from GHG emissions.[2] In addition, individuals and groups could use emissions disclosures to criticize companies, which might cause product-market losses and political problems.
On the benefit side, GHG emissions disclosures could allow investors to assess the negative effects of emissions on a company’s cash flow. Prior studies suggest that investors price in firms’ environmental performance (e.g., Matsumura, Prakash, and Vera-Munoz, 2014; Griffin, Lont, and Sun, 2017; Bolton and Kacperczyk, 2021). In addition, equity investors might have a preference for firms with lower environmental risk, and the expanded disclosure would allow them to evaluate the impact of GHG emissions separately on environmental risk (e.g., Geczy, Stambaugh, and Levin, 2005; Fama and French, 2007; Friedman and Heinle, 2016). Disclosure could also mitigate overinvestment (Xue, 2022) and facilitate inter-firm comparisons that would improve the efficiency of allocating capital (Admati and Pfleiderer, 2000, Bushee and Leuz, 2005).
We study 31 events that would increase the likelihood of the SEC’s climate-disclosure proposal going into effect. Our variable of interest is the cumulative abnormal return during a three-day window (i.e., [t-2, t]) around each event (e.g., Zhang, 2007; Armstrong, Barth, Jagolinzer, and Riedl, 2010). Because the regulation would affect all publicly-listed U.S. firms, we benchmark U.S. returns using factors from other developed countries that share similar risks but are not directly affected by the regulation. We fail to find evidence that the U.S. stock market would react positively to these events, suggesting that, on average, investors do not perceive a net benefit from the disclosure requirement.
Next, we analyze cross-firm variation in the market’s net-cost assessment. We test whether the market reaction varies with a firm’s pre-regulation carbon dioxide (CO2) disclosure. We find a significant negative market reaction among CO2-non-reporting firms. Their counterparts, CO2-reporting firms, fared better, displaying a muted negative reaction. If pre-regulation disclosure reflects shareholders’ preference for GHG emission information, the evidence suggests non-trivial regulatory costs for CO2-non-reporting firms and no significant positive externality (e.g., standardization benefits) from the disclosure mandate. These results also suggest that our null findings for all firms are not caused by the noisy identification of policy-relevant events. In an additional test designed to capture cross-sectional variation in C02-reporters’ voluntary assumption of assurance requirements, we divide CO2 reporters into assured and unassured subgroups. We find a more positive market reaction for both groups of firms relative to non-reporters but no measurable difference between the two groups. Our interpretation is that assurances from outside experts that the disclosures are accurate do not affect the net benefit of the mandate to shareholders, casting doubt on the usefulness of those assurances. Finally, we use Environment Disclosure Score from the Bloomberg dataset as another proxy for the extent to which the regulation affects firms. We find corroborative evidence that firms disclosing finer environmental information before the mandate have less-negative reactions to the mandate’s announcement.
Our finding of no market reaction suggests the mandate does not produce net benefits for equity investors. The moderating effect of the compliance-cost proxy implies that firms with less prior disclosure incur higher compliance costs but not increased investor information demand. The insignificant difference in market reaction between firms that do and do not voluntarily obtain outside assurances of disclosure accuracy further suggests little benefit from those assurances. Therefore, it is not apparent that adopting a one-size-fits-all disclosure mandate meets shareholders’ needs.
A caveat is that while our tests capture anticipated spillovers between equity investors, they do not speak to social welfare. If the SEC aims to increase social welfare rather than provide aid to equity investors, disclosure mandates might add value.
ENDNOTES
[1] Scope 1 emissions refer to emissions that come from a firm’s owned or controlled operations (e,g., emissions associated with fuel combustion in boilers, furnaces, vehicles). Scope 2 emissions refer to those from purchased or acquired electricity, steam, heat, or cooling. Scope 3 emissions refer to those from indirect upstream and downstream activities. Firms may set a target for scope 3 emissions reduction, which is referred to as scope-3 target.
[2]Take Google, for example. Google provides its services through data centers, which consume large amounts of energy. Energy consumption is considered a key to decoding Google’s operations. In 2011, Google started to release its carbon footprint. Glanz (2011) speculated on the reasons for Google’s former reluctance to disclose this type of information. Competitors could indirectly derive information about the growth and efficiency of Google’s operations from its energy consumption and GHG emissions. Similarly, Amazon, whose delivery operations across the U.S. also consume substantial amounts of energy, did not start to disclose its carbon footprint until 2019. (https://www.cnbc.com/2019/03/08/jeff-bezos-to-end-secrecy-over-amazons-role-in-carbon-emissions.html).
This post comes to us from Richard M. Frankel, Yongzhao (Vincent) Lin, and Xiumin Martin at Washington University in Saint Louis – Olin School of Business. It is based on their recent paper, “Does Market Demand for Climate-Related Disclosure Regulation?” available here.