Imposing mandatory disclosure policies on businesses is a popular tool—but does it work?
Among certain environmental and human rights activists, compelling businesses and corporations to match their enthusiasm in the pursuit of social responsibility has been a key objective for years. Using shareholder pressure, creating public affairs campaigns and encouraging consumers to make socially responsible purchases have all made these issues more salient, with firms like McKinsey, United Airlines, General Motors and many more pledging action to advance climate sustainability, ethical supply chains and values-based investments. But some activists, and the political figures who work with them, don’t believe these companies are making this transition quickly enough. Accordingly, they’re turning to regulation like mandatory disclosure policies, which require companies to report on a regular basis how they’re performing on various environmental, social and governance (ESG) priorities, such as their carbon emissions or manufacturers’ wages.
When companies choose to pursue ESG-friendly policies themselves, they may do it because company leadership believes in the principles behind the policies, or perhaps because these choices appeal to and attract younger customers who are statistically more likely to express socially aware preferences. Either way, when ESG policies bubble up from within, they align with company priorities and benefit leadership, employees and other stakeholders. Mandatory disclosures, on the other hand, are government regulations imposed on businesses from the outside. And while they are becoming increasingly politically popular, they not only fail to accomplish their objectives but also disproportionately harm smaller businesses.
Where are mandatory disclosures being proposed?
As a new regulatory proposal, mandatory disclosures are popping up across several industries at both the state and federal level. In California, Washington, New York and several other states, regulators require insurance companies operating in their states to disclose their investments in the fossil fuel industry, in alignment with the Task Force on Climate-related Financial Disclosures. Most recently, in New York, State Sen. Alessandra Biaggi and Assemblywoman Anna R. Kelles introduced the New York Fashion Sustainability and Social Accountability Act, commonly referred to as the New York Fashion Act, to require fashion companies with at least $100 million in global revenue to disclose their supply chain details and potential environmental risks, including greenhouse gas emissions and water conservation, to the New York attorney general.
These disclosures aim to give citizens and elected officials the information they need to pressure companies to change their behavior. They are intended to avert further regulatory or legislative action requiring companies to change their disclosed behavior, but they are ineffective in achieving that goal.
Does mandatory disclosure meaningfully inform consumer decisions?
Research published in the University of Pennsylvania Law Review shows that political leaders bear few costs when they impose regulations like mandatory disclosures, which increases their incentives to enact them; however, the information nearly always goes unused by those it is intended to educate, significantly limiting its utility.
Take, for instance, the deluge of information with which consumers will be inundated if the New York Fashion Act passes. Every fashion company that sells its products in New York and makes $100 million or more in revenue—which includes fast-fashion brands like SHEIN and Forever 21 all the way up to luxury conglomerates like LVMH Moët Hennessy Louis Vuitton and Kering—would have to publish regular reports on the environmental and social impacts of the manufacturing, shipping and sale of their goods. Especially when considering some of the conglomerates each manage dozens of brands whose supply chains intersect and diverge, the complexity increases beyond rationale, particularly for consumers who have only a minimal understanding of business practices. Researchers call this inundation of information beyond usefulness the “overload effect” of mandatory disclosures.
Further, even if consumers do manage to sift through the ocean of information for a select few companies they’re interested in learning about, there’s little evidence the information they receive changes their behavior. Studies have found that mandatory disclosures of everything from caloric content to patient standards are often beyond readability for most consumers. One study found that even when participants were tested with the most fastidious procedures, including the use of laymen’s terms and information reinforced over the phone and direct mail, they could only answer approximately half of researchers’ follow-up comprehension questions.
The Costs on Companies
Mandatory disclosure policies have meager benefits to consumers, but the costs exacted on companies are high. Because these policies have very low costs for political figures—as Ben-Shahar and Schneider identify, instituting these requirements bolsters the perception they are “doing something” without raising taxes—it can quickly add up to duplicative, extraneous reports mandated by several offices and agencies at the federal, state and local level. Researchers identify this as an “accumulation effect,” which exists on the flip side of the overload effect. Too many mandated reports make it increasingly difficult for companies to keep up, increasing the odds of unintentional noncompliance.
The costs of mandated disclosures weigh especially heavily on small firms. Multibillion-dollar conglomerates may grumble about the need to hire an extra team of legal and compliance experts to track and report the required information, and they may need to raise prices on their products to make it feasible, but it likely wouldn’t irreparably hurt their business. Smaller firms, on the other hand, may be less able to absorb and redistribute these costs adequately. Mandating additional layers of bureaucracy within the firm takes time and resources, and to compensate, smaller firms are more likely than larger ones to resort to layoffs or decreases in quality, all of which may harm the business’ ability to attract and retain customers.
Whether the company is large or small, the cost of their noncompliance, even if unintentional, is considerable. For instance, the New York Fashion Act mandates that any companies that fail to disclose the required information fully must pay a fee of 2 percent of their total annual revenue to the New York Department of Environmental Conservation. Two percent may not sound like a lot, but in real terms, it adds up fast. For H&M, 2 percent of revenue represents nearly $500 million; for Nike, over $800 million; for Inditex, which owns Zara and is the highest-revenue fashion company in the world, it equates to a cool $2.2 billion. When profit margins across all industries sit at just under 8 percent for U.S. companies, payment of one-quarter of profits significantly impedes a company’s ability to hire more people, give raises and improve employees’ quality of life.
Conclusion
Mandatory disclosure policies, like many regulatory burdens borne by businesses of all sizes, are rarely written or applied to achieve their intended outcome effectively. The costs for businesses, from investing in new personnel to paying any noncompliance fees, are high, and the incomprehensible deluge of legalese these reports generally produce rarely has any meaningful impact on consumer behavior. Thus, the benefits certainly do not justify the costs—that is, except for politicians, who face little political penalty for imposing new mandatory disclosures on businesses, however ineffectual they may be.
