Many firms now issue ESG reports voluntarily in response to fast-growing investor and stakeholder demand. Yet survey evidence shows that corporate lawyers consider ESG-related disputes a top source of litigation risk for their clients.[1] In a new study, we examine the impact of expected shareholder litigation on ESG reporting.

Our Setting 

We exploit the 2010 U.S. Supreme Court ruling in Morrison v. National Australia BankLtd. (hereafter,Morrison). Prior to Morrison, investors who purchased shares on non-U.S. exchanges could pursue litigation in United States courts under Section 10(b) of the Securities Exchange Act of 1934 if fraudulent conduct affected U.S. markets or investors. Morrison overturned four decades of established legal precedent by limiting plaintiffs to investors who acquired shares on U.S. exchanges. Consequently, Morrison reduced the overall expected litigation costs for non-U.S. firms that trade on both U.S. and non-U.S. exchanges (hereafter U.S.-cross-listed foreign firms).

As an example of the effect of Morrison, in the lawsuit filed against Vivendi Universal, S. A., the jury initially awarded an estimated verdict of $9 billion prior to the Morrison decision. However, approximately $7 billion of the damage award was ultimately set aside after the Morrison ruling because investors who purchased Vivendi shares on non-U.S. exchanges were excluded from the eventual plaintiff class.[2] Morrison allows us to use a difference-in-differences research design to compare post-ruling changes in ESG reporting between U.S.-cross-listed foreign firms and foreign firms that are not U.S.-cross-listed (and thus are not expected to be affected by Morrison).

The Effect of Morrison on the Tone of Corporate ESG Reports

Our first test examines changes in the tone of ESG reports in response to the Morrison ruling. Firms retain substantial latitude in setting that tone. An increasing number of class action lawsuits are filed under Section 10(b) to hold firms accountable for their ESG misconduct, many of which allege that defendant firms provided misleading optimistic information or omitted material negative information about their ESG activities. Plaintiffs’ legal challenges often target disconnections between firms’ ESG conduct and their stated commitments. The anti-fraud provisions of federal securities laws require plaintiffs to specify in a complaint the misleading statements, which provides attorneys with a strong incentive to comb through defendant firms’ ESG statements to identify material misrepresentations or omissions. By providing extensive details on a firm’s ESG activities, “loosely-controlled” ESG reports can easily become subject to attorneys’ intensified scrutiny after adverse ESG events

Nevertheless, shareholder litigation might not affect the tone of ESG reports, considering the long-standing debate over whether upbeat qualitative statements should be deemed material in investors’ decision-making or simply aspirational. Courts’ inconsistent interpretations of securities laws increase the uncertainty about the success of lawsuits targeting upbeat information provided by defendant firms. These firms may argue that reasonable investors should not be influenced by their optimistic ESG statements.

We find that U.S.-cross-listed foreign firms increase their use of optimistic words relative to pessimistic words in their ESG reports in the post-Morrison period. This result is consistent with the notion that a decrease in expected litigation costs reduces firms’ concern about litigation tied to optimistic statements in their ESG reports.

The Effect of Morrison on the Issuance of Corporate ESG Reports 

Our second test examines the impact of Morrison on the issuance of ESG reports. Insurance theory posits that a positive ESG reputation builds moral capital, which offers an insurance-like benefit of preserving firm value in bad times. Specifically, when an adverse event occurs, investors are more likely to give firms the benefit of the doubt and react less negatively to the event if firms have a record of treating the environment and society responsibly. Thus, firms have an incentive to issue ESG reports to protect their stock price from events that can trigger shareholder litigation. A smaller decline in stock prices reduces the expected damage awards in securities class actions. As discussed previously, Morrison reduces expected litigation costs for U.S.-cross-listed foreign firms by reducing the number of potential plaintiffs who are eligible to file class action lawsuits in U.S. courts under Section 10(b). As a result, the benefit of issuing ESG reports for their insurance-like protection against shareholder litigation is less pronounced after Morrison.

On the other hand, the issuance of ESG reports may increase after the ruling. In the pre-ruling period, firms may have been reluctant to issue ESG reports due to the concern of providing detailed disclosures that can be used by plaintiffs to identify material discrepancies between their ESG statements and actual ESG outcomes. This concern is weakened because Morrison reduces investors’ ability to recover economic losses by pursuing litigation in U.S. courts.

We find that relative to foreign firms that are not U.S.-cross-listed, U.S.-cross-listed foreign firms are less likely to issue an ESG report in the post-Morrison period. This finding supports the expectation that a reduction in expected litigation costs following Morrison reduces the need for insurance and thus lowers firms’ incentive to engage in costly ESG reporting. In additional tests, we reinforce this conclusion by showing that following Morrison, U.S.-cross-listed foreign firms are less likely to purchase external assurance for their ESG reports and less likely to adopt the Global Reporting Initiative guidelines. These results are further consistent with the notion that a decrease in expected litigation costs weakens firms’ incentive to commit resources to ESG reporting.

Other Important Findings 

Although Morrison reduced the expected shareholder litigation costs for all U.S.-cross-listed foreign firms, the strength of the effect is not the same across these firms. As a result of the ruling, investors who can no longer join class action lawsuits in U.S. courts may instead pursue damages in their home country. The ease of pursuing class actions differs across countries, which creates an opportunity to strengthen our inferences by testing whether the effect of Morrison is stronger where courts do not provide good substitutes for U.S. courts. As expected, we find that Morrison has a stronger effect on increasing the optimistic tone of ESG reports and reducing the likelihood of their issuance among U.S.-cross-listed foreign firms headquartered in countries where shareholder litigation is more difficult.

Unlike many regulatory or legal events that affect only U.S. firms, Morrison’s impact on U.S.-cross-listed foreign firms allows us to offer interesting insights into how corporate ESG reporting varies depending on a country’s  attitudes toward ESG. The audience for corporate ESG information includes stakeholders as well as  investors. In countries that take ESG responsibilities seriously, non-investor stakeholders want more information about firms’ ESG activities and have a greater incentive to closely monitor firms’ ESG pledges. Changes in expected shareholder litigation are less likely to affect ESG reports when the demand from non-investor stakeholders remains high. In contrast, in countries less concerned about ESG, Morrison should have more of an impact on corporate ESG reporting. As expected, we find that Morrison has a stronger effect on ESG reporting among U.S.-cross-listed foreign firms headquartered in countries with more lax attitudes toward ESG.

Implications 

Our use of Morrison as a quasi-natural experiment, supplemented with many cross-sectional tests and additional analyses, provides the first evidence that expected shareholder litigation affects voluntary ESG reporting. Our results have practical implications for regulators and standards setters by identifying the role of private enforcement of securities laws in influencing corporate ESG reports. Although we do not aim to provide a comprehensive cost-benefit analysis, these results should help stakeholders around the world better understand the trade-offs that management makes in ESG reporting.

ENDNOTES

[1] https://www.bakermckenzie.com/-/media/files/insight/publications/2024/the-year-ahead-report-2024.pdf.

[2] See In Re Vivendi Universal, S.A. Securities Litig. 765 F.Supp.2d 512 (S.D.N.Y. 2011).

This post comes to us from professors Lijun (Gillian) Lei at the University of North Carolina at Greensboro, Sydney Qing Shu at Miami University of Ohio, and Wayne B. Thomas at the University of Oklahoma. It is based on their recent paper, “The Effect of Expected Shareholder Litigation on Corporate ESG Reporting: Evidence from a Quasi-Natural Experiment,” available here.