Mandatory ESG disclosures will impose substantial costs on companies in Canada

Should government regulators in Canada force companies to file Environmental, Social and Governance (ESG) disclosure reports? Proponents argue that mandatory disclosures would make it easier for investors to identify and compare ESG performances (greenhouse gas emissions data, for example) and reduce the likelihood of companies fabricating or exaggerating their ESG-related activities.

But if ESG is important to shareholders, consumers, employees and other stakeholders that can affect corporate profitability, companies already have strong financial incentives to disclose voluntarily, without a government mandate. Furthermore, since companies that get caught fabricating their ESG-related activities (a practise known as “greenwashing”) can expect financial repercussions in the form of reduced demand for their products or higher costs for labour, they’re incentivized not to greenwash. Clearly, the case for mandating ESG disclosure is debatable, to say the least.

In addition to mandatory disclosure, advocates also want ESG disclosures standardized—that is, to create a universal ESG reporting system that applies across industries and borders. But, as documented in a new essay published by the Fraser Institute, this is also a flawed idea.

For starters, “ESG” encompasses many corporate issues including carbon emissions, water management and conservation, diversity in hiring, board composition, financial support for community organizations, and more.

As such, any standardized format for mandated ESG disclosures, which hoped to address ESG-related issues of potential interest to stakeholders beyond the shareholders, is clearly impractical. And any initiative on the part of regulators to narrow the list of ESG-related disclosures—a likely necessary step in any standardization process—would involve arbitrary value judgments that would further politicize the regulatory process.

Moreover, much of the information of potential relevance to stakeholders is not quantifiable (or at least not capable of being reported in a uniform metric such as dollars). For example, how can regulators assign monetary values to the racial and gender compositions of corporate boards of directors? Without being able to aggregate components of the disparate ESG activities of different companies into a uniform metric, it would be impossible to compare companies based on their overall standardized ESG performances.

Finally, effectively auditing and enforcing mandated and standardized ESG disclosures across all public companies would be extremely costly and likely legally impossible. In particular, requiring audit quality ESG-related information from internationally diversified companies with complex and dispersed supply chains would require those companies to collect and process ESG-related information from hundreds if not thousands of suppliers and distributors in numerous countries. In many cases, national governments have legal restrictions on the transfer of information that would be needed by multinational companies headquartered in foreign countries.

If government regulators force public companies to disclose all their ESG-related information, they will impose substantial administrative costs on these companies, which will likely be orders of magnitude greater than costs associated with the existing financial disclosure regulatory regime. And the imposition of additional reporting costs on public companies will discourage many privately owned companies from going public with attendant efficiency losses to the Canadian economy and more limited investment opportunities for retail investors in Canada.