Expanding the Accounting Model by Disclosing External Costs and Benefits: Refinement of Mandatory ESG Disclosures

ESG has been offered as a potential, albeit partial, remedy for climate change and a variety of harms allegedly inflicted by firms on society. Specifically, it is generally argued that firms should disclose ESG activities. It is presumed that such disclosures would discipline the firms. It is surmised that investors prefer that firms avoid polluting the environment, mistreating their employees, and committing various social sins, even while diminishing financial returns. Some advocate a broadening of fiduciary duty to extend to all stakeholders, not only shareholders. ESG disclosures are rated, albeit ratings are highly dispersed. Funds often make investment decisions favoring firms with active ESG agenda. Empirical evidence on the benefits of ESG disclosure and actions is mixed. In this essay, I argue that curing social ills and reversing climate change is the task of the government, not the private sector. If ESG activities increase financial returns, rational managers will undertake them; if not, they should shun them. Nevertheless, firms should not harm other entities or individuals. I offer a mechanism that allows policymakers to elicit truthful information on external harm inflicted or benefit conferred on others and act on such information to give rise to optimal production of externalities.