ESG Disclosures and the Decision to Go Public (ESG: Myths and Realities)

An initial public offering (IPO) involves listing a firm’s shares for sale on a stock exchange for the first time (known colloquially as “going public”). This essay analyzes two questions critically. First, does mandatory environmen­tal, sustainable, and governance (ESG) disclo­sure increase the net costs of going public, so that privately owned companies are less likely to do so? Second, if private companies are indeed less likely to go public, what are the associated economic costs of that choice?

Mandatory ESG disclosures are distinct from mandatory ESG practices. While both have costs and benefits, their magnitudes are likely to differ, and the conceptual arguments underlying their benefits and costs may also differ. In this paper, we focus on mandatory ESG reporting, not on ESG practices. Mandatory ESG disclosures are requirements that stock exchanges and securities regulators impose.

There is conflicting evidence on the impact of mandatory ESG reporting on stock market performance following an IPO. On one hand, some empirical evidence suggests that man­datory ESG disclosure improves IPO performance once the stock is listed. The rationale is that ESG disclosures lead to reduced information asymmetry, lower costs of capital, and higher share prices. This evidence could be used to imply that private companies filing for IPO approval should be mandated to issue ESG disclosures prior to their IPOs. Further, this evidence could imply that all private companies that might someday list in public markets should be reporting ESG information even before going public. On the other hand, some empirical evidence shows that mandatory ESG disclosures harm the share prices of publicly traded companies, suggesting that the costs of such disclosures outweigh the benefits. This latter body of evidence is consistent with firms electing not to make ESG disclosures when they are not forced to do so; said differently, if ESG disclosure contributes to higher equity prices and, therefore, to lower costs of capital, why would firms not voluntarily disclose ESG information even if they were not required by regulators to do so?

Overall, the available evidence reviewed in this paper shows that we should expect some firms to delay or avoid taking their companies public due to issues related to mandatory ESG disclosure. The efficiency of capital markets and the performance of the Canadian economy could be significantly affected by whether and how ESG reporting mandates and related compliance costs influence the incentives of investors and firm managers to avoid or delay going public, and, consequently, the performance of IPOs.