Mandatory ESG disclosure, information asymmetry, and litigation risk: Evidence from initial public offerings

• Published date: 01 November 2024
• Author: Thomas J. Boulton
• Date: 01 November 2024
• DOI: http://doi.org/10.1111/eufm.12494

DOI: 10.1111/eufm.12494

ORIGINAL ARTICLE

Mandatory ESG disclosure, information

asymmetry, and litigation risk: Evidence

from initial public offerings

Thomas J. Boulton

Department of Finance, Farmer School

of Business, Miami University, Oxford,

Ohio, USA

Correspondence

Thomas J. Boulton, Farmer School of

Business, Miami University, Oxford, OH

45056, USA.

Email: boultotj@miamioh.edu

Abstract

I use the staggered adoption of mandatory environ-

mental, social, and governance (ESG) disclosure

regulations around the world to explore the impact of

ESG disclosure on initial public offering (IPO) under-

pricing. I find robust evidence that underpricing is

substantially lower in countries with ESG disclosure

mandates. High‐quality disclosure environments mod-

erate and tougher liability standards amplify the

negative association between ESG disclosure mandates

and underpricing, which suggests that ESG disclosure

mandates reduce information asymmetry and litigation

risk. The impact of ESG disclosure mandates on

underpricing is stronger in countries with more

pronounced environmental, social, and governance

concerns.

Eur Financ Manag. 2024;30:2790–2839.2790

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This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits

use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or

adaptations are made.

© 2024 The Authors. European Financial Management published by John Wiley & Sons Ltd.

The author thanks John Doukas (EFM editor), two anonymous reviewers, Dave Kale (CCSR discussant), Dirk

Schoenmaker (FMA Europe discussant), Dona Siregar (FMA discussant), Lukai Yang (Boca discussant), and

participants at the 4th Annual Boca Corporate Finance and Governance Conference (Boca Raton, FL), the 2023

Conference on Corporate Social Responsibility: Creating Value through ESG (Boston); the 2023 FMA Annual Meeting

(Chicago), and the 2023 FMA European Conference (Aalborg, Denmark) for valuable feedback. Philip Barrett

graciously shared the Reported Social Unrest Index data used in this study. All errors or omissions are the responsibility

of the author. Research funding was provided by the Jack R. Anderson Professorship.

KEYWORDS

disclosure, ESG, information asymmetry, IPO underpricing,

litigation risk

JEL CLASSIFICATION

G12, G15, G18, M14

1|INTRODUCTION

According to a recent survey of institutional investors, 28% of respondents believe that climate risk

disclosure is “more important”or “much more important”than financial disclosure (Ilhan

et al., 2023). Despite substantial increases in ESG‐related disclosure in recent years,

1

most

respondents agree that the qualitative and quantitative information firms provide is not sufficiently

precise, that standardized and mandatory reporting is necessary and currently insufficient, and that

investors should demand more disclosure from firms. The appetite for greater ESG disclosure

corresponds with increased investor attention to ESG‐related issues.

2

For instance, the United States

SIF Foundation reports that investments influenced by ESG considerations grew at a 14% compound

annual rate from 1995 to 2020, reaching approximately $17 trillion at the beginning of 2020.

3

Due in large part to investor demand for more and higher‐quality ESG disclosure from firms,

many countries have introduced ESG disclosure mandates in recent years. For example, Krueger

et al. (2023) identify 35 countries that mandate environmental, social, and governance disclosure

between 2001 and 2019. Many other countries mandate disclosure in one or two, but not all three,

areas.

4

While Larcker et al. (2022) question their cost‐effectiveness, ESG disclosure mandates have

been found to increase the amount and quality of ESG disclosure firms provide (Ioannou &

Serafeim, 2019). This has a positive effect on firms' information environments, as Krueger et al. (2023)

find that firm‐level stock liquidity increases in countries that introduce disclosure mandates.

5,6

This study considers the impact of ESG disclosure on initial public offering (IPO) underpricing,

which refers to the large positive returns experienced by many IPO firms on their first day of

trading. IPOs are an interesting setting to study the impact of ESG disclosure because, as Ljungqvist

(2007)notes“… the empirical evidence supports the view that information frictions have a first‐

order effect on underpricing.”(Abstract) To the extent that ESG disclosure mandates alleviate

information frictions, they should have an unmistakable effect on IPO underpricing. I propose two

channels with the potential to link ESG disclosure mandates and underpricing. The first is

motivated by prominent theories that suggest that uncertainty and information asymmetry are

1

See, for example, https://www.whitecase.com/sites/default/files/2022-06/esg-disclosure-trends-in-sec-filings-2022-

annual-survey-web.pdf (Accessed: February 26, 2024).

2

ESG disclosure is alternatively referred to as sustainability or corporate social responsibility (CSR) disclosure in related

literature. For consistency, I use “ESG disclosure.”

3

US SIF Foundation “Report on US Sustainable and Impact Investing Trends 2020.”https://www.ussif.org/files/Trends

%20Report%202020%20Executive%20Summary.pdf (Accessed: February 26, 2024).

4

I follow Kreuger et al. (2023) and use the terms “ESG disclosure mandate”and “ESG mandate”to refer to countries

that require disclosures in all three areas.

5

Related studies by Dhaliwal et al. (2011,2012), and Bernardi and Stark (2018) document lower analyst forecast errors

and forecast dispersion after firms voluntarily initiate ESG disclosure.

6

Brooks and Oikonomou (2018) and Tsang et al. (2023) provide comprehensive reviews of ESG disclosure research.

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primary determinants of underpricing (e.g., Beatty & Ritter, 1986; Rock, 1986). If ESG disclosure

mandates reduce uncertainty and information asymmetry, IPOs should be underpriced less in

countries that require ESG disclosure. The second is prompted by studies that propose that issuers

deliberately underprice their shares to decrease the probability and prospective costs of IPO‐related

litigation (e.g., Hughes & Thakor, 1992;Lowry&Shu,2002; Tiniç, 1988). To the extent that

mandatory ESG disclosure reduces IPO‐related litigation risk and decreases the cost when litigation

does occur, IPO underpricing should be lower where ESG disclosure is mandatory.

I test the information asymmetry and litigation risk hypotheses in a sample of 15,456 IPOs

issued in 36 countries between 1998 and 2018. My international setting allows me to exploit the

staggered adoption of ESG disclosure mandates through time, capturing both within and between

country effects. Consistent with both channels, I find that IPOs are less underpriced in countries

that mandate ESG disclosure. My baseline result indicates that first‐day returns are 15.9 percentage

points lower for IPOs issued in countries with an ESG disclosure mandate. Given that gross

proceeds for a typical IPO is approximately 105.93 million (inflation adjusted USD), an ESG

disclosure mandate is associated with an additional 16.8 million in capital raised. I find similar

results when I consider mandates that cover the individual pillars of ESG. Namely, underpricing is

10.3, 20.6, and 15.5 percentage points lower for IPOs issued in countries with environmental, social,

and governance mandates, respectively.

7

The effect is of similar magnitude in matched sample and

in subsample tests that help disentangle the influence of disclosure mandates from other potentially

confounding effects and is robust to different initial return measures, various estimation

techniques, and the exclusion of countries with large numbers of IPOs and extreme underpricing.

The information asymmetry hypothesis predicts that mandatory ESG disclosure should be more

impactful in countries with greater ex ante uncertainty and information asymmetry. When I

consider heterogeneity across my sample countries in the quality and enforcement of accounting

standards, which affects the information environment of IPO firms (Boulton et al., 2011,2017), I

find evidence consistent with this hypothesis. Specifically, the influence of mandatory ESG

disclosure on underpricing is weaker for IPOs issued in countries that adopt IFRS and in countries

with higher‐quality auditing environments and enforcement of accounting standards. This is also

consistent with Dhaliwal et al. (2012), which finds that stand‐alone ESG‐related disclosures are

more impactful in countries with more opaque financial disclosures.

I use several indicators of the quality of my sample countries' legal environments to test the

litigation risk hypothesis. These include La Porta et al.'s (2006) liability standard index, the

availability of class action lawsuits, the number of lawyers, and a measure of the rule of law. If

ESG disclosure mandates reduce the risk of litigation and other ESG‐related penalties, their

effect should be greater in countries where litigation risk is a significant concern. Consistent

with this prediction, the negative relation between ESG disclosure mandates and underpricing

is stronger in countries with higher liability standards, where class action lawsuits are allowed,

with more lawyers, and with a weaker rule of law.

I also show that the negative association between mandatory ESG disclosure and underpricing

is stronger when environmental, social, and governance concerns are greater. I use a measure of

climate vulnerability and readiness reported by the Notre Dame Global Adaptation Initiative to

examine the influence of environmental concerns and find that the negative impact of ESG

disclosure mandates on underpricing is stronger for IPOs issued in countries struggling to adapt to

the challenges posed by climate change. Barrett et al.'s (2022) Reported Social Unrest Index

7

Cornell and Shapiro (2021) argue that it is a mistake to bundle environmental, social, and governance together.

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