The Impact of Mandatory ESG Disclosure on Firms’ Graph Disclosure Quality: Evidence from the European Union Directive

Synopsis The research problem We examined the graphical presentation of environmental, social, and governance (ESG) disclosures after the passage of the European Union ESG reporting mandate (“EU Directive”). We also investigated the market consequences of the change in the quality of the graphical presentations of ESG disclosure. Motivation or theoretical reasoning ESG graphs assist firms’ legitimation strategies, and disclosure intentions influence their use. Some firms choose to make rhetorical visual disclosures for pragmatic legitimacy without substantive actions (i.e., green impression management), while others pursue moral legitimacy with genuine sustainability actions and disclosures that align with societal expectations. Examining how firms adjust the quality of their visual communication strategies offers insights into management’s ESG disclosure intentions and incentives in response to a mandatory ESG reporting regulation. The test hypotheses EU firms could comply with the EU Directive to improve all aspects of their ESG disclosures, including graphical disclosures presenting comprehensive details about their policies, risks, and performance concerning environmental concerns, social and employee factors, human rights, anticorruption measures, and board director diversity. Thus, we studied whether the EU reporting directive can improve the quality of ESG graph disclosures. Target population This study addresses the current initiatives taken by policymakers, regulators, standard setters, investors, and businesses to improve the quality of sustainability disclosures worldwide. Our study offers valuable evidence supporting the notion that mandatory ESG disclosure regulation positively influences the quality of ESG graphs, thereby better-equipping stakeholders with relevant information for their pricing decisions. Adopted methodology Our analysis began with manually collecting graph information from the top 100 EU and U.S. firms’ ESG reports spanning from 2016 to 2020, resulting in a dataset of 5593 graphs. We utilized the difference-in-differences (DID) method, using the EU indicator to identify treatment firms and the POST indicator to identify the postadoption period. The interaction term [Formula: see text] estimates the impact of the EU Directive on ESG graph quality for EU firms. Additionally, we created an ESG graph distortion index to quantify graph quality. Analyses We evaluated the reduction in ESG graph distortion among EU firms compared to U.S. firms during the postadoption period of the EU Directive. We also applied the instrumental variable approach to investigate the value relevance of ESG graphical disclosure on financial and market performance. Moreover, we utilized a structural equation model (path analysis) to estimate the indirect effects of ESG performance and ESG disclosure on the relationship between ESG graph distortion and firms’ financial and market performance. Findings We found that EU firms produced better ESG graphs than U.S. firms after the implementation of the EU Directive. We also found that firms producing high-quality ESG graphs are associated with better financial and market performance. This positive relationship is independent of the influence of ESG performance but partially explained by the impact of ESG disclosure. Finally, EU firms that continued to produce low-quality ESG graphs exhibited poorer market and financial performance and increased market illiquidity in the postadoption period.