Environmental, Social, and Governance (ESG) Disclosures and Firm Value: The Role of Earnings Quality

Abstract

The growing interest in Environment, Social, and Governance aspects and its disclosures have become inevitable for businesses and stakeholders. Diverse stakeholders, including institutional investors, individual investors, and financial institutions, increasingly consider Environment, Social, and Governance (ESG) or sustainability disclosures as an important component of the investment decision-making process. The rising importance of ESG information disclosures, especially in investment decisions, is attracting the interest of regulators towards the rules and regulations of mandatory sustainability or ESG reporting. In this dissertation, the link between ESG disclosures and earnings quality is established, and its economic implications are examined through reduced cost of capital. Moreover, with the increased demand for additional ESG information disclosures by the firms and a plethora of accessible ESG information, it becomes difficult for the stakeholders to assess the integrity of such disclosures. Therefore, this thesis aims to investigate the value relevance of ESG disclosures, establish the link between firms' ESG disclosures and earnings quality, and explore the collective impact of all three variables viz. ESG disclosures, earnings quality, and cost of capital. The overall findings of the thesis are three-fold. First, to establish the impact of earnings quality on ESG disclosures, findings show a complementary association, which implies that firms with high (low) earnings quality disclose more (less) ESG information. Thus, the complementary relationship is reported in line with voluntary disclosure theory. Second, to assess the value relevance of Environmental, Social, and Governance disclosures, two competing theoretical perspectives are used, i.e., the stakeholder approach and the shareholder approach. The results indicated that higher ESG disclosures lead to lower cost of capital. The findings confirm the stakeholder approach to ESG or sustainable activities. Third, under the purview of voluntary disclosure and stakeholder theory, the conditional role of earnings quality between ESG disclosures and the cost of capital is explored. The findings of the thesis indicate the first-order effect of firm’s earnings quality on its cost of capital; interestingly, ESG disclosures become insignificant in the presence of earnings quality in the model. The overall results suggest that despite the rising trend of sustainable information, investors prefer the accounting quality of the system over ESG data/ information.