(with Henry L. Friedman and Mirko S. Heinle)
Accepted at Review of Accounting Studies
Firms and jurisdictions are increasingly adopting ESG reporting, driving a growing empirical literature on the consequences of ESG reporting for investors, firms, and other stakeholders. We develop a model to understand the nuanced effects of the introduction of outcome-based ESG reporting. In our model, a firm provides ESG and financial reports, which investors use to price the firm's stock, influencing management's real and reporting incentives. We characterize how investors respond to new ESG reporting; how the introduction of ESG reports affects stock prices and market responses to financial disclosures; and trace these effects to managerial decisions, ESG performance, expected cash flows, and misreporting. We provide conditions under which the introduction of ESG reporting discourages corporate ESG, and under which it encourages corporate ESG but lowers the equity price at the same time. Comparative statics show how investor preferences (e.g., concern for ESG) affect real outcomes and market responses to reports. We discuss empirical implications of our results and how our model can be applied to settings involving non-ESG disclosures.
(with Mirko S. Heinle and Christopher S. Armstrong)
Review of Accounting Studies 29 (2024)
https://doi.org/10.1007/s11142-024-09832-w
Standard Bayesians' beliefs converge when they receive the same piece of new information. However, when agents have uncertainty about the precision of a signal, their beliefs might instead diverge more despite receiving the same information. We demonstrate that this divergence leads to a unimodal effect of the absolute surprise in the signal on trading volume. We show that this prediction is consistent with the empirical evidence using trading volume around earnings announcements of US firms. We find evidence of elevated volume following moderate surprises and depressed volume following more extreme surprises, a pattern that is more pronounced when investors are more uncertain about earnings' precision. Because investors can disagree even further after receiving the same piece of news, the relationship between news and trading volume is not necessarily linear, suggesting that trading volume may not be an appropriate proxy for market liquidity.