By Rüdiger Hahn, Daniel Reimsbach, Peter Kotzian, Madeleine Feder, & Barbara E. Weißenberger

Sustainability reporting is nowadays a mainstream issue and companies are expected to provide a truthful picture of their sustainability performance, including negative aspects such as environmental accidents, human rights abuses or compliance violations. However, mandatory standards prescribing the exact content of sustainability reports hardly exist. Thus, companies find themselves in a dilemma. On the one hand, a company voluntarily disclosing negative incidents risks its perceived legitimacy. If, on the other hand, a negative incident is not proactively disclosed by the company but rather uncovered, for example, by nongovernment organizations or whistleblowers, this could lead to a public outcry as evident, for example, in the Volkswagen Diesel scandal. Furthermore, in some cases the disclosure of a negative sustainability-related incident might be mandated by regulations , for example, if the incident potentially has an impact on stock market prices. Against this background, companies use various legitimation strategies when they voluntarily or mandatorily disclose negative sustainability-related incidents (Hahn & Lülfs, 2014) and we asked ourselves: How do different legitimation strategies explaining negative sustainability incidents affect investors’ decision-making?

Answering this question proved to be methodically challenging because a traditional survey would have been prone to the well-known intention-behavior gap, that is, people’s self-reported intentions do not correlate with their actions (e.g., Auger & Devinney, 2007). We therefore conducted an incentivized experiment, or in other words, we paid participants real money for making fictitious investment decisions. In the study, we manipulated the legitimation strategy chosen by the reporting company to measure their effect on investment decisions.

To be able to judge the effect of legitimation strategies, we first had to see whether a negative sustainability-related incident per se influenced investment decisions. Indeed, the average investor invested much less of her funds into a company when a negative incident was reported. As expected, this was the case for environmental (oil spill), social (child labor), and governance incidents (bribes). If a company used symbolic legitimation, which only evasively explains a negative incident, the results were again intuitive: such weak legitimation did not help to reduce divestments. However, some unexpected results occurred: Even substantive legitimation, which reports on concrete measures and behavioral changes, influenced the divestment decisions only in very specific cases. It was only if companies reported on very concrete remediation measures (i.e., providing education for children or repairing environmental damage) that divestment decisions could be partly offset.

We inferred two key observations from these results. First, the actions put forward in the legitimation strategy need to be costly for the reporting company so that they are not directly discarded as “cheap talk” (as would be the case for symbolic legitimation). Second, the legitimation also needs to be perceived as appropriate by the receiver, that is, investors need to approve of the respective corporate actions. The combination of these two aspects is what we call “valuable signals”. The concept of valuable signals is important for companies aiming to legitimize negative incidents in their reporting. The reporting company should be aware that only valuable signals can potentially prevent or mitigate divestments from the company. Since it is not ex ante clear what a receiver perceives as appropriate (e.g., is it ok to provide schooling to previous child laborers to atone for previous corporate sins?), managers should pay close attention to their actions and how they might be perceived.

In sum, our experiments showed that investors divest from companies with a negative sustainability-related incident. Symbolic legitimation that only evasively explains a negative incident in sustainability disclosure does not trigger changes in this divestment behavior. Even substantive legitimation, which reports on concrete measures and behavioral changes, influenced divestment decisions only if the company reported on very concrete remediation actions in morally charged situations, such as social or environmental incidents.

References:

Auger, P., & Devinney, T. M. 2007. Do what consumers say matter? The misalignment of preferences with unconstrained ethical intentions. Journal of Business Ethics, 76(4), 361–383.

Hahn, R., & Lülfs, R. 2014. Legitimizing Negative Aspects in GRI-Oriented Sustainability Reporting: A Qualitative Analysis of Corporate Disclosure Strategies. Journal of Business Ethics, 123, 401–420.