Non-Financial Reporting: Economics and Real Effects

Sustainability plays an increasingly important role in society and the political debate. In addition to environmental factors, sustainability also includes social factors and good corporate governance, such as human rights and the prevention of corruption and bribery. In the Paris Agreement of 2015, most countries agreed to limit global warming well below 2 degrees in this century. As a result, the EU developed the European Green Deal in 2019 to make Europe the first climate-neutral continent. Companies have to make a significant contribution to the EU`s sustainability goals. Part of the EUs strategy is to increase companies transparency. The reasoning behind this is that increased transparency should lead to a change in corporate behavior. This effect can be triggered, among other things, by pressure from the capital and product markets. In recent years, the EU has developed many transparency rules for companies. Currently, the EU develops even stricter rules and works on European standards for sustainability reporting. Unfortunately, there is currently little theoretical foundation for sustainability reporting. However, the current legal initiatives can only be crowned with success if the regulation developed is smart. Since there are few empirical studies because sustainability reporting has only recently become mandatory for companies, a theoretical foundation is of utmost importance. This research project aims to close this gap. Based on mathematical and game -theoretical modeling, we aim to develop a better understanding of the economic mechanisms and also possible unintentional effects. On the one hand, our results will help predict the economic effects of future regulation. On the other hand, the results may serve politicians and standard setters.

The research project provides valuable insights into the theoretical findings on associations and causal effects of non-financial reporting (NFR). By applying analytical modelling, it provides a clearer understanding of how NFR affects stakeholders. By focusing on investors and capital markets as the primary target group of NFR, the project explains how information spillovers between NFR and financial reporting affect firms' investments in environmental, social, and governance (ESG) improvements and NFR and financial reporting strategies, revealing interactions between earnings management and greenwashing. Mandatory NFR proves to be a powerful regulatory tool to promote corporate ESG efforts, where information spillovers alter investment and reporting strategies. Due to the discretionary nature of non-financial information, NFR often lacks credibility, making third-party certification mechanisms and auditing crucial for ensuring high quality NFR. The project highlights that a truth-telling certification mechanism - which accurately identifies a firm's underlying ESG characteristics- is essential for effectively reducing environmental damage. From an audit perspective, it emphasizes the need to consider the interaction between financial and non-financial audit markets when introducing mandatory auditing of NFR. Beyond auditors, secondary stakeholders such as non-governmental organizations (NGOs) play a vital role in exposing greenwashing through activism. NGOs can also influence the effectiveness of mandatory NFR through strategic communication and by raising investor awareness of ESG issues. Additionally, the project examines product markets - comprising consumers, competitors, and suppliers - as another target group of NFR. It reveals that firms might have incentives to voluntarily commit to transparency about their ESG performance if consumer positively value such a commitment. A transparency mandate can enhance total welfare by compelling firms to reduce negative ESG impacts. However, when considering vertical competition, transparency strategies in downstream markets and the welfare effects of a mandate may shift. Finally, when examining the quality of NFR reporting in supply chains, the project findings show that increasing the quality of reporting can lead to detreating effects on ESG performance. Another major focus of the project was the design of optimal performance contracts in the presence of varying shareholder preferences. The project findings show that while owners cannot directly incentivize managers to pursue ESG strategies, they can do so indirectly through financial incentives within a conservative accounting system. This result offers important implications for empirical studies that so far find mixed results. To engage with the broader academic and policy-making communities on the project topics, the project staff gave talks at renowned academic and practitioner events. Additionally, the project hosted a symposium at the Center for Accounting Research at the University of Graz. This event brought together leading scholars who shared their perspectives on the economics of NFR and featured high-level discussions on current regulatory challenges and future developments.