Transmission Effects of ESG Disclosure Regulations Through Bank Lending Networks

• Published date: 01 June 2023
• Author: LYNN LINGHUAN WANG
• Date: 01 June 2023
• DOI: http://doi.org/10.1111/1475-679X.12478

DOI: 10.1111/1475-679X.12478

Journal of Accounting Research

Vol. 61 No. 3 June 2023

Printed in U.S.A.

Transmission Effects of ESG

Disclosure Regulations Through

Bank Lending Networks

LYNN LINGHUAN WANG ∗

Received 16 October 2021; accepted 23 February 2023

∗Faculty of Business and Economics, The University of Hong Kong

Accepted by Rodrigo Verdi. This paper is based on my dissertation. I am very grateful for

the guidance and support from my dissertation committee members, Mingyi Hung (chair),

Zhihong Chen, Yiwei Dou, and Haifeng You. I appreciate the helpful and constructive com-

ments and suggestions from an anonymous associate editor and an anonymous referee. I

thank Ulrich Atz, Thomas Bourveau, Ferdinand Bratek, Matthias Breuer, Anna Costello,

Henry Friedman, Pingyang Gao, Vidhan Goyal, Sangeun Ha, Allen Huang, Chao Jin, Min-

jeong Kim, Oksana Kim (discussant), Amit Kumar, Anthony Le, Christian Leuz, Brian Jongh-

wan Lee, Xi Li, Steve Lin, Yupeng Lin, Ronald Lui, Daniele Macciocchi, Abhiroop Mukherjee,

Lakshmi Naaraayanan, Valeri Nikolaev, Evgeny Petrov, Aneesh Raghunandan, Guoman She,

Nemit Shroff, Andrew Sutherland, Chao Tang,Roberto Vincenzi, Emily Wang, Juanting Wang,

Shiheng Wang, Wei Wang(discussant), Joe Weber, Christopher Williams, Regina Wittenberg-

Moerman, Li Yang, Guochang Zhang, Zilong Zhang, Wanli Zhao, and Yue Zheng; workshop

participants at the University of Michigan, Hong Kong University of Science and Technology,

National University of Singapore, WHU-Otto Beisheim School of Management, Hong Kong

Polytechnic University, Hong Kong Baptist University, Shanghai University of Finance and

Economics, NEOMA Business School, Bocconi University, London School of Economics and

Political Science, and University of Hong Kong; and conference participants at the EAA Talent

Workshop, Miami Accounting Rookie Camp, the 2021 AAA IAS Midyear Meeting, the 2021

Eastern Finance Association Annual Meeting, the 2021 First EAA Virtual Annual Congress,

and the 2022 Journal of Accounting Research Conference. I thank Deepa Sundaran from Re-

finitiv ESG Content Support for sharing data insights. I also thank the GRI team for providing

a complete version of the GRI Reports List. Melanie Hsu, Jane Li, Yanis Ng, and Henry Yeung

provided excellent research assistance for this project. I completed the main analysis while I

was visiting the Ross School of Business, University of Michigan. Financial support from the

Hong Kong University of Science and Technology, Bocconi University, and University of Hong

Kong is gratefully acknowledged. This paper was previously circulated under the title “Spillover

Effects of CSR Disclosure Regulation across Lending Relationships.” An online appendix to this paper

can be downloaded at https://www.chicagobooth.edu/jar-online-supplements.

935

© 2023 The Chookaszian Accounting Research Center at the University of Chicago Booth School of

Business.

936 l. l. wang

ABSTRACT

This paper studies whether and how environmental, social, and governance

(ESG) disclosure regulations imposed on banks generate transmission effects

along the lending channel. I use a setting of U.S. firms borrowing from non-

U.S. banks and exploit the staggered adoption of ESG disclosure regulations

in banks’ home countries. I find that exposed borrowers of affected banks im-

prove their environmental and social (E&S) performance following the dis-

closure mandate. Consistent with banks enhancing both their engagement

and selection activities, affected banks impose more environmental action

covenants in loan contracts, and they are more likely to terminate a bor-

rower with bad E&S records following the regulation. Further evidence shows

that the transmission effects are stronger when a disclosure regulation is well-

enforced (as indicated by a greater increase in banks’ disclosure) and among

borrowers with greater switching costs. Collectively, the findings document

the role of lending relationships in transmitting the real effect of ESG disclo-

sure regulations from banks to borrowing firms.

JEL codes: G18, G21, M14, M40, M48, N20

Keywords: disclosure regulation; ESG reporting; real effect; financial inter-

mediary; bank lending relationship; bank monitoring; borrowers

1. Introduction

I study whether and how environmental, social, and governance (ESG) dis-

closure regulations create transmission effects through bank lending net-

works. ESG considerations have become increasingly important for busi-

nesses around the world due to growing globalization and social advocacy

efforts. In recent decades, banks have played a growing role in the goal

of promoting a culture of environmental and social (E&S) responsibility.1

As important capital and liquidity providers for nonfinancial firms, banks

work as financial accelerators to propagate economic shocks and regulatory

changes (e.g., Bernanke, Gertler, and Gilchrist [1999], Khwaja and Mian

[2008], Chava and Purnanandam [2011]). Although regulations have in-

creasingly required banks to disclose information about their commitment

to ESG engagement (KPMG [2013]), little is known about whether and

how the effects of these disclosure mandates transmit from banks to their

borrowing firms, that is, by altering borrowers’ incentives to engage in ESG.

Identifying such transmission effects helps us understand the role of banks

in accelerating the transition to a sustainable economy and the costs and

benefits of disclosure regulations (Leuz and Wysocki [2016], Roychowd-

hury, Shroff, and Verdi [2019], Christensen, Hail, and Leuz [2021]).

1See media reports: “Greenpeace hits out at Davos banks for $1.4tn climate hypocrisy” (The

Guardian, January 22, 2020) and “Davos 2020: Bankers push back against climate action calls”

(Financial Times, January 20, 2020).

transmission effects of esg disclosure regulations 937

To study this question, I exploit a set of regulations mandating banks to

provide ESG disclosure,2and I investigate the impacts of such disclosure on

the E&S performance of firms borrowing from these banks. My hypothesis

is motivated by a large literature (e.g., Bénabou and Tirole [2010], Ioan-

nou and Serafeim [2012, 2017]), which suggests that disclosure regulations

impose public pressure on banks, inducing them to improve their related

performance (i.e., ESG). Because a key component of a bank’s ESG perfor-

mance involves the extent of the E&S consciousness in the projects it funds

(GRI [2013]), banks looking to provide a favorable ESG report and build

up a sustainable loan portfolio may require borrowers to exhibit positive

ESG behavior. To this end, banks might increase their ESG engagement by

enhancing monitoring activities and increasing ESG-related covenants for

loan contracts initiated after the disclosure regulation. Moreover,banks can

induce borrowers to improve their ESG investments by screening out exist-

ing borrowers with weak ESG performance and selecting good-ESG borrow-

ers. Thus, I predict that ESG disclosure regulations imposed on banks will

induce their borrowers to improve their E&S performance.

While I expect ESG disclosure mandates to have a transmission effect on

borrowers’ E&S performance, borrowing firms may not adjust their activ-

ities. They may not have incentives to increase their E&S activities if the

costs of doing so outweigh the benefits obtained from banks, especially

when they can easily switch to alternative financing sources. Furthermore,

banks may describe ESG activities in their reports without implementing

real changes. Therefore, it is an empirical question whether the effects of

ESG disclosure regulations are transmitted from affected banks to their bor-

rowing firms.

The main empirical challenge in studying this question is that local ESG

disclosure regulations often apply uniformly to both banks and nonfinan-

cial firms, making it difficult to identify transmission effects. Even when a

regulation affects only banks, studying its impact on borrowers in the same

country is subject to a potential reflection problem (Manski [1993]) be-

cause bank disclosures and borrower behaviors may be driven by latent fac-

tors common to all firms in the country (e.g., country-level environmental

regulations). To resolve this issue, I rely on a setting of U.S. firms borrowing

from non-U.S. lead banks and exploit the staggered adoption of ESG disclo-

sure regulations in non-U.S. banks’ home countries.3The advantage of this

setting is that these regulations affect only non-U.S. banks, not their U.S.

borrowing firms. In addition, the Dealscan loan database provides rich data

on the lending relationships between borrowing firms and both affected

and unaffected non-U.S. lead banks, which allows me to examine how

2I follow Christensen, Hail, and Leuz [2021] and define ESG disclosure or ESG reporting as

“the measurement, disclosure, and communication of information about CSR or ESG topics,

activities, risks, and policies” and ESG disclosure regulation as “a mandate for reporting” on

CSR, ESG, or sustainability issues.

3For simplicity, I use country or economy to indicate country or region in this paper.