Abnormal disclosure and the cost of equity capital: evidence from textual characteristics of sustainability disclosure

Sustainability reporting has increasingly attracted investors’ attention by providing information critical for informed decision-making regarding a firm’s valuations. However, concerns regarding disclosure quality and the potential for greenwashing have heightened uncertainty around corporate valuations. This study examines how equity investors respond to abnormal sustainability disclosures. We employ textual analysis to generate disclosure measures and explore the relationship between abnormal sustainability disclosures and the cost of equity capital. Using a sample of Swedish listed firms, we find that abnormal disclosures related to uncertainty, negativity, litigiousness, and discretionary disclosure are positively associated with the cost of equity capital. These disclosures also increase cost of equity for firms with high idiosyncratic risk, which may act as a channel to increase the cost of equity capital. By contrast, abnormal positivity is negatively associated with the cost of equity capital among firms with fewer incentives for positive manipulation. Furthermore, investors’ sensitivity to abnormal disclosures is significantly greater following the implementation of the Non-Financial Reporting Directive. Our main findings are robust across alternative measures of abnormal disclosures and multiple robustness tests, indicating that equity investors generally perceive abnormal disclosures unfavorably, effectuating a higher cost of equity capital.