The effect of environmental, social and governance disclosure on corporate investment efficiency

Elsa Allman and Joonsung Won

Abstract

This paper examines the impact of environmental, social and governance (ESG) disclosure on investment efficiency, leveraging the implementation of Directive 2014/ 95/EU as a quasi-natural experiment to assess changes in disclosure quality. It finds a significant and robust reduction in underinvestment among US firms with substantial operations in the European Union – and thereby subject to the Directive – compared with US-centric firms unaffected by the directive. The former experienced an increase in debt financing post-directive, though no significant changes are observed in the equity capital raised. The improvement in investment efficiency is most pronounced in firms with initially low ESG disclosure levels, those facing financial constraints and those with more entrenched managers. These findings imply that nonfinancial disclosure mandates, akin to financial reporting requirements, can alleviate capital rationing issues for underinvesting firms, particularly in debt markets. The study underscores the potential role of ESG disclosure in improving financial outcomes and informing policy on nonfinancial reporting standards.