ESG is currently a hot topic, very hot indeed. Awareness, regulation, and economical returns are clearly shifting perspectives…. However, ESG management requires a lot more information to ensure relevant actions, as indeed management comes with measurement. As such, authorities have enhanced companies’ disclosure requirements. Although the primary objective of mandatory ESG disclosure rules are to improve the supply of ESG information, it is not clear that these regulations actually improve the ESG information environment.
The economics of information theory suggests that a lender would acquire information until to the point where the marginal cost of acquiring additional information equals the marginal benefit. Similarly, the borrower would not convey complete information because of signaling cost. This causes information asymmetry between lender and borrower. Asymmetry of ESG information between lenders (companies) and borrowers (investors), for example, triggers anti-selection, destructive to markets, and also influences opportunistic behavior. In the case of the ESG project, asymmetry of information means that a company (company’s managers) has more knowledge of relevant factors and details of the project than ESG-investors. If the project is not sustainable enough (or not at all) as presented to ESG-investors, this means that the company has not entered in good faith or has provided misleading information about its project. That is called “opportunistic behavior” or “moral hazard”. If this type of dishonest project exists in the market of sustainable projects, it will gain ground over time and exclude the real sustainable projects
(destruction of sustainable market).
Moreover, information is expensive; and available information is reflected in the price according to the market efficiency concept. More information implies lower prices. An important asymmetry of information amplifies economic crisis and causes financial instability (higher and volatile prices). Complete divulgation (symmetry) of information collapses trade and markets because it leads to zero price. ESG disclosure reporting should allow the investors to have green-information for free. And green information represents only a part of overall market information. Thus, even with complete ESG-disclosure, the marginal cost of acquiring additional information (the entire market) is still not zero. Thus, ceteris paribus, the overall cost of investment decreases (lender side) due to the decrease of the risk incurred by investors (they are more informed), which will lower the cost of capital for the borrowers. That gives a positive signal to companies and investors.
But ESG-disclosure can have negative effects, opposite to its original purpose. In fact, ESG-disclosure can have a reverse effect and cause reduction of transaction on sustainable markets, or even lead to its destruction in several cases. First, when project’s information is sufficiently available, a gap between a stated ESG policy and its implementation (greenwashing) negatively impacts pro-ESG customer-investors satisfaction. Second, if the development of technologies will not follow the rapid and optimistic evolution of sustainable objectives, then corporates will not be able to achieve their ESG-targets and will be constrained to reorient their technology policy by using polluting or less-efficient technologies. Finally, the intensification of competition (local, regional and global) can lead many companies to suffer losses or go bankrupt. In fact, studies find that most firms lack an overall plan for approaching ESG and delivering results, and most of them launch a hodgepodge of business initiatives with no overall vision or plan (technology evolution, potential concurrent…).
The failure to meet the expectations of various stakeholders will generate market fears, and consequently, will increase corporate’s risk premium and ultimately result in lost profit opportunities. If companies will not be able to fulfil their obligations (because of the limits cited above) they will have only two options: Either to be transparent, in which case they run the risk of having a bad reputation; otherwise, they will publish false information taking regulation and reputation risk. In both cases, they will not be able to engage effective transition. The hypothesis of possible manipulation of extra-financial reports is credible according to [Callery and Perkins, 2020]: ”findings demonstrate that firms routinely manipulate intermediary ratings with false claims, undermining institutional and societal goals”; and ”may exploit the lack of sufficient audit oversight in disclosure to strategically mask false or otherwise
misleading claims”.
ESG is currently a hot topic, very hot indeed. Awareness, regulation, and economical returns are clearly shifting perspectives…. However, ESG management requires a lot more information to ensure relevant actions, as indeed management comes with measurement. As such, authorities have enhanced companies’ disclosure requirements. Although the primary objective of mandatory ESG disclosure rules are to improve the supply of ESG information, it is not clear that these regulations actually improve the ESG
information environment.
The economics of information theory suggests that a lender would acquire information until to the point where the marginal cost of acquiring additional information equals the marginal benefit. Similarly, the borrower would not convey complete information because of signaling cost. This causes information asymmetry between lender and borrower. Asymmetry of ESG information between lenders (companies) and borrowers (investors), for example, triggers anti-selection, destructive to markets, and also influences opportunistic behavior. In the case of the ESG project, asymmetry of information means that a company (company’s managers) has more knowledge of relevant factors and details of the project than ESG-investors. If the project is not sustainable enough (or not at all) as presented to ESG-investors, this means that the company has not entered in good faith or has provided misleading information about its project. That is called “opportunistic behavior” or “moral hazard”. If this type of dishonest project exists in the market of sustainable projects, it will gain ground over time and exclude the real sustainable projects
(destruction of sustainable market).
Moreover, information is expensive; and available information is reflected in the price according to the market efficiency concept. More information implies lower prices. An important asymmetry of information amplifies economic crisis and causes financial instability (higher and volatile prices). Complete divulgation (symmetry) of information collapses trade and markets because it leads to zero price. ESG disclosure reporting should allow the investors to have green-information for free. And green information represents only a part of overall market information. Thus, even with complete ESG-disclosure, the marginal cost of acquiring additional information (the entire market) is still not zero. Thus, ceteris paribus, the overall cost of investment decreases (lender side) due to the decrease of the risk incurred by investors (they are more informed), which will lower the cost of capital for the borrowers. That gives a positive signal to companies and investors.
But ESG-disclosure can have negative effects, opposite to its original purpose. In fact, ESG-disclosure can have a reverse effect and cause reduction of transaction on sustainable markets, or even lead to its destruction in several cases. First, when project’s information is sufficiently available, a gap between a stated ESG policy and its implementation (greenwashing) negatively impacts pro-ESG customer-investors satisfaction. Second, if the development of technologies will not follow the rapid and optimistic evolution of sustainable objectives, then corporates will not be able to achieve their ESG-targets and will be constrained to reorient their technology policy by using polluting or less-efficient technologies. Finally, the intensification of competition (local, regional and global) can lead many companies to suffer losses or go bankrupt. In fact, studies find that most firms lack an overall plan for approaching ESG and delivering results, and most of them launch a hodgepodge of business initiatives with no overall vision or plan (technology evolution, potential concurrent…).
The failure to meet the expectations of various stakeholders will generate market fears, and consequently, will increase corporate’s risk premium and ultimately result in lost profit opportunities. If companies will not be able to fulfil their obligations (because of the limits cited above) they will have only two options: Either to be transparent, in which case they run the risk of having a bad reputation; otherwise, they will publish false information taking regulation and reputation risk. In both cases, they will not be able to engage effective transition. The hypothesis of possible manipulation of extra-financial reports is credible according to [Callery and Perkins, 2020]: ”findings demonstrate that firms routinely manipulate intermediary ratings with false claims, undermining institutional and societal goals”; and ”may exploit the lack of sufficient audit oversight in disclosure to strategically mask false or otherwise
misleading claims”.
ESG is currently a hot topic, very hot indeed. Awareness, regulation, and economical returns are clearly shifting perspectives…. However, ESG management requires a lot more information to ensure relevant actions, as indeed management comes with measurement. As such, authorities have enhanced companies’ disclosure requirements. Although the primary objective of mandatory ESG disclosure rules are to improve the supply of ESG information, it is not clear that these regulations actually improve the ESG
information environment.
The economics of information theory suggests that a lender would acquire information until to the point where the marginal cost of acquiring additional information equals the marginal benefit. Similarly, the borrower would not convey complete information because of signaling cost. This causes information asymmetry between lender and borrower. Asymmetry of ESG information between lenders (companies) and borrowers (investors), for example, triggers anti-selection, destructive to markets, and also influences opportunistic behavior. In the case of the ESG project, asymmetry of information means that a company (company’s managers) has more knowledge of relevant factors and details of the project than ESG-investors. If the project is not sustainable enough (or not at all) as presented to ESG-investors, this means that the company has not entered in good faith or has provided misleading information about its project. That is called “opportunistic behavior” or “moral hazard”. If this type of dishonest project exists in the market of sustainable projects, it will gain ground over time and exclude the real sustainable projects
(destruction of sustainable market).
Moreover, information is expensive; and available information is reflected in the price according to the market efficiency concept. More information implies lower prices. An important asymmetry of information amplifies economic crisis and causes financial instability (higher and volatile prices). Complete divulgation (symmetry) of information collapses trade and markets because it leads to zero price. ESG disclosure reporting should allow the investors to have green-information for free. And green information represents only a part of overall market information. Thus, even with complete ESG-disclosure, the marginal cost of acquiring additional information (the entire market) is still not zero. Thus, ceteris paribus, the overall cost of investment decreases (lender side) due to the decrease of the risk incurred by investors (they are more informed), which will lower the cost of capital for the borrowers. That gives a positive signal to companies and investors.
But ESG-disclosure can have negative effects, opposite to its original purpose. In fact, ESG-disclosure can have a reverse effect and cause reduction of transaction on sustainable markets, or even lead to its destruction in several cases. First, when project’s information is sufficiently available, a gap between a stated ESG policy and its implementation (greenwashing) negatively impacts pro-ESG customer-investors satisfaction. Second, if the development of technologies will not follow the rapid and optimistic evolution of sustainable objectives, then corporates will not be able to achieve their ESG-targets and will be constrained to reorient their technology policy by using polluting or less-efficient technologies. Finally, the intensification of competition (local, regional and global) can lead many companies to suffer losses or go bankrupt. In fact, studies find that most firms lack an overall plan for approaching ESG and delivering results, and most of them launch a hodgepodge of business initiatives with no overall vision or plan (technology evolution, potential concurrent…).
The failure to meet the expectations of various stakeholders will generate market fears, and consequently, will increase corporate’s risk premium and ultimately result in lost profit opportunities. If companies will not be able to fulfil their obligations (because of the limits cited above) they will have only two options: Either to be transparent, in which case they run the risk of having a bad reputation; otherwise, they will publish false information taking regulation and reputation risk. In both cases, they will not be able to engage effective transition. The hypothesis of possible manipulation of extra-financial reports is credible according to [Callery and Perkins, 2020]: ”findings demonstrate that firms routinely manipulate intermediary ratings with false claims, undermining institutional and societal goals”; and ”may exploit the lack of sufficient audit oversight in disclosure to strategically mask false or otherwise misleading claims”.
By Yacoub Bebekar