Environmental transparency and investors' risk perception: Cross‐country evidence on multinational corporations' sustainability practices and cost of equity

Abstract

We explore whether a greater amount of environmental disclosure can reduce a firm's ex ante cost of equity. This could occur because the quantity of environmental information changes investors' risk perception of the company, thereby influencing its ex ante cost of equity. Our study is a cross-country analysis of 1481 multinational corporations (MNCs) across 43 countries and territories from 2013 to 2019. Firstly, we measure investors' risk perception as a firm's ex ante cost of equity by employing five different valuation models, all based on equity analysts' forecasted data. We then investigate whether large quantities of environmental information disclosed by an MNC affect its ex ante cost of equity. We find evidence that investors price the amount of environmental disclosure. More environmental disclosure decreases a firm's ex ante cost of equity because it lessens investors' information asymmetry.However, this relationship is non-linear. Once the amount of environmental disclosure data exceeds a certain threshold level, a firm's ex ante cost of equity will rise again. Our empirical results also suggest that non-financial factors at the country level play a role in shaping how investors perceive a firm's riskiness. Locating the firm in a country with better environmental performance and a higher score of the human development index can reduce investors' risk perception and result in a lower ex ante cost of equity. A policy implication of our findings is that a global standardised and effective corporate sustainability reporting is needed to provide investors a more holistic view for evaluating the riskiness of their investments.

Are firms with better sustainability performance more resilient during crises?

“…GDP growth is the annual change of GDP in percentage from the World Bank. We use the World Bank's Worldwide Governance Indicators (WGI) as the proxy for country‐level governance (Orazalin & Mahmood, 2021; Yu et al, 2021). WGI has six indicators, and each indicator ranges from −2.5 weak to 2.5 strong: (1) voice and accountability, (2) political stability and absence of violence/terrorism, (3) government effectiveness, (4) regulatory quality, (5) the rule of law, and (6) control of corruption.…”

The impact of environmental disclosure on initial public offering underpricing: Sustainable development in Singapore

“…For instance, Reber et al (2021) found that voluntary CSR disclosures reduce idiosyncratic volatility and downside risk of stock price declines at IPOs. Environmental disclosures, the focus of our study, have been found to decrease information asymmetry and reduce the risk profiles of firms (Benlemlih et al, 2018; Cormier & Magnan, 2015; Yu et al, 2021). However, studies on the relationship between environmental disclosures and post‐IPO returns have produced equivocal results (Huang et al, 2019; Pencle & Mălăescu, 2016).…”

“…For instance, Reber et al (2021) found that voluntary CSR disclosures reduce idiosyncratic volatility and downside risk of stock price declines at IPOs. Environmental disclosures, the focus of our study, have been found to decrease information asymmetry and reduce the risk profiles of firms (Benlemlih et al, 2018;Cormier & Magnan, 2015;Yu et al, 2021).…”

“…Social disclosures in the prospectuses largely cover GRI categories related to employment, occupational health and safety, training and education, customer health and safety, local communities, socioeconomic compliance, labor/management relations, and customer privacy. We also controlled for the total number of words in environmental disclosures and social disclosures (in tens of thousands) to ensure that our results are not driven by the quantity of such disclosures (Yu et al, 2021).…”

“…Environmental disclosures play an important role in decreasing information asymmetry by conveying complementary and relevant information to investors (Clarkson et al, 2004; Du & Yu, 2020; Feng et al, 2018; Grewal et al, 2021; Yu et al, 2021). According to The Global Risks Report 2021, the top 3 risks that the world is likely to face over the next decades are predominantly environmental risks: extreme weather events, climate action failures, and anthropogenic environmental damages (WEF, 2021).…”