By Jay Fishman, J.D.
An "Insights from Finance" panel, one of several panels comprising an April 30, 2021 New York University (NYU) conference on Environmental, Social and Governance Disclosures (ESG), asked participants to address ESG disclosures’ impact on corporations globally. The conference itself arose from President Biden’s 2021 appointment of Gary Gensler as SEC Chair, Gensler’s having made ESG Disclosures one of his priorities, and the Commission’s determination to mandate ESG disclosures for companies.
Overall theme of conference. To address these priorities, the conference broadly asked the expert-participants to consider how companies can promote corporate cultures of compliance and meet regulators’ and stakeholders’ expectations about ESG initiatives. To dissect this broad question, each panel focused on one of the following questions: (a) What are the best practices for ESG disclosure?; (b) What are the most sophisticated asset managers looking for?; (c) What are the most forward thinking companies currently providing?; and (d) What can finance scholarship tell us about what the market uses?.
Insight from finance. Moderator April Klein, an accounting professor at NYU’s Stern School of Business, covered this last question in her panel: "What can finance scholarship tell us about what the market uses?" To address this question, Klein asked the panelists to specifically remark upon: (1) the usefulness and reliability of ESG disclosures for investors and companies; (2) whether ESG disclosures should be voluntary or mandatory—the SEC’s disclosure for U.S. companies is currently voluntary; and (3) what recommendations would they make to the SEC about ESG disclosures.
Usefulness of ESG disclosures. Klein asked Christian Leuz, a professor of international economics, finance, and accounting at the University of Chicago’s Booth School of Business to speak about the usefulness of ESG disclosures. Leuz said that a corporation’s ESG disclosures can be material to investors by providing useful information about a company’s corporate social responsibility (CSR). Investments in CSR, like other investments, are associated with future cash flows and risks. Standardized CSR disclosures could help the market gain a clearer picture of a company’s risks and value, making it possible to compare one company’s CSR activities with another’s, and helping investors monitor these activities (or the lack of them). Furthermore, Leuz proclaimed, these disclosures, if they are informative, could show investors a firm’s increase in liquidity of secondary securities markets, just as the usual financial information does. Conversely, uncertainty about a firm’s value could evidence a lower cost of capital.
Answering Klein’s follow-up question whether investors see ESG exposures as more of a performance or risk driver, Leuz indicated that CSR reporting could help shareholders drive a company to act in more responsible and sustainable ways. CSR disclosures could make a company more inclined to, for example, stop polluting. But disclosures upon which a company does not act could result in investors pulling out of that company and, instead, backing companies that either use renewable energy or purchase ethically sourced materials.
The second panelist, Marcin Kacperczyk, a finance professor at Imperial College London, limited his remarks to climate change disclosure. He emphasized that climate change disclosures are not only useful but imperative now in order to sustain the planet into the foreseeable future. He specifically asserted that firms must disclose their respective carbon emission amounts, which need to be zero by 2050 to bring Earth’s temperature down to a sustainable level. Kacperczyk said that, unfortunately, most companies are not disclosing their carbon emission amounts because of the financial and social cost of revealing this information.
Voluntary vs. mandatory disclosures. Concerning the question whether the disclosures should be voluntary or mandatory, Kacperczyk said the good news for advocating mandatory disclosure of a company’s carbon emissions is that the data is objective and, therefore, cannot be easily manipulated by a company. On the positive side, he stated that mandatory disclosure results in a higher emissions benefit for companies required to disclose. But whether mandatory or voluntary, Kacperczyk proclaimed that financial markets do value disclosure.
Lucretzia Reichlin, an economics professor at the London Business School and chair of the European Corporate Governance Institute (ECGI) (an international scientific non-profit association providing a forum for debate and dialogue between academics, legislators and practitioners, focusing on major corporate governance issues and thereby promoting best practice), declared that we not only need mandatory disclosure but we need a global mandatory standard. She said, moreover, that a global standard addresses the "reliability of ESG disclosures" issue by focusing on the materiality of the disclosures.
Regarding how to create this global mandatory standard, Reichlin said there is already a lot of material on the subject that needs to be consolidated. The standard must come from a common baseline with flexibility that depends on each country’s needs. Reichlin made the following points: (1) there is already support for a global mandatory standards from U.S. Treasury Secretary Janet Yellin and European Central Bank President Christine Lagarde; (2) the ECGI could help define the global baseline; and (3) a global mandatory standard would be important to investors and asset managers.
On the voluntary vs. mandatory disclosure question, panelist Leuz chimed in that if materiality drives ESG disclosures, voluntary disclosure will not work. Only mandatory disclosure, he said, would ensure that disclosures material to investors and other stakeholders are made. Leuz similarly stated that if the goal of ESG disclosures is to force or incentivize a company to change its behavior, then voluntary disclosure will also not work, but mandatory disclosure will be complicated by having to decide who will create a mandatory standard to get companies to comply.
Reliability of ESG disclosures. The last panelist to speak was Sara DeSmith, an ESG specialist and partner in PricewaterhouseCooper’s (PwC) sustainability assurance practice, who spoke about the reliability of ESG disclosures. She said the problem today is that since an ESG global mandatory standard does not exist, whether or not disclosures are made varies by company. Furthermore, for companies that do make ESG disclosures, the information is not only inconsistent from one organization to the next but the information is often not reviewed by the firm’s auditors or chief financial officer.
Concerning companies that make ESG disclosures, DeSmith declared that PwC will issue a "limited assurance report" that goes toward the reliability of the information. Noting that companies rely on credit rating agencies to evaluate their ESG disclosures, she proclaimed that what is really needed to ensure full reliability is a move away from credit ratings toward a global standard that applies Generally Accepted Accounting Principles and Generally Accepted Auditing Standards. DeSmith emphasized that these high standards would ensure ESG disclosure reliability by putting ESG disclosures through the same review as financial statements.
Recommendations to SEC. Klein, in lastly posing to the panel the question "What recommendations would you make the SEC," remarked that Commissioner Hester Peirce does not support a world-wide standard for ESG disclosures. Nevertheless, all the panelists agreed that a global standard is, indeed, needed. Kacperczyk, furthermore, declared that on climate change, the SEC must do something now about company carbon emissions because there is no time to wait. DeSmith similarly proclaimed that a global standard on all ESG disclosures is imperative because time is of the essence. Leuz said that because the entire ESG disclosure issue is complicated, perhaps the SEC could be quick on climate change disclosures but slower on other ESG disclosures, e.g., those pertaining to accounting and finance. Reichlin reiterated that while the ECGI cannot determine a country’s (or the world’s ESG disclosure standard) it can work with the SEC and other country financial agencies to define the global baseline. nce issues. ECGI is an international scientific non-profit association providing a forum for debate and dialogue between academics, and practitioners, focusing on major corporate governance issues.