Environmental,social and governance reporting in annual reports: A textual analysis

Considering environmental, social, and governance (ESG) factors becomes increasingly important for companies and investors. However, “ESG” is not clearly defined so far and, therefore, it is difficult to measure the ESG activity of companies. We analyze the extent and changes in 10‐K reports and proxy statements on ESG, using a textual analysis and creating an ESG dictionary. The results show an average of 4.0 % ESG words on total words in the reports. The ESG word list with 482 items can be used to quantitatively examine the extent of ESG reporting, which will be helpful especially for SRI investors. Our classification of 40 subcategories allows a highly granular analysis of different ESG related aspects. Moreover, indications for a relation between changes in reporting and real events, especially negative media presence, are detected. Regulatory bodies have to be aware of the use of such words and how they are used.     

The Israeli XBRL Adoption Experience

eXtensible Business Reporting Language (XBRL) is a language for the electronic communication of business and financial data which is revolutionizing business reporting around the world. It is a tool to bridge potential language barriers and unify financial reporting. This has appeal to foreign investors, among others, who can rely on information in XBRL‐tagged financial reports to make investment decisions without having to translate financial statements from local language. In 2008, Israel required most public companies to adopt International Financial Reporting Standards (IFRS) for financial reporting and to use XBRL‐tagged reporting format, as part of an aggressive effort to make its capital markets more transparent and attractive for foreign investors. In this paper, we study all Israeli public companies and analyze the accuracy and reliability of their XBRL‐tagged financial statements that are available on MAGNA, the Israel Securities Authority's electronic system. We describe the process by which the XBRL‐based data were collected and reported. We document, categorize, and analyze deficiencies in the XBRL‐tagged filings, and inconsistencies between them and the Hebrew‐based annual reports. We observe pervasive data entry errors resulting in inaccurate XBRL‐generated financial reports, which went undetected for over one year. Further, first year XBRL reporting (in conjunction with IFRS adoption) did not increase foreign investment in the Israeli capital markets. This analysis allows us to better understand the benefits and challenges of the adoption of XBRL.     

ESG for All? The Impact of ESG Screening on Return,Risk, and Diversification

A large body of research has documented a positive relationship between different measures of sustainability—such as indicators of employee satisfaction and effective corporate governance—and corporate financial performance. Nevertheless, many investors still struggle to quantify the value of ESG to investment performance. To address this issue, the authors tested the effects of using different ESG filters on an investable universe that serves as the starting point for a fund manager. In this way, they attempted to determine the extent to which ESG data can add value to any investment approach, regardless of preferences towards sustainable investing. The authors report “an unequivocally positive” contribution to risk‐adjusted returns when using a 10% best‐in‐class ESG screening approach (one that effectively removes companies with the lowest 10% of ESG rankings), both on a global and a developed markets universe. More specifically, as a result of such screening, both the global and developed markets portfolios show higher returns, lower (tail) risk, and no significant reduction of diversification potential despite the reduction in the number of companies. Use of a 25% screening filter was also found to add value, especially by reducing tail risks, but with a larger deviation from the unscreened universe. Overall, then, the authors’ finding is that the incorporation of ESG information contributes to better decision‐making in every investment approach, with the optimal configuration depending on a fund manager's preferences and willingness to deviate from an unscreened benchmark.     

ESG Integration in Investment Management: Myths and Realities

The number of public companies reporting ESG information grew from fewer than 20 in the early 1990s to 8,500 by 2014. Moreover, by the end of 2014, over 1,400 institutional investors that manage some $60 trillion in assets had signed the UN Principles for Responsible Investment (UNPRI). Nevertheless, companies with high ESG “scores” have continued to be viewed by mainstream investors as unlikely to produce competitive shareholder returns, in part because of the findings of older studies showing low returns from the social responsibility investing of the 1990s. But studies of more recent periods suggest that companies with significant ESG programs have actually outperformed their competitors in a number of important ways. The authors’ aim in this article is to set the record straight on the financial performance of sustainable investing while also correcting a number of other widespread misconceptions about this rapidly growing set of principles and methods: Myth Number 1: ESG programs reduce returns on capital and long‐run shareholder value. Reality: Companies committed to ESG are finding competitive advantages in product, labor, and capital markets; and portfolios that have integrated “material” ESG metrics have provided average returns to their investors that are superior to those of conventional portfolios, while exhibiting lower risk. Myth Number 2: ESG is already well integrated into mainstream investment management. Reality: The UNPRI signatories have committed themselves only to adhering to a set of principles for responsible investment, a standard that falls well short of integrating ESG considerations into their investment decisions. Myth Number 3: Companies cannot influence the kind of shareholders who buy their shares, and corporate managers must often sacrifice sustainability goals to meet the quarterly earnings targets of increasingly short‐term‐oriented investors. Reality: Companies that pursue major sustainability initiatives, and publicize them in integrated reports and other communications with investors, have also generally succeeded in attracting disproportionate numbers of longer‐term shareholders. Myth Number 4: ESG data for fundamental analysis is scarce and unreliable. Reality: Thanks to the efforts of reporting and investor organizations such as SASB and Ceres, and of CDP data providers like Bloomberg and MSCI, much more “value‐relevant” ESG data on companies has become available in the past ten years. Myth Number 5: ESG adds value almost entirely by limiting risks. Reality: Along with lower risk and a lower cost of capital, companies with high ESG scores have also experienced increases in operating efficiency and expansions into new markets. Myth Number 6: Consideration of ESG factors might create a conflict with fiduciary duty for some investors. Reality: Many ESG factors have been shown to have positive correlations with corporate financial performance and value, prompting ERISA in 2015 to reverse its earlier instructions to pension funds about the legitimacy of taking account of “non‐financial” considerations when investing in companies.     

ESG preferences,risk and return

There are two primary factors that affect expected returns for companies with high ESG (environmental, social and governance) ratings—investor preferences and risk. Although investor preferences for highly rated ESG companies can lower the cost of capital, the flip side of the coin is lower expected returns for investors. Regarding risk, the jury remains out on whether there is an ESG-related risk factor. However, to the extent, ESG is a risk factor it also points towards lower expected returns for investments in highly rated companies. Though ESG investing may have social benefits, higher expected returns for investors are not among them.     

Innovation in Stock Exchanges: Driving ESG Disclosure and Performance

Stock exchanges are in a unique position to promote ESG transparency and leverage their institutional capacity to build more sustainable capital markets. To facilitate the quick uptake of material ESG disclosure and raise the quality and comparability of the data, the Athens Stock Exchange has created ESG guidelines for listed companies that will be published in the summer of 2019. One important feature of the guidelines is their degree of sectoral specificity and emphasis on materiality. The guidelines and supporting metrics they propose are based on reporting practices endorsed by international sustainability standards like the SASB's industry standards. This materiality‐oriented approach will help issuers focus on the sustainability value drivers inherent in their business, and so ensure that corporate ESG disclosures satisfy the demand of investors for comparable quantitative and accounting metrics that help companies communicate their commitment to long‐term value creation.     

Application of the Reporting Entity Concept in Australia

For decades, the reporting entity concept has been the foundation of differential reporting in Australia. Those entities classified as ‘reporting entities’ are, prima facie, required to produce full GAAP‐based financial reports while other (non‐reporting) entities are generally able to produce less complex and shorter ‘special purpose’ financial reports. In recent years, the application of the concept, as originally set out in the Statement of Accounting Concepts (SAC) 1 Definition of the Reporting Entity, has been criticized on several grounds—particularly, that it does not yield the reporting outcomes originally intended by regulators. Our analysis of 1,546 companies lodging financial statements with the corporate regulator in Australia (ASIC) shows the principles‐based criteria in SAC 1, designed to indicate the existence of a reporting entity, do not systematically explain its application by entities. Our findings are relevant for policy makers, researchers, and regulators concerned with how these choices might be more effectively regulated in future and whether this is best done through principles‐based or rules‐based approaches.     

Sustainability priorities,corporate strategy,and investor behavior

Using a sequential experiment, this study examines whether integration of material environmental, social, and governance (ESG) priorities into corporate strategy impacts investors’ short‐ and long‐term stock price assessments and investment allocation. In our examination, we consider the potential moderating effect of financial performance. We find that integration of ESG priorities into strategy does not have a significant effect on investors’ price assessments or investment allocation. This is true regardless of the trend in the company's financial performance. Our results hold across various demographics and the levels of investment knowledge and investment experience. Investors’ perception of relevance and reliability of material ESG information, however, has a mediating effect on their long‐term price assessment and investment allocation. Overall, our findings suggest that any future requirements on disclosure of ESG information by regulators and standard setters should aim to improve investors’ perception of the relevance and reliability of that information.     

Secret Recipe of IPO survival: ESG disclosure and performance

While ESG initiation and disclosure may help newly listed companies maintain a social license to operate, mitigate information asymmetry, and attract investor attention, it may impose significant costs on initial public offering (IPO) firms and magnify agency problems. Using a sample of 1102 IPOs issued in the U.S and the ESG data from MSCI between 1999 and 2016, the paper empirically tests the competing hypotheses and examines the influence of ESG disclosure and performance on the survivability of IPOs. We document that (1) voluntary ESG disclosure reduces IPO failure risks and improves long-run performance of IPO; (2) the sooner ESG information is disclosed after the IPO, the greater the likelihood of survival and better long-run performance; and (3) IPOs with better ESG score are less likely to fail, with the impact largely attributable to the company's social and governance performance. Our findings identify new failure risks for IPOs, supply evidence of value-relevance of ESG, and provide practical guidance for managers.     

ESG,risk, and (tail) dependence

While environmental, social, and governance (ESG) trading activity has been a distinctive feature of financial markets, the debate if ESG scores can also convey information regarding a company’s riskiness remains open. Regulatory authorities, such as the European Banking Authority (EBA), have acknowledged that ESG factors can contribute to risk. Therefore, it is important to model such risk dependencies and quantify what part of a company’s riskiness can be attributed to the ESG scores. This paper aims to question whether ESG scores can be used to provide information on (tail) riskiness. By analyzing the (tail) dependence structure of companies with a range of ESG scores, that is within an ESG rating class, using high-dimensional vine copula modeling, we are able to show that risk can also depend on and be directly associated with a specific ESG rating class. Empirical findings on real-world data show positive not negligible ESG risks determined by ESG scores, especially during the 2008 crisis.     

Reporting Frequency, Information Precision and Private Information Acquisition

Abstract:  This study examines whether the choice between quarterly and semiannual reporting affects the precision of investors' information and their private information acquisition activities. In the first part of this study, we show that a firm's reporting frequency has no effect on the average precision of investors' information. However, our analysis of announcement-period price variance and share turnover shows that an increase in reporting frequency does make interim and annual financial reports a more important component of investors' information set, relative to other sources of information. In particular, the results of this analysis suggest that investors of semiannual reporters hold more precise pre-announcement information than investors of quarterly reporters. In the second part of our study, we test one explanation for this finding. We argue that an increase in a firm's reporting frequency reduces investors' incentives to acquire private information between consecutive announcement dates and, consequently, should reduce information asymmetry among investors, increase share liquidity, and stimulate trading. Consistent with this reasoning, we find that quarterly reporters have lower average bid-ask spreads and higher abnormal share turnover than semiannual reporters.     

The Use of Management Accounting Techniques by Small and Medium‐Sized Enterprises: A Field Study of Canadian and Australian Practice

Small and medium‐sized enterprises (SMEs) represent a large and important part of developed economies. However, little is known about the extent to which SMEs use contemporary management accounting (MA) techniques such as costing systems, budgets, responsibility center reporting, and analysis for decision making. To address this gap in the literature, we conducted in‐depth field interviews at 22 SMEs to: (1) determine the extent to which common MA techniques and tools are being used by SMEs; and (2) explore the underlying reasons why specific MA techniques are not being used. We find that of the 19 common MA techniques covered in our interviews, a very small number are moderately or highly used by our respondent companies. Moreover, we find that manufacturing companies in our study are more likely to use a broader set of techniques such as costing systems, operating budgets, and variance analysis and that smaller, early‐stage SMEs are the lightest users of MA tools overall. We identify three main factors affecting the adoption and use of MA techniques: (1) the perceived decision‐usefulness of the technique; (2) the complexity of the SMEs’ operating environment; and (3) the age of the SME. We discuss the contributions of our study and its potential implications for MA educators, developers of professional education programs, designers of SME control systems, and textbook authors.     

Enterprise resource planning enabling segmental information reporting practices of UK‐FTSE 100

The ERP impact on management accounting practices has been widely recognised as having a knowledge gap in relation to how it may facilitate Segmental Information Reporting following the International Financial Reporting Standard No. 8’s (IFRS‐8) management approach. This study contributes to filling this gap by investigating the joint effect of the ERP and IFRS‐8 Post‐Implementation Review (PIR) on dimensions: quality, quantity and the reporters’ identity of FTSE‐100 companies in the period 2013–2017. The study found that ERP is significantly and positively associated with the dimensions of segmental information reporting. The implications of this study extend research and the practices of segmental reporting on the importance of ERP in operationalising segmental reporting and in understanding variations.     

“Non‐Financial” Is a Misnomer,but Doesn't Have to Be a Missed Opportunity

With enterprise values now representing increasing multiples of companies' net book assets, investors are clearly looking beyond financial reporting for enhanced insights and understanding of when and how companies are adding value. This shift includes growing attention to environmental, social, and governance (ESG) information. Although ESG data presents its own unique challenges, dismissing it as “non‐financial” can be misleading. When explicitly linked to a company's long‐term value creation strategy, ESG information can serve as a valuable input to more farsighted financial analysis. Market‐driven initiatives, notably that of the Sustainability Accounting Standards Board (SASB), aim to standardize a subset of business‐critical, industry‐specific sustainability data for investors. Research indicates such approaches can generate positive outcomes not only for providers of financial capital, but for their portfolio companies and markets in general. In illustrating these concepts, the authors explore ESG impacts in three sectors and industries, while examining how access to consistent, comparable, reliable sustainability information in those sectors can augment an analysis of traditional business fundamentals. One example focuses on water management in the Oil & Gas Exploration & Production industry, a major environmental issue where geographic considerations can shed light on company‐specific exposures to cost increases, production disruptions, increased CapEx and R&D spending, as well as the potential for asset write‐downs. In the Food & Beverage sector, health and nutrition concerns are shown to be changing consumer preferences, triggering regulatory action, and reshaping companies' product portfolios—with significant implications for the companies' brand values and ability to compete for market share. Finally, in Aerospace & Defense, lapses in business ethics such as bribery of government officials present a governance challenge that comes with the risk of value‐destroying fines and penalties and, even more significant, associated reductions in revenues.     

The end of ESG

ESG is both extremely important and nothing special. It's extremely important because it's critical to long-term value, and so any academic or practitioner should take it seriously, not just those with “ESG” in their research interests or job title. Thus, ESG doesn't need a specialized term, as that implies it's niche—considering long-term factors isn't ESG investing; it's investing. It's nothing special since it's no better or worse than other intangible assets that create long-term financial and social returns, such as management quality, corporate culture, and innovative capability. Companies shouldn't be praised more for improving their ESG performance than these other intangibles; investor engagement on ESG factors shouldn't be put on a pedestal compared to engagement on other value drivers. We want great companies, not just companies that are great at ESG.     

Is sustainability rating material to the market?

This study examines whether information about a firm's engagement in environmental, social, and governance (ESG) practices is material to market participants. Evidence from a sample of 1856 initial public offerings (IPOs) by U.S. companies for the 2007–2018 period robustly documents that firms for which there is available ESG performance information prior to going public exhibit higher underpricing due to a positive market response. Such a reaction is validated by agency cost-reducing practices that ESG-rated firms follow prior to the IPO, the superior post-IPO market performance they exhibit in terms of equity financing, and the higher share of financially sophisticated investors they attract compared to their ESG-unrated peers. Overall, our results highlight that it pays off to do good and to have the right investors; however, firms’ good ESG practices need to be visible to the market, through rating practices, to reap the benefits.     

Integrated Reporting,Quality of Management,and Financial Performance

Interest in integrated reporting continues to grow as its proponents cite a number of significant benefits to both companies and investors. But given the still‐early stages of development of this new management practice and the relative paucity of data, establishing empirical confirmation of these claims is difficult. Using RobecomSAM's proprietary database of over 2,000 companies surveyed during its annual Corporate Sustainability Assessment (CSA), the authors discuss the extent and recent growth of integrated reporting, and its likely effects on important indicators of both ESG quality of management and financial performance. The authors begin by reporting that although only 12% of the companies in the survey dataset practiced some form of integrated reporting in 2012, that number represented a 50% increase from 2011. The authors also report a strong relationship between integrated reporting and ESG quality of management, which some studies suggest has become a useful indicator of the overall effectiveness of management in creating value over the long term. This relationship is particularly strong in certain sectors, notably healthcare. At the same time, the authors find a relationship between integrated reporting and financial performance for two sectors—healthcare and information technology—though not for the population as a whole. The authors suggest that this apparent lack of effect may be attributable to a time lag between integrated reporting's contribution to better ESG quality of management, and the eventual reflection of such management in financial performance.     

When ESG talks: ESG tone of 10-K reports and its significance to stock markets

Since the ESG topic consistently gains on importance in the investment universe, companies provide investors with information regarding recent and future ESG activities through different reporting channels. The most recent research finds relevance of ESG-related corporate activities for formation of investors' opinion regarding companies' valuations and growth prospects. Based on a sample of more than seventeen thousand unique 10-K reports of US companies filed with SEC in period 2013 to 2019 and the word-power methodology proposed by Jegadeesh and Wu (2013), this study also shows evidence for significant relation of ESG textual tone of 10-K reports to stock market returns of filing companies around the report filing dates. Using the ESG linguistic dictionary recently proposed by Baier, Berninger, and Kiesel (2020), this study shows evidence for significant relation of social and governance-related topics disclosure to stock returns, while environmental narratives being ignored by the markets. When looking at individual words from the ESG lexicon, such words as “community”, “health”, “control” imply positive reaction of markets, while “discrimination”, “embezzlement”, and “crime” are related to negative returns. The robustness analysis based on the inverse document frequency word weightings and actual ESG performance scores confirms the significance of ESG information disclosure of 10-K reports for investors. Thus, this study sheds light on the mechanics of ESG information perception and its influence on capital markets.     

Material weakness disclosures and restatement announcements: The joint and order effects

We examine differences in stock price, option volatility, and litigation reactions to restatement announcements that are associated with a material weakness (MW) disclosure. Contrasted with restatements that are not associated with any MW disclosure, our analyses reveal that firms that announce both a restatement and an associated MW experience significantly more negative market returns, greater implied volatility, and higher likelihood of class action lawsuits. Separating the restatements into timely reporters, where the MW precedes the restatement, and non‐timely reporters, where the MW is concurrent with or follows the restatement, we find that timely reporters experience more negative returns at the time of the restatement, relative to non‐timely reporters, suggesting that investors perceive the early MW disclosure to signal more pervasive control‐related problems. Interestingly, we find that timely and non‐timely reporters are equally likely to be sued, consistent with the argument that wrongdoing (through either a timely or non‐timely MW disclosure) provides stronger grounds for establishing scienter. However, timely reporters appear to secure more favorable litigation outcomes: they face higher likelihood of lawsuit dismissals and pay much lower settlements, compared to non‐timely reporters. Overall, our evidence provides new insights into how market participants incorporate information about internal control weaknesses into their perceptions regarding the economic implications of financial restatements, and financial reporting quality.     

Audit 4.0-based ESG assurance: An example of using satellite images on GHG emissions

As Environment, Social, and Governance (ESG) information has become an essential resource for investors, regulators have attempted to assure its quality. While more companies offer ESG disclosure, it is usually not fully substantiated with supporting information. Assurance is needed to verify that ESG reports are free of substantive errors. However, traditional financial audit approaches are less effective in providing ESG assurance due to the difference in the nature of evidence, difficulty in measuring and verifying ESG measures, and ever-changing ESG performance. To increase the effectiveness of ESG audit approaches, this study proposes Audit 4.0-based ESG assurance, which uses Big Data and emerging technologies of Audit 4.0 to capture evidence from the physical world and provide accurate assurance on ESG reports in a timely manner. We further perform a case study as a proof of concept of the proposed approach, which explores the integration of satellite-based methane estimation as ESG audit evidence. The use of satellite images provides opportunities for regulators and companies to monitor and assure ESG reports in a continuous manner.