Market Reaction to Mandatory Nonfinancial Disclosure

Abstract

This paper examines the equity market reaction to events associated with the passage of a directive in the European Union (EU) mandating increased nonfinancial disclosure, which affected firms listed on EU exchanges or having significant operations in the EU. The mandated disclosures relate to firms’ environmental, social, and governance performance. Using a cross-country sample, we first document an on average negative market reaction to events increasing the likelihood of passage for this regulation, consistent with equity investors anticipating net costs with the directive’s passage for most firms. Exploiting cross-sectional variation, we then predict and document a more negative market reaction for firms having: (i) low pre-directive nonfinancial disclosure levels, consistent with investors anticipating these future disclosures to reveal worse-than-expected news; (ii) weaker performance on nonfinancial issues, consistent with expectations for these firms to incur future costs to internalize current externalities; and (iii) lower ownership by institutional asset owners, consistent with such investors demanding further disclosures than mandated by the directive. The average market reaction for firms with superior nonfinancial performance and disclosure in our sample is positive, suggesting that investors expect net benefits from the passage of the directive for these firms.