Impact of ESG disclosure and financial reporting quality on investment efficiency

• DOI: https://doi.org/10.1108/CG-06-2021-0209
• Published date: 03 February 2022
• Date: 03 February 2022
• Pages: 1094-1111
• Subject Matter: Strategy,Corporate governance
• Author: Nejla Ould Daoud Ellili

Impact of ESG disclosure and f‌inancial

reporting quality on investment eff‌iciency

Nejla Ould Daoud Ellili

Abstract

Purpose –This study aims to examine the impacts of environmental, social and governance (ESG)

disclosureand financial reporting quality (FRQ) on investmentefficiency.

Design/methodology/approach –Several econometric models have been applied to estimate the

impacts of ESGdisclosure and FRQ on investment efficiency,using the United Arab Emirates (UAE)as a

sample in 2010–2019.Estimations considered subsamples of underinvestment,overinvestment and low

and high FRQ values.

Findings –Empirical resultsshow a positive relationship between ESGdisclosure, FRQ and investment

efficiency,and that this relationship is moreimportant in the underinvestmentand high FRQ sub-samples.

Results suggest that ESG disclosure improves transparency, mitigates information asymmetry and

enhancesinvestment efficiency.

Research limitations/implications –The findings could help UAE regulators incorporate ESG

informationinto reporting and implement effective mechanismsto increase the extent of ESG information

to improve investment efficiency. This study only examined UAE traded companies. Future research

should investigate other factors influencing investment efficiency and conduct comparative studies

acrossGulf Cooperation Council countries.

Social implications –This study reveals the significantpositive impact of ESG disclosure and FRQ on

investment efficiency. These findings will help companies optimize their ESG information disclosure,

improve the qualityof their financial reports and comply with ESG standards.The study aims to develop

knowledge thatwill not only benefit companies regardingthe potential impact of ESG disclosure but also

help nationaland international society createa better social environment and reduce climatechange.

Originality/value –To the best of the authors’ knowledge, this study is the first to examine the

relationship between ESG disclosure, FRQ and corporate investment efficiency. The research

contributes to understandingthe financial impacts of ESG disclosure and FRQ andsupports regulators’

effortsto enforce ESG disclosure and improve FRQ.

Keywords ESG disclosure, Financial reporting quality, Investmenteff‌iciency, Panel data

Paper type Research paper

1. Introduction

Over time, natural resources are being depleted, and environmental changes are occurring

more rapidly; consequently, international legal bodies and most developed nations are

continuously raising questions about sustainability. In the past decade, sustainability

disclosure has attracted the interest of many i nternational organizations working toward a

sustainable green economy. These organizations have developed several frameworks, such

as the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC),

the Sustainability Accounting Standards Board (SASB), the Carbon Disclosure Project and

the United Nations Global Compact, that provide companies with clear guidance on reporting

non-financial financial issues such as environmental and corporate social responsibility (CSR)

disclosures. In the United Arab Emirates (UAE), the Securities and Commodities Authority

updated the code of corporate governance, which was initially established in 2009, with new

rules including, among others, those pertaining to the sophistication of corporate governance,

Nejla Ould Daoud Ellili is

based at the College of

Business, Abu Dhabi

University, Abu Dhabi,

United Arab Emirates.

JEL classif‌ication –C33, G32,

G34

Received 16 March 2021

Revised 15 September 2021

27 December 2021

Accepted 6 January 2022

Author contributions: The

author conceived and

designed the project, collected

the data, performed the

analysis and wrote the paper.

Funding: This research was

funded by Abu Dhabi

University, Abu Dhabi, United

Arab Emirates.

Conflicts of interest: The author

declares no conflicts of interest.

PAGE 1094 jCORPORATE GOVERNANCE jVOL. 22 NO. 5 2022,pp. 1094-1111, ©Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-06-2021-0209

further protection for shareholders and the promoti on of CSR with respect to investing in and

facilitating the financing of sustainable development projects. More recently, in 2019, UAE

financial regulators introduced the environmental, social an d governance (ESG) reporting

guide to listed companies to incorporate ESG information into their reporting processes,

improve their transparency and meet their investors’ requirements. Thus far, ESG disclosure

has been implemented on a voluntary basis, but listed companies have been strongly

encouraged to disclose their ESG information.

In recent years, ESG disclosure has playedan important role in satisfying investors’ growing

demand for non-financial information, and investors consider it to be strong evidence of

companies’ compliance with non-financial disclosure best practices (such as the GRI, IIRC

and SASB). The importance of ESG disclosure has grown exponentially and attracted the

interest of researchers, financial regulators and rating agencies (e.g. Fitch, Standard and

Poor’s and Moody’s). These agencies have undertaken ESG assessments based on

companies’ disclosed ESG informationto obtain scores and ratings and assist the investors

in their financial decisions.

The literature has analyzed different aspects of ESG disclosure. For instance, Ellili (2020),

Sharma et al. (2020) and Suttipun (2021) examined the extent of ESG disclosure and

confirmed that although it is still low level, the extent of this information has been increasing

over the years. Additionally, governance information accounts for the largest part of ESG

disclosure, followed by social and environmental information. More recently, many studies

(Manita et al., 2018;Arayssi et al., 2020;Shakil, 2021;De Masi et al., 2021) have explored the

impact of different corporate governance mechanisms on ESG disclosure. There is no

consensus in the results, and the evidence is mixed, with the association having been found

to be positive, negative or neutral. Furthermore, none of the abovementioned studies

examined the potential impact of ESG disclosure on investment efficiency. This is an

interesting research opportunity because in the UAE, emphasis is on requiring all listed

companies to incorporate ESG information into their reporting processes and improve their

compliance with ESG disclosure best practices. The UAE is the subject of this study for many

reasons. First, it is top-ranked in the Middle East and North Africa region for transparency,

according to the corruption perception index (Transparency International, 2020). Second,

according to the Kearney foreign direct investment (FDI) confidence index, the UAE has

enhanced its appeal for FDIs, moving from an inde x ranking of 21st in 2017 to 19th in 2020

(Kearney, 2020). This international progress is due toforeign investors’ optimism following the

UAE’s implementation of financial regulation reforms addressing transparency and reporting

quality. Third, the UAE has the highest corporate governance index in the Gulf Cooperation

Council (GCC) region, which indicates that it is implementing the best corporate governance

practices (Pillai and Al-Malkawi, 2016). In addition, there have been many initiatives in the

UAE to increase sustainability awareness. For instance, in 2010, the UAE launched its

national vision 2021 with the aim of realizing a more diversified and knowledgeable economy

by focusing on a sustainable environment, including infrastructure. More recently, in 2017, the

UAE initiated the 2050 national strategy to meet its econo mic and environmental goals, and

achieve an energy mix that combines renewable, nuclear and clean energy sources. The

focus areas are to increase clean energy’s contribution to the total energy mix from 25% to

50% by 2050 and reduce power generation’s carbon footprint by 70%. Realizing this vision

entails mandatory ESG disclosure for all listed companies. Hence, this study will provide

insight into the extent of companies’ compliance with gover nmental sustainability initiatives.

Against this background, this study attempted to answer two main questions: Is there any

significant association between ESG disclosure and investment efficiency? Is there any

significant relationshipbetween financial reporting quality (FRQ) and investment efficiency?

Although this study is similar to previous studies on the potential impacts of non-financial

disclosure and FRQ on investment efficiency, it contributes to the existing literature –

particularly to filling the gap in ESG disclosure research –in several ways. First, by

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