We exploit a unique dataset to examine how auditors integrate financially material environmental, social, and governance (ESG) issues into their audits, particularly following the introduction of the Sustainability Accounting Standards Board (SASB) and the 2013 Committee of Sponsoring Organizations (COSO) frameworks, which highlighted the link between ESG and clients’ internal control over financial reporting (ICFR). We find that auditors exhibit excessive optimism when evaluating ICFR effectiveness in the presence of material ESG incidents. Auditors often fail to detect material weaknesses in ICFR when clients experience negative ESG incidents, which leads clients to restate their financial statements. These results are driven by the post-SASB and the 2013 COSO period and are the strongest when ESG incidents are illegal and occur well before the fiscal year-end. Overall, audit firms do not seem to fully understand the implications of material ESG issues from an ICFR standpoint and make assessments that are incorrect.

We find Flammer's (2021) reported positive market response to the announcement of issuance of corporate green bonds is not replicable in a data set designed to mimic her own. In our closest replication, on her 16-day event window, the t-statistic is not +2.03, but +1.10. The largest positive daily mean return occurs 9 days after the announcement. Furthermore, the three-day response around the announcement day is-0.012% (using the country-specific market model benchmark) and statistically insignificant. Also, we do an out-of-sample test of whether the reported effect (in the 2013 to 2018 period) exists in a later period (2019 to 2025); we find no such effect in the latter period. Finally, during 2019 to 2025 (which has almost ten times the sample than during 2013 to 2018), the 16-day announcement return is negative and Flammer's estimate lies outside the 95% confidence interval.

This editorial commentary synthesizes conceptual frameworks and empirical research on environmental, social, and governance (ESG) reporting and integration, aiding us in better understanding the evolution of ESG and the inception of regulatory responses aspiring to advance ESG’s relevance and credibility, and how ESG improves firm value. We review a number of theories that explain the advancement and evolution of ESG, offering distinct insights into the drivers and consequences of corporate sustainability initiatives. Recent trends suggest a transition of ESG from a peripheral narrative element to a more integrated component of capital market operations. Within this landscape, there is a growing opportunity for accounting research to contribute to the development of robust measurement, verification, and assurance mechanisms for ESG-related disclosures.

We assess whether and how financial analysts incorporate information about downside ESG risk. Using a unique dataset on firm-day level negative ESG incidents, we find that analysts' outputs (i.e., stock recommendations, EPS forecasts, and target prices) are associated with negative future ESG risk events, especially those that are financially material. Further investigation suggests that analysts incorporate ESG risk not only through adjusting future cash flow expectations (i.e. the "numerator"), but also through adjusting discount rates (i.e., the "denominator"). Overall, our results highlight the ability of financial analysts to synthesize and integrate ESG risk into their research.

We compare the ESG ratings of MSCI, a global rater, with those of SINO, a local Chinese rater, to evaluate their effectiveness in capturing ESG risks within the Chinese context. Using ESG issues revealed in negative incidents as a proxy for ESG risk, we find that the ratings from the two raters often diverge, with SINO generally outperforming MSCI in predicting ESG risks in China. This divergence is more pronounced for firms with extensive ESG disclosures and when there are significant differences in how the raters define and measure ESG issues. Distance-based information asymmetry does not appear to play a significant role in explaining the performance gap. The advantage of local raters likely stems from their flexibility in tailoring methodologies to reflect country-specific nuances. In contrast, global raters adopt consistent methodologies to meet investor demand for comparability, but this approach may inadvertently reduce their relevance for capturing localized ESG risks.

Using a novel measure that captures negative ESG incidents at both listed and private suppliers, we provide large-scale evidence on the value implications of supply chain ESG. We find that firms with fewer supply chain ESG incidents exhibit higher future accounting performance and that this effect is stronger in the presence of more conscious customers and vulnerable supply chains. We also find that firms with robust supply chain ESG exhibit higher future stock returns and that this effect is more pronounced when information frictions are higher, which suggests that it takes time for the market to understand the value implications of supply chain ESG. Overall, we highlight the benefits of managing supply chain ESG and the decision usefulness of the related information.

We use a novel dataset that links audit-firm and client-firm financial statement information from the U.K.'s largest audit firms to examine drivers of audit-firm profitability and its implications for audit outcomes. We first explore the determinants of audit-firm profitability and conclude that Big-4 and non-Big-4 audit firms have fundamentally different profitability structures. Big-4 firms have higher profit margins than non-Big-4 firms. Furthermore, Big-4 profitability increases with client size and complexity, while non-Big-4 profitability is higher for smaller, private-firm clients. Next, we examine the relation between audit-firm profitability and audit outcomes. Using a battery of alternative outcome measures, we find that more profitable audit firms deliver higher audit quality. In supplemental analyses we show that the positive relation between audit-firm profitability and audit outcomes is generally stronger for more influential and illiquid clients (i.e. when auditors are exposed to more litigation risk). Our inferences are robust to several endogeneity controls, such as using an instrumental variables approach, controlling for client-firm and audit-firm fixed effects, employing lead-lag and changes specifications, and assessing bias from correlated omitted variables. Our study contributes to the literature by being the first to provide insights into audit-firm profitability and examine in detail its implications for audit quality.

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This paper examines the long-term value implications of supply chain ESG performance. We find that firms with fewer supply chain ESG incidents exhibit higher future stock returns and accounting performance. We also find that robust supply chain ESG creates value by (i) enhancing supply chain stability, (ii) attracting pro-social stakeholders, and (iii) hedging regulatory risk. Further, we find evidence that the signal about supply chain ESG is initially mispriced due to the lack of supply chain disclosure and high information acquisition costs. Overall, we highlight the net benefits of robust supply chain ESG performance and inform regulators and investors about the implications of relevant disclosure.

The United Nations Principles for Responsible Investment (PRI) is the largest global environmental, social, and governance (ESG) initiative in the asset-management industry to date. We analyze what happens after active U.S. mutual funds sign the PRI to assess whether they exhibit ESG implementation. We find that PRI signatories attract a large fund inflow, but we do not observe improvements in fund-level ESG scores or fund returns. We consider a battery of ways to proxy for funds’ ESG incorporation (e.g., entry/exit, screening, engagement, voting for pro-ESG proposals), but fail to observe evidence of meaningful on average follow-through. Next, we explore cross-sectional fund characteristics and find that only quant funds exhibit small improvements in ESG performance versus other funds, mainly through buying high-ESG-performing stocks. Furthermore, we note that signatories are not superior performers in ESG issues prior to joining the PRI relative to non-PRI funds, but PRI affiliation tends to be widely advertised on company websites, marketing materials, and fund documents. Overall, a reasonable reader may perceive our findings as consistent with PRI funds’ greenwashing. We note, however, that what we uncover is based only on outcome-based measures and may miss some actual efforts of signatories. This paper was accepted by Brian Bushee, accounting. Supplemental Material: The online appendix and data are available at https://doi.org/10.1287/mnsc.2022.4394 .

We explore financial market structures that incentivize firms to prioritize ESG. Borrowers may prefer reducing expected interest payments by pursuing ESG over financial prof- its, particularly at high borrowing rates. However, competition between ESG-friendly and non-ESG lenders lowers equilibrium borrowing rates, discouraging ESG prioritization. When firms privately know their true ESG preferences, early-moving ESG-friendly lenders can “cleanse” the ESG capital market. Specifically, non-ESG lenders perceive holdout borrowers as those with strong ESG preferences and thus charge high borrowing rates so that even non-ESG borrowers pursue ESG to reduce interest payments. Ultimately, promoting lender competition may deter rather than support ESG integration.

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Financial analysts closely follow a firm's operations and assess the risks that it faces. Operational risks have value implications to firms, and as such are expected to be reflected in analysts' outputs. In this paper, we examine whether analysts incorporate assessments of operational risks. We use firm-day level data from RepRisk about negative operational incidents that are classified into environmental, social, and/or governance issues. We find that analyst outputs predict negative ESG incidents, suggesting that analyst outputs contain information that is predictive of these events. Our results are robust to controlling for negative ESG incidents that firms experienced in the past, and are stronger in more transparent information environments, and in the presence of more guidance on ESG issues from the Sustainability Accounting Standards Board. Finally, we find that these ESG risks are incorporated into analyst outputs through adjustments to discount rates rather than to cash flow estimates. Overall, our results highlight the ability of financial analysts to synthesize and integrate operational risks, and in particular ESG-related risks, into their research outputs.

Firm managers are facing increasing external pressure to allocate firm resources to environmental, social, and governance (ESG) efforts. Given that ESG activities are frequently perceived as in opposition to shareholder value, however, managers may find it difficult to decide which projects they should select and how much they should invest. Using MSCI ESG Ratings and Glassdoor employee ratings of senior managers as signals for firm ESG efforts and high managerial ability, we find evidence that high-ability managers allocate resources to ESG in a way that enhances shareholder value. Specifically, we implement a calendar-time portfolio regression design and find that firms with highly rated managers and high ESG exhibit significantly higher future stock returns than firms with low ratings on both. The results are robust to using different fixed effect structures as well as controlling for more covariates in a panel regression. Overall the results highlight the importance of senior managers in allocating resources to ESG efforts.