Around the globe, governments are taking action to require large companies – including those in the fashion and broader retail segments – to make disclosures about their climate and other environment, social and governance (“ESG”)-related risks and opportunities in annual reports and regulatory filings. This follows a global trend for businesses to be more upfront about their social and environmental impact. Companies are increasingly expected to provide safe and environmentally friendly products, and ensure that their activities are socially and environmentally responsible. But does requiring businesses to report these things actually push them to make better decisions around climate and sustainability? A decade of data from Europe offers some insight.
Our new research examining the effect of the European Union’s sustainability reporting regulation (Directive 2014/95/EU) on business performance suggests reporting is not always enough. If governments want businesses to take their impact on the climate seriously, reporting requirements need to include sanctions for companies that fail to achieve basic environmental standards.
Regulating ESG Disclosures
Disclosure requirements related to social and environmental issues have two main objectives. The first is to provide investors with the information they need to decide where to invest. The second is to enable the rest of society to understand the social and environmental impacts of business on everyone’s lives. In discussing these issues, terms – such as ESG, sustainability, triple bottom line, and integrated reporting – are often used interchangeably. While this can be confusing, they all really just refer to anything that relates to the natural environment or society.
Several studies have shown that investors find ESG disclosures to be useful for their decision making. In research published last year, we found investors were prepared to pay for additional environmental disclosures. But whether these reporting requirements improve companies’ social and environmental performance is, perhaps, the more important question.
The EU directive at the heart of our study requires large companies to report their performance on non-financial matters, including environmental issues, social and employee matters, human rights, anti-corruption, and bribery. We looked at the social and environmental performance of companies between 2009 and 2020 using information contained in ESG databases.
The 358 European companies included in our sample did not meaningfully improve after the directive – nor did they improve when compared to the 470 companies in the United States in our sample. This was a surprise, considering that Europe is often perceived as placing a greater emphasis on social responsibility, while business in the U.S. is associated with a strong investor focus.
An Ineffective Directive?
It is possible that the EU directive did not have a major impact on social and environmental outcomes due to the absence of meaningful sanctions for companies that do not comply. EU directives usually leave detailed implementation up to each country within the 27-member bloc. In this case, few countries have implemented significant sanctions for companies that do not meet the standards of the directive. This is important in light of the fact that prior research has shown that a lack of meaningful sanctions often results in poor outcomes.
According to the data, the social and environmental performances of both the European and U.S. companies are steadily improving – just not as a direct response to the EU’s reporting requirements. While the sum total of legislation enacted both in Europe and the U.S. is probably still improving companies’ environmental and social impact, which is something to applaud, it is worth noting that sustainability reporting requirements – along with meaningful sanctions for companies that do not comply – can play a role in further ensuring that our economic system works for everyone.
Charl de Villiers is a Professor of Accounting at the University of Auckland.
Share
