Firm Value and the Quality of Sustainability Reporting

in Australia
Kaveen Bachoo, Xstrata
Rebecca Tan, Australian National University
Mark Wilson, Australian National University

This paper investigates the relationship between firm value and the quality of Australian listed corporations’
sustainability reporting. We examine whether firms that make higher-quality sustainability disclosures exhibit
systematically higher equity prices, through either (or both) cost of capital or expected future performance
effects. Using proprietary data obtained from a specialist responsible investment research firm, we document a
significant negative association between quality sustainability reporting and the cost of equity capital for ASX
200 firms from 2003–2005, and a significant positive association between expected future performance and the
quality of sustainability reporting. We also test for industry-specific associations and find that our main results
are driven heavily by the reporting behaviour of, and market response to, firms in environmentally sensitive
industries.

If further evidence could be gathered to suggest that
markets can be persuaded to start to see the social and
environmental implications of their financial decisions
then a practical case can be added to the moral case that
substantive environmental disclosure needs to become
a regular, significant and regulated part of corporate
disclosure. (Murray et al. 2006: 246)
his paper investigates whether firm value implied
because of the high concentration of energy, mining and
industrial firms whose operations have significant direct
sustainability impacts.
There are a number of reasons why firms may make
sustainability-related disclosures additional to those
mandated by regulators. Traditional signalling theory
suggests an obvious incentive; firms making relatively
infrequent or low-quality disclosures may be perceived
to be hiding politically or economically unpalatable in-

T by market prices reflects information inferable

from firms’ sustainability reporting practices. In
particular, we ask whether firms’ sustainability reporting
quality is associated with either (or both) the cost of
equity capital, which reflects the discount rate applied by
investors when converting expected future performance
into present day values, or expected future performance.
While a trend towards more frequent and higher-quality
sustainability disclosures has been evident in Australian
firms for some time (DEH 2000; Gamble et al. (1996)),
relatively little evidence exists as to the impact these
disclosures have on financial markets. To this end,
our study uses unique proprietary data provided by
an independent sustainability research firm to examine
whether investors pay a premium for equity of firms that
produce higher-quality sustainability reports. Australian
corporations represent excellent subjects for such a study,
formation regarding their current performance or future
risk exposure (Akerlof 1970). Alternately, environmental
disclosure may lead to the creation of corporate value
as a result of the synergies between economic and
environmental performance (Figge 2005). Furthermore,
a significant literature has developed that argues that
corporations, being abstract entities created by society,
must demonstrate their legitimacy to society if they are to
survive in the long run (Dowling and Pfeffer 1975). Firms
whose apparent behaviour is significantly incongruent
with societal expectations may suffer through consumer
Correspondence: Mark Wilson, School of Accounting and
Business Information Systems, Australian National University, ACT
0200, Australia. Tel: +61 2 6125 3659; fax: +61 2 6125 4310;
email: mark.wilson@anu.edu.au

Australian Accounting Review No. 64 Vol. 23 Issue 1 2013 doi: 10.1111/j.1835-2561.2012.00187.x 67

Firm Value and the Quality of Sustainability Reporting
or supplier boycotts, or future legislative action aimed
at curtailing the firm’s aberrant behaviour (Terreberry
1968). Each of these consequences of a firm’s perceived
illegitimacy may affect the expected level and riskiness of
the firm’s future cash flows, and thus the current value
of the firm’s equity.
If sustainability reporting quality affects either (or
both) the perceived riskiness of a firm’s future earnings,
or the expected level of long-run earnings, rational
investors will pay a premium for each dollar of the
expected short-run earnings of high-quality reporting
firms. It is thus plausible that managers may believe
that benefits will accrue to high-quality sustainability
reporting, either because investors ascribe lower risk to
the earnings stream of high-quality reporters, or because
higher-quality sustainability reporting affects the level of
the long-run earnings stream that investors anticipate.
We test for risk effects using firms’ estimated cost of
equity capital, and for future long-run performance
effects using an Ohlson-type regression of stock price
against book value, short-term earnings, and proxies for
sustainability reporting quality.
We define sustainability reporting consistent with the
Global Reporting Initiative (GRI 2006: 3): ‘Sustainability
reporting is the practice of measuring, disclosing and
being accountable to internal and external stakeholders
for organizational performance towards the goal of
sustainable development. “Sustainability reporting” is a
broad term synonymous with others used to describe
reporting on economic, environmental and social
impacts’. While this definition encompasses social and
environmental reporting, we expect environmental
aspects to dominate any firm value effects, because
the majority of large firms’ future cash flows are more
obviously sensitive to environmental outcomes, through
fines, restoration costs and consumer sentiment. Our
primary measure of sustainability reporting quality
potentially reflects all aspects of sustainability reporting.
However, our secondary proxies for sustainability
reporting quality focus on environmental reporting only,
to maintain consistency with the established literature on
which they are based.
To test our hypotheses, we use forward-looking
measures, rather than realised share price returns,
because our test variable represents a stock of
information available at a point in time. Historical share
return data is traditionally applied in ‘event studies’,
whereby a particular stimulus (event) is identified
and stock price changes surrounding the event are
estimated in an attempt to determine whether the
‘event’ caused a change in stock price. This method is
suitable where discrete sustainability-related events are
observable, such as was the case in the Bhopal disaster
(see Blaconnierre and Patten 1994). In the case of
sustainability reporting, however, information is often
68 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
provided via several media, which may be made publicly
available at different times. Rather than attempt to detect
changes in stock price over a particular time interval,
we seek to determine, on an annual basis, whether the
currently available set of sustainability information
regarding a firm is associated with the price paid for the
firm’s stock, after controlling for fundamental factors
likely to affect the relativity of stock price and expected
future performance. Thus, we seek to identify relatively
permanent premia paid by investors for firms that make
high-quality sustainability disclosures, either because
such firms’ future earnings are perceived to be less risky
(cost of capital effect) or because long-term earnings are
expected to be of a greater magnitude (latent liability
effect).
We report evidence that our proprietary measure
of the quality of sustainability reporting is negatively
associated with firms’ ex ante cost of equity capital, and
positively associated with the expected level of future
long-term earnings, consistent with our conjectures
above. These key results also hold when we employ
author-constructed measures of (environmentally fo-
cused) reporting quality based on the disclosure schema
of Clarkson et al. (2008), and after controlling for the
impact of financial and environmental performance on
the likelihood that a firm will produce high-quality
sustainability reports. We also provide evidence that the
significant association between both measures of firm
value and sustainability reporting quality is concentrated
in industry sectors (energy, materials and industrials)
most sensitive to sustainability issues, and in large firms.
Our study makes several important contributions
to the literature. First, our primary measure of
sustainability reporting quality is provided by an
independent responsible investment research firm,
distinct from other recent studies (Clarkson et al. 2010;
Plumlee et al. 2010) which rely largely on author-
constructed measures of quality. Thus, we are arguably
better able to examine the impact of reporting quality
as it is observed or inferred by market participants.
Second, we focus on overall sustainability reporting
quality and its association with firm value. This is distinct
from Dhaliwal et al. (2011), who study the initiation
of stand-alone corporate sustainability reporting (CSR)
(regardless of sustainability reporting quality), and also
distinct from Clarkson et al. (2010) and Plumlee et al.
(2010) who restrict their focus to the environmental
component of sustainability reporting. Our approach
has the potential to inform investors and regulators
in regard to a broader set of reporting issues than is
possible by reference to the extant literature. Finally, ours
is the first study to examine the association between
firm value and sustainability reporting by Australian
corporations, for which the firm value impact of
sustainability reporting may differ from that observed

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson
internationally, due to the concentration of firms in
sustainability-sensitive industries.
Institutional Background: Emergence
of Sustainability Reporting
There has been an increase in the quantity and
quality of environmental and social disclosures in
many countries following criticisms that the traditional
financial reporting framework gives an incomplete
picture of the operation of a company (Elkington
1998; Gray et al. 1995; Murray et al. 2006). This
increase in sustainability disclosures is consistent with
the exponential growth of ethical investment funds
(D’Antonio et al. 2000) and the widespread popularity
of sustainability rating indices such as the Dow Jones
Sustainability Index and the FTSE4Good Index. In
the United States (US), the number of institutional
investment entities seeking information about listed
corporations’ environmental performance under the
Carbon Disclosure Project (CDP) increased from 35
in 2003 to 315 in 2007 (Stanny and Ely 2008).
Further, recent international efforts to develop common
principles guiding the production of reports that demon-
strate the relation between organisations’ environmental
and social behaviour and an organisation’s broader
strategy, governance and performance, and which are
intended to ‘help businesses to make more sustainable
decisions and enable investors and other stakeholders to
understand how an organisation is really performing’
(IIRC 2011) highlight the importance of improving
our understanding of the relation between markets and
reported sustainability performance.
A number of initiatives aimed at promoting
sustainability reporting has been introduced by the
Australian Government. In 2005, a study by CAER –
Corporate Analysis Enhanced Responsibility (CAER)
(2005) revealed that the number of ASX 300 companies
producing sustainability reports increased from 42
in 2004 to 52 in 2005, but that the incidence of
such reporting was heavily concentrated in the 200
largest firms. CPA Australia (2005, 2007) reported
similar trends. In June 2005 the Parliamentary Joint
Committee on Corporations and Financial Services
resolved to inquire into Triple-Bottom-Line reporting
(Commonwealth of Australia 2006). During the inquiry,
the Committee heard evidence that many Australian
companies employ socially responsible approaches, in
areas beyond a company’s traditional core business.
Despite the increasing interest in sustainability reporting
in Australia, the majority of such disclosures are volun-
tary. The only federally-related mandated requirements
affecting firms’ reporting to shareholders are:
• s. 299(1)(f) of the Corporations Act 2001, which
requires companies to include details in their annual

C 2013 CPA Australia
Firm Value and the Quality of Sustainability Reporting
reports regarding the extent to which they have
complied with environmental laws and licences;
and
• ss. 1013(A) to (F) of the Corporations Act 2001,
which requires providers of financial products with
an investment component to disclose the extent to
which labour standards or environmental, social
or ethical considerations are taken into account in
investment decision making.
While Frost and English (2002) suggest that the
introduction of s. 299(1)(f) has led to an increase in
the level of information reported, other studies have
been highly critical of the legislation. For example,
Burritt (2002) raises concerns regarding the subjective
assessment of what constitutes significant environmental
regulation and preparer discretion over the level
of detail provided. Despite a gradual increase in
environmental disclosures by Australian firms, Australia
has lagged behind many other countries with respect
to sustainability reporting and the main reason behind
this trend is the lack of more stringent mandatory
environmental regulation (CAER 2005).
There are two regulatory bodies to which Australian
firms may be compelled to report. First, following
the establishment of the National Pollutant Inventory
(NPI) in 1997, each facility producing emissions of
any of 93 registered pollutants in excess of prescribed
thresholds must report the pollutant-specific level of
emissions to the NPI. This data is then published by the
NPI, on a facility-by-facility and pollutant-by-pollutant
basis. Second, the National Greenhouse and Energy
Reporting Act 2007 requires corporations whose energy
usage or greenhouse gas emissions exceed prescribed
thresholds to report the magnitude of these statistics to
the Commonwealth. From this data, the Department
of Climate Change and Energy Efficiency publishes a
report detailing each firm’s energy consumption, and
direct and indirect greenhouse gas emissions. There
is no requirement that either of the above disclosures
be reported separately to shareholders, nor do these
sources allow users to directly compare emissions
or consumption to the scale and nature of a firm’s
operations to determine efficiency.
Literature Review and Hypothesis
Development
This section reviews the relevant literature regarding the
market response to sustainability reporting and develops
the core hypothesis of this paper. We first examine
the relationship between sustainability reporting and
the cost of equity, before considering the association
between sustainability reporting and expected future
performance.
Australian Accounting Review 69
Firm Value and the Quality of Sustainability Reporting
The ‘voluntary disclosure’ literature predicts a
negative association between the incidence or quality
of disclosure and the cost of equity capital. While this
literature typically uses financial disclosures as exem-
plars, the underlying logic applies to other information
relevant to a firm’s future cash flows, including that
provided by sustainability disclosures. The voluntary
disclosure literature identifies two potential links
between disclosure and the cost of capital: information
asymmetry effects and estimation risk effects.
Diamond and Verrecchia (1991) argue that disclosure
affects information asymmetry between informed
insiders and uninformed investors, and that this
information asymmetry is priced. In a stylised world
in which firms are one of two types (high-quality or
low-quality), Diamond and Verrecchia (1991) show that
failure to disclose performance information results in
the market assuming a firm to be of low quality because
the undisclosed information is likely to be ‘bad news’.
High-quality firms therefore have an incentive to signal
their type by disclosing their performance, which in turn
is reflected in a higher price and a lower cost of equity
capital.
The second impact of disclosure on stock prices is
via estimation risk, which is defined as the additional
risk incorporated in the covariance structure of returns
by investors facing incomplete information (Handa and
Linn 1993). A firm’s total risk comprises an unsystematic
component, which can be eliminated by diversification,
and a systematic component, which cannot be reduced
without sacrificing expected return. Research by Barry
and Brown (1985), Handa and Linn (1993) and Coles et
al. (1995) suggests that as uncertainty regarding a firm’s
future performance increases, the assumed correlation
between that firm’s returns and that of the market
increases, and if this risk is not diversifiable, the cost of
equity necessarily increases.1 Greater disclosure is argued
to reduce uncertainty regarding future performance, and
thus the cost of equity is reduced.
Alternative perspectives on the relation between cost
of equity and sustainability reporting quality can be
deduced from ‘socio-political’ theories of firm disclosure
(Gray et al. 1995; Lindblom 1994). Centrally, these
theories argue that because a firm’s survival is ultimately
conditional on societal and political perceptions of
its legitimacy, firms whose legitimacy is challenged
as a consequence of poor sustainability performance
may respond by increasing disclosure in an attempt
to improve their reputation (Clarkson et al. 2008).
Clarkson et al. (2011) report a negative relation between
firms’ environmental performance and the quality of
voluntary environmental disclosures made by Australian
firms in environmentally sensitive industries. If the
additional disclosures contain new information, from
an estimation risk perspective, cost of equity may be
reduced. The empirically observed association between
70 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
these legitimacy-inspired disclosures and cost of equity
is, however, potentially subject to a selection bias because
there may be a significant positive correlation between
firms whose legitimacy is threatened and those firms’
pre-existing cost of equity (Dhaliwal et al. 2011).
With respect to the relationship between the cost
of equity and the quality of sustainability disclosures,
we consider the information asymmetry perspective
most compelling. In some industries, the events to
which sustainability reporting pertains have clear
potential to impact the firm’s ability to generate returns
to investors. Higher-quality sustainability reporting
decreases information asymmetry between firm insiders
and other stakeholders, and may reduce investors’
uncertainty regarding the firm’s future environmental
and social performance, and the cash flows associated
with these. Consider, for example, a firm that operates
in an industry that necessarily produces air pollution,
and which reports minimal sustainability information.
Stakeholders, including potential equity investors, may
experience great uncertainty regarding the impact of
future environmental events on such a firm’s future
economic performance, and adjust their required return
or expected future performance accordingly.
We now discuss the results of empirical studies of
the relationship between sustainability reporting and
the ex ante cost of equity. Richardson and Welker
(2001) employ a measure of firms’ ‘social reporting’
quality, in which environmental reporting represents
just 18% of the total measure, to test for cost of capital
effects.2 Contrary to their prediction, Richardson and
Welker (2001) report a significant positive relationship
between social disclosures and cost of equity capital for
a sample of Canadian firms between 1990 and 1992.
The authors argue that many aspects of a firm’s socially
responsible behaviour may be perceived by the market
as negative NPV investments, and that the disclosure of
this behaviour may increase perceived risk. In sensitivity
tests, Richardson and Welker find that the positive
relation between cost of equity and social disclosure
holds only for firms with below-industry median
financial performance. It is also plausible that firms
with an inherently low inherent cost of equity capital
have less incentive to make high-quality sustainability
reporting disclosures, and that this selection bias may
have influenced Richardson and Welker’s (2001) results.
Dhaliwal et al. (2011) study the antecedents and
consequences of the initiation of voluntary stand-alone
CSR reporting by US firms. Principally, they find that
a) firms with higher cost of equity in the prior period
are more likely to initiate stand-alone CSR reporting in
the current period, and b) firms with above industry
median CSR performance experience a fall in the cost
of equity after initiating stand-alone CSR reporting.
The types of reports considered, and the performance
controls employed are very broad, with environmental

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson
performance weighted at less than 15% of total measured
CSR performance. Further, Dhaliwal et al. (2011) do
not distinguish between the quality of the CSR reports
introduced. Overall, however, their results are consistent
with an information asymmetry motivation for the
initiation of CSR reporting.
In a recent working paper, Plumlee et al. (2010) study
the relationship between cost of equity and the quality
of US firms’ environmental disclosures. When a naive
measure of total disclosure scores is employed, a positive
association between reporting quality and cost of equity
is reported, inconsistent with information asymmetry or
estimation risk arguments, but consistent with a socio-
political explanation. However, when disclosure quality
is disaggregated by type (hard/soft) and direction (good
news/bad news) they find evidence that an increase in
the quality of soft disclosures is associated with reduced
cost of equity, and argue that this result is consistent with
an information risk explanation.
Clarkson et al. (2010) also study the association
between cost of equity and US firms’ environmental
reporting quality, as proxied by an index weighted heavily
towards ‘hard’ disclosure items such as quantitative
relative performance data, but restrict their sample
to environmentally sensitive industries. They find no
significant relation between the cost of equity and
environmental reporting quality, regardless of whether
environmental performance is controlled.
We follow Clarkson et al. (2010) and Plumlee et al.
(2010) and predict a negative relationship between the
quality of sustainability disclosures and the ex-ante cost
of equity capital. We argue that higher sustainability
reporting quality decreases investors’ perceptions of the
riskiness of firms’ future cash flows. To the extent that this
risk is not perfectly diversifiable, a lower ex ante cost of
equity should accrue to firms with higher sustainability
reporting quality.
Consequently, our first hypothesis is stated formally
in positive form:
H1: There is a negative association between ex ante cost
of equity capital and the quality of sustainability
reporting.
The quality of sustainability reporting may affect firm
value through mechanisms other than cost of equity.
The cost of equity is essentially a ‘denominator effect’,
reflecting the rate at which investors discount expected
future cash flows, and derives primarily from the
perceived riskiness of future performance. The expected
level of future cash flows, however, is also potentially
affected by sustainability reporting quality. If high-
quality reporting reduces the market’s perception that
a firm will be forced to incur future environmental or
other sustainability-related costs, this will increase the
expected future net cash flows impounded in the firm’s
stock price. To the extent that these cash flow effects

C 2013 CPA Australia
Firm Value and the Quality of Sustainability Reporting
are long-term phenomena not fully reflected in short-
term earnings expectations, the quality of sustainability
reporting may induce the market to pay a premium price
for a firm’s stock, relative to that firm’s book value and
short-term earnings. High-quality firms, therefore, have
an incentive to signal their type by comprehensively
reporting their sustainability strategy, governance and
performance (Diamond and Verrechia 1991).
Two current working papers examine the relation
between environmental reporting quality and expected
future performance impacts on firm value. Clarkson
et al. (2010) argue that high-quality environmental
performers are able to signal their type by releasing high-
quality environmental reports, and that this positively
affects the market’s expectation of future net cash flows,
and therefore, firm value. Further, Clarkson et al. (2010)
argue that this effect is incremental to any firm value
effect arising from environmental performance revealed
in mandated submissions to government agencies.
Using Ohlson-type regressions, they find a significant
positive relation between firm value and environmental
reporting quality for US firms in environmentally
sensitive industries, regardless of whether environmental
performance is controlled in their model.
Using a more broadly defined US sample, Plumlee
et al. (2010) test the expected cash flow effect of
environmental reporting quality in two ways. First,
similar to Clarkson et al. (2010), they conduct Ohlson-
type regressions of stock price against book value
per share, current abnormal earnings per share and
proxies for sustainability reporting quality. They also
develop a model of expected future long-run cash flows
using forecast data from Value Line, and regress these
predicted cash flows against measures of sustainability
reporting quality. Both methods reveal strong positive
associations between expected future performance (net
cash flows) and an aggregate measure of environmental
reporting quality, regardless of whether mandatorily re-
ported environmental performance is controlled. When
environmental reporting quality is disaggregated by
type (hard/soft) and nature (positive/neutral/negative),
Plumlee et al. (2010) find that the cash flow impact
is concentrated in reports with higher-quality ‘soft’
disclosures and of a ‘positive’ nature (regardless of type).
Due to the sparseness of long-run earnings or cash
flow forecasts for Australian firms, our study relies on
the Ohlson-type regressions to examine the association
between sustainability reporting and the level of expected
future net cash flows. Because higher reporting quality is
argued to reduce expected liabilities, we predict a positive
relationship between sustainability reporting quality and
future cash flows.
H2: There is a positive association between the level
of expected future performance and the quality of
sustainability reporting.
Australian Accounting Review 71
Firm Value and the Quality of Sustainability Reporting
The following sections detail our empirical measures of
sustainability reporting quality and cost of equity.
Measurement of Firms’ Sustainability
Reporting Quality
Al-Tuwaijri et al. (2004) identify two broad types of mea-
sures of sustainability reporting quality: measures that
quantify the level of disclosure in the annual report (e.g.,
number of pages or words); and measures that assign a
particular score to qualitative factors such as existence of
an environment policy, achievement of environmental
goals and others. Inevitably, attempts to quantify and
measure the notional information content of reports are
imperfect; the very essence of information is its potential
to change the perceptions of the recipient, and the
likelihood that this will occur is specific to context and
individuals. Page counts do not discriminate according
to quality or relevance of content, and may include
pictures that have no information content, while simple
word counts may ignore necessary graphs and tables
(Al-Tuwaijiri et al. 2004). Disclosure scores necessarily
require subjective weighting of items which, however
robustly determined, require the researcher to impute
the beliefs of a heterogeneous group of stakeholders.
Many early papers focusing specifically on environ-
mental disclosures adopt a variant of the Wiseman
(1982) Index (Freedman and Wasley 1990; Bewley
and Li 2000; Patten 2002; Hughes et al. 2001), which
allocates a score to various disclosures according to
specificity of disclosure and whether quantitative data
is reported. Cormier and Magnan (1999) contend that
the Wiseman Index is a good proxy for environmental
disclosure because it is a comprehensive measure that
allows information of various types to be integrated into
a single comparable figure; it also allows researchers’
judgements to be impounded in rating the ‘value of
disclosure’. Seeking a stronger measure, Clarkson et al.
(2008) compute an index that discriminates between
hard and soft disclosures. Hard disclosure items, such
as quantitative measures of performance, are weighted
more heavily than soft disclosures, such as the existence
of an environment policy, because the latter is easily
mimicked by firms regardless of their quality. Thus,
the index computed by Clarkson et al. (2008) has the
advantage of distinguishing between genuine firms that
have a good performance and disclose from those that
perform badly and still disclose positively.
Rather than restrict our analysis to a scholar-defined
measure of sustainability reporting quality, the main tests
reported in this paper focus on proprietary classifications
of reporting quality prepared by an independent,
not-for-profit research firm that provides advice to
responsible investors: Corporate Analysis Enhanced
Responsibility (CAER).3 This organisation analyses
72 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
corporations’ statutory annual reports, websites and
stand-alone disclosures to advise subscribers interested
in applying environmental, social and governance
criteria to their investment activity. The organisation’s
clients include a number of Australian and international
investment funds. Between 2003 and 2005, CAER
analysed the sustainability disclosures of all firms in the
ASX 200 at 30 June of each year, and identified firms
as having acceptable sustainability disclosures if at least
three of the following criteria were met:
• details of firms’ sustainability policy are provided;
• the main impacts/issues in all key areas such as
energy, emissions, waste, water are described;
• quantitative data (including year-on-year data) in
all key areas, as graphs or tables are provided;
• measures of performance against targets in all key
areas are provided.
In determining whether the above criteria were
satisfied, CAER researchers considered the substance
of the information reported by companies, and both
the quality and quantity of information produced.
Professional judgement was applied in determining
whether disclosures provided substantive information,
or were largely ‘window dressing’. In order to satisfy
the criteria above, the report component needed to
cover all of the key sustainability issues (as identified by
CAER) facing the firm. The existence of a voluminous
sustainability report, encompassing a large amount
of quantitative analysis did not in itself constitute
acceptable sustainability reporting. In the main tests
of H1, sustainability disclosure was measured by a
dichotomous dummy variable SUSTAIN , equal to 1 if a
particular firm was classified by CAER as having made
acceptable sustainability disclosures, and 0 otherwise.
While attempts to measure what is inherently
a qualitative phenomenon are prone to error and
misspecification, our primary measure has two advan-
tages. First, the classification of firms’ sustainability
reporting behaviour was conducted independently of the
authorship of this paper. Second, research was performed
by an organisation whose core function and expertise is
the identification of firms whose stock is acceptable for
inclusion in the investment portfolios of individuals or
trusts concerned with sustainable corporate behaviour.
Thus, unlike measures constructed by academics, this
measure is likely to be more representative of advice
provided to investors.
Because our primary measure of disclosure quality is
not publicly observable, we report additional descriptive
statistics regarding the relation between this measure
and other measures of firms’ sustainability reporting
quality. In Table 1 we examine the specific reporting
behaviour of firms classified by CAER as providing
acceptable and non-acceptable sustainability disclosures.

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson Firm Value and the Quality of Sustainability Reporting

Table 1 Comparison of CAER sustainability classification with attributes of firms’ annual reports and sustainability reports
Frequency of disclosure
SUSTAINABILITY SUSTAINABILITY
REPORTING REPORTING
Reporting attribute UNACCEPTABLE ACCEPTABLE
Soft disclosures
Description of sustainability profile 40.2% 91.3%
Description of sustainability vision 32.1% 82.6%
Description of sustainability policy 32.9% 82.5%
Description of sustainability performance – Non-quantitative 34.3% 82.6%
Disclosure of awards for sustainability performance or reporting 6.7% 27.2%
Hard disclosures
Description of the governance structure controlling sustainability-related behaviour 53.6% 93.2%
External verification of sustainability reports 20.6% 72.8%
Quantitative performance information – Basic 17.5% 61.9%
Quantitative performance information – Advanced 8.9% 48.9%
Details of expenditure on sustainability-related issues 3.1% 8.6%
∗
The differences in all of the means listed above are statistically significant with p-values <0.01.

We apply the broad logic of Clarkson et al. (2008)
to classify sustainability disclosures as ‘hard’ or ‘soft’
according to the extent to which a poorly performing
firm could be expected to use such disclosures to
portray itself as a superior sustainability performer. To
do this we inspected the annual reports and stand-
alone sustainability reports of all firms in our sample,
and recorded the instance of hard and soft disclosures.4
Unlike the CAER analysis, however, we make no attempt
to determine whether or not the sustainability issues
covered in a firm’s report cover all of the firm’s material
responsibilities to society. Further, our self-constructed
indices focus on the environmental component of
sustainability reporting, because hard disclosures were
overwhelmingly of this type. The soft disclosure items
identified by Clarkson et al. (2008) include descriptions
of firms’ sustainability vision, profile and overall strategy.
These are items where it appears less likely that the CAER
classificatory scheme will detect a difference between
firms. However, we find that firms classified by CAER
as providing acceptable disclosures are significantly
more likely to report details of the sustainability issues
relevant to their operations (profile), their sustainability
vision and broad sustainability strategy. We also find
that CAER-ratified firms are significantly more likely
to report the receipt of awards for sustainability
performance or reporting.
Clarkson et al. (2008) identify the reporting of
governance, credibility (external verification), per-
formance and spending-related data as representing
hard disclosures. We find that CAER-ratified firms
exhibit a significantly greater likelihood of detailing the
governance mechanisms relevant to their sustainability
behaviour. There is also a stark difference in the
proportion of CAER-ratified and other firms providing
evidence of external assurance (credibility) regarding
their sustainability reporting. Further, CAER-ratified
firms are significantly more likely to provide mean-
ingful quantitative data regarding their environment
performance. Given that the disclosure of advanced
quantitative performance is arguably the ‘hardest’ form
of disclosure, and approximately 48% of CAER-ratified
firms make such disclosures, it is reasonable to conclude
that approximately half of the CAER-ratified firms meet
all four of the criteria listed above. Finally, CAER-
ratified firms are also more likely to disclose quantitative
data relating to sustainability-related expenditures made
by the firm. Overall, the consistency of the CAER
classifications with independently measured reporting
attributes is reassuring.
While the focus of this paper is on our proprietary
measure of sustainability reporting quality, additional
tests include regressions, which use author-constructed
measures based on the schema of Clarkson et al. (2008).
First, CLARKIND is a four-level ordinal variable in which
firms are allocated one point for each of the following
hard disclosure items:
• disclosure of the governance structure through
which firms’ sustainability-related behaviour is
controlled;
• the firm’s sustainability report has been verified by
an independent third party;
• the firm discloses quantitative data regarding
sustainability-related expenditures (excluding fines
or other sanctions levied against the firm by an
environmental regulator);
• the firm provides quantitative analysis of its
sustainability performance, with (at a minimum)
cross-sectional or time-series comparisons.
In constructing this index, we make no attempt
to identify whether the firm’s sustainability reporting
covers all material issues relevant to the firm. Further,


C 2013 CPA Australia Australian Accounting Review 73
Firm Value and the Quality of Sustainability Reporting
the data used to construct this index was limited
to surviving documentary sources, and thus ignores
possible company website disclosures that were no longer
accessible at the time of data collection. Section 299(1)(f)
of the Corporations Act requires corporations to
report on their compliance with relevant environmental
regulations, and thus firms have little discretion
regarding the disclosure of fines or other sanctions
incurred for breaching environmental regulations. We
therefore consider disclosure of such breaches as a
performance proxy, rather than a reporting quality
measure. To aid comparison to our measure of reporting
quality provided by CAER (SUSTAIN ), we also employ a
dichotomous re-coding of CLARKIND. CLARKBIN is a
dichotomous indicator variable equal to 1 if CLARKIND
is greater than or equal to 3, reflecting a threshold score
that is most similar to the classification system adopted
by CAER.
Estimating the Ex Ante Cost of Equity
Capital
A firm’s ex ante cost of equity capital represents the
discount rate used by investors when converting the ex-
pected future cash flows from an investment in the firm’s
stock to present day value. Factors that affect the rate at
which investors discount each dollar of future profits
include: the risk-free rate of interest; the perceived risk
attaching to the firm’s expected profits; and investors’
risk tolerance. Given that, at any instant in time, the risk-
free rate of interest and investors’ average risk tolerance
are constant, investors’ required return with respect
to individual firms varies singularly in proportion to
the perceived riskiness of firms’ expected future perfor-
mance. This required return is equivalent to the firm’s
cost of equity capital; it is the required rate of return that
is impounded in the firm’s current share price.
Thus, if one could observe the totality of the future
cash flow stream expected by investors in a firm’s stock,
the ex ante cost of equity is the interest rate that equates
the present value of those cash flows with the current
market price. The future cash flows expected by investors
are not, however, perfectly observable. Methods of
estimating the cost of equity capital use either discounted
cash flow (Botosan 1997) or residual earnings-based
approaches (Claus and Thomas 2001; Gode and
Mohanram 2003; Easton 2004; Cheng et al. 2006).
Studies using the residual earnings-based model
rely on the availability of security analyst forecasts of
earnings, and are defined only where forecast earnings
possess certain numerical properties. For example,
Easton’s (2004) price-earnings-growth (PEG) model is
only defined if analysts’ two-year ahead earnings forecast
(EPS2) is greater than forecast earnings one year ahead
(EPS1). Such restrictions may bias the sample towards
74 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
more stable firms (Francis et al. 2004). Other studies,
such as Bhattacharya et al. (2003), show that there
are significant differences between generally accepted
accounting principles earnings and earnings forecasts,
thereby questioning the reliability of earnings forecasts
used in some of the cost of capital valuation models.
Despite these criticisms, models based on earnings
forecasts have been demonstrated to correlate signifi-
cantly with economic fundamentals expected to drive
investors’ required return. Both Botosan and Plumlee
(2005) and Botosan et al. (2012) show that PEG-based
models perform at least as well as more complex models
such as those of Gebhardt et al. (2001) and Ohlson and
Juettner–Nauroth (2003), in terms of their relation to
firm-specific risk factors such as market risk, leverage
risk, information risk, residual risk and growth. For
this reason, and in the interest of obtaining as large a
sample as possible,5 we use Easton’s (2004) modified
PEG model to estimate the ex ante cost of equity capital,
as per equation 1:

eps 2 − eps 1 + ke × Div 1
ke = (1)
P0
The value of ke that solves equation (1) thus represents
the estimated cost of equity capital for a firm. If a
company’s cost of equity varies systematically with
sustainability disclosure policy (after controlling for
factors known to impact the cost of equity), this implies
that investors are prepared to sacrifice greater current
wealth for each dollar of these firms’ future expected
earnings.
For each firm year, we estimate the cost of equity
in the month immediately following the release of the
firm’s annual report. This ensures that sustainability
information in the annual reports is publicly available
when cost of equity is estimated. While firms can
potentially meet CAER’s sustainability reporting criteria
through media other than the annual report, the
release of the annual report is the organisation’s cue
for reviewing their assessment of firms’ reporting
performance. Consistent with the bulk of the extant
literature, median analyst forecasts are employed as our
consensus measure.
Regression Models
We use ordinary least squares (OLS) regressions with
standard errors adjusted for within-firm and within-year
clustering in the main tests of our hypotheses.6 In our
additional tests, we also employ endogeneity corrected
regression methods (Heckman-type corrections and
two-stage least squares models). Equation 2 regresses
cost of equity against sustainability reporting quality and

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson
control variables.
ke = a + B 1 REPTQUAL + B 2 SIZ E + B 3 BETA
(2)
+B 4 B toM + INDUSTRY + ε
Where
ke = cost of equity capital in month subse-
quent to reporting date
REPTQUAL = a measure of sustainability report-
ing quality (SUSTAIN, CLARKIND,
CLARKBIN ), where
SUSTAIN = 1 if firm classified by CAER as exhibit-
ing acceptable sustainability disclosures,
otherwise = 0
CLARKIND = multi-level disclosure index based on
Clarkson et al. (2008)
CLARKBIN = 1 if CLARKIND > = 3, otherwise = 0
SIZE = natural log of opening total assets
BETA = firms equity beta estimated using previ-
ous 36 monthly stock returns
BtoM = book-to-market ratio
INDUSTRY = vector of dummy variables indicating
industry sector membership
As described previously, SUSTAIN is a dichotomous
variable indicating that a firm’s sustainability reporting
practices are of sufficient quality to satisfy CAER.
CLARKIND and CLARKBIN are, respectively, ordinal
and dichotomous measures of sustainability reporting
quality constructed by the authors based on the incidence
of hard sustainability disclosures as per the schema of
Clarkson et al. (2008).
The control variables included in equation 2 are
consistent with those employed in the literature. SIZE
is included because larger firms have been found to
have lower costs of equity capital, presumably because of
lower perceived risk (Botosan and Plumlee 2005). Firms’
equity beta (BETA) is included to control the impact
of systematic risk on the cost of capital (Plumlee et
al. 2010). Similarly, firms’ book-to-market ratio (BtoM)
consistently exhibits a positive relationship with cost of
equity in prior studies (Plumlee et al. 2010). Intuitively,
this relationship arises because the market has less
confidence in the economic value of high book-to-
market firms’ reported assets and earnings, and thus
discounts future expected growth in reported earnings
more severely. Industry dummies are included to proxy
for differences in firms’ inherent business risk.
A significant negative coefficient for SUSTAIN would
be consistent with H1, which predicts that firms that
engage in quality sustainability reporting experience a
lower ex ante cost of equity capital.
In addition to our tests of the economy-wide
relationship between the quality of sustainability
reporting and firms’ cost of equity, we test for evidence
of industry-specific effects (equation 3). To this end,

C 2013 CPA Australia
Firm Value and the Quality of Sustainability Reporting
we include REPTQUALxSENS, an interaction between
each of our reporting quality proxies and an additional
dichotomous indicator (SENS) variable denoting firms
in the sustainability sensitive industry sectors (energy,
materials and industrials). We do not include the
main effect SENS variable in our regressions because
the (untabulated) individual industry sector dummy
variables are a finer control for general risk-related
cost of equity effects. A significant negative coefficient
for REPTQUALxSENS indicates a greater negative
association between cost of equity and sustainability
reporting in sectors where the sensitivity to sustainability
reporting and behaviour is likely to be greatest.
ke = a + B 1 REPTQUAL + B 2 REPTQUALxSENS
+ B 3 SIZ E + B 4 BETA + B 5 B toM
+ INDUSTRY + ε
(3)
Where
ke = cost of equity capital in month
subsequent to reporting date
REPTQUAL = a measure of sustainability
reporting quality (SUSTAIN,
CLARKIND, CLARKBIN ), where
SUSTAIN = 1 if firm classified by CAER as ex-
hibiting acceptable sustainability
disclosures, otherwise = 0
CLARKIND = multi-level disclosure index based
on Clarkson et al. (2008)
CLARKBIN = 1 if CLARKIND > = 3, otherwise
=0
REPTQUALxSENS = 1 if REPTQUAL = 1 and the firm is
a member of the energy, industrial
or materials sector, 0 otherwise
Other control variables in equation 3 are defined as
per equation 2.
To test the relationship between sustainability
reporting quality and expected future performance we
use a standard Ohlson-type model, which relates the
current price of a firm’s stock to its current book value,
a proxy for expected earnings in excess of the required
return on equity, and our test variable and a control for
firm size:
P = a + B 1 B V + B 2 AE + B 3 REPTQUAL + ε (4)
Where
P = stock price in month following repo-
rting date
BV = book value per share
AE = abnormal earnings per share, equal to
the median analyst forecast of earnings
per share one year ahead, less the cost
of equity capital times the beginning of
year book value
Australian Accounting Review 75
Firm Value and the Quality of Sustainability Reporting
REPTQUAL = a measure of sustainability reporting
quality SUSTAIN , CLARKIND, CLARK-
BIN , where
SUSTAIN = 1 if firm classified by CAER as exhibit-
ing acceptable sustainability disclosures,
otherwise = 0
CLARKIND = multi-level disclosure index based on
Clarkson et al. 2008
CLARKBIN = 1 if CLARKIND > = 3, otherwise = 0
We use analysts’ one-year ahead forecast earnings in
our estimation of abnormal earnings to maintain con-
sistency with our cost of equity measure. If sustainability
reporting quality is associated with higher expected
future cash flows beyond the forecast horizon used to
calculate cost of equity, the coefficient on our reporting
quality proxies (SUSTAIN, CLARKIND, CLARKBIN )
should be positive and significant. Intuitively, such a
result suggests that the market pays a premium for the
equity of firms with higher-quality sustainability reports,
relative to the price implied by current book value and
short-term earnings. Given that cost of equity effects
are controlled in the calculation of abnormal earnings,
any valuation effects detected logically derive from
differences in the extent to which long-run performance
is expected to be superior (inferior) to short-run
performance. We also test a variant of equation 4 that
includes interactions between sustainability reporting
quality and industry sensitivity to sustainability issues,
similar to our cost of equity tests.
Finally, following Al-Tuwaijiri et al. (2004), we
recognise that the relationship between sustainability
reporting and firm value is potentially complicated by the
endogenous determination of sustainability reporting
quality. There is, for example, evidence that firms’
sustainability reporting quality is associated with proxies
for sustainability performance (Bewley and Li 2000;
Patten 2002; Clarkson et al. 2008; Clarkson et al.
2011), and that better sustainability performance may
enhance firm value via cost of equity or future financial
performance effects (Sharfman and Fernando 2008;
Connors and Silva-Gao 2008; Clarkson et al. 2010).
The directional impact of sustainability performance-
related endogeneity on our main tests is unclear, because
the extant literature reports contradictory relationships
between sustainability performance and sustainability
reporting quality. Using a sample of US firms in envi-
ronmentally sensitive industries, Clarkson et al. (2008),
find that firms with better environmental performance
issue higher-quality sustainability reports, although
poor performers are likely to make a greater number
of soft disclosures. However, Clarkson et al. (2011)
find that Australian firms with weaker environmental
performance issue higher-quality environmental reports
(regardless of whether one considers hard or soft
disclosures). Firms’ financial performance (Richardson
76 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
and Welker 2001), and relative exposure to political
action (Patten and Trompeter 2003; Cormier and
Magnan 1999), may also jointly impact disclosure
decisions and firm value.
We test the sensitivity of our main results to potential
endogeneity using two-stage regression methods com-
mon in the literature. For our dichotomous reporting
quality measures (SUSTAIN and CLARKBIN) we use
a Heckman-type correction. We first estimate a probit
regression of the probability of a firm producing high-
quality sustainability reports as a function of proxies
for expected financial performance (forecast return on
equity), poor and strong environmental performance
(incidence of fines or other sanctions for breaching
environmental regulations and the receipt of awards
relating to environmental performance)7 , and political
exposure (the number of times a corporation or any
of its subsidiaries was mentioned in the proceedings of
Commonwealth or state parliaments) and the control
variables from equation 2.8 We then control for these
predicted probabilities in our second-stage regressions,
implying that the estimated coefficients for our test
variables reflect the extent to which their association
with firm value is incremental to that of a randomly
selected firm with similar sustainability performance,
expected financial performance and political exposure.
For models using our ordinal sustainability proxy,
CLARKIND, we use the two-stage least squares method.
We first regress CLARKIND against the proxies for
sustainability performance, financial performance and
political exposure, and then use the fitted values
from this regression in place of the actual value
of CLARKIND when estimating our second-stage
regressions. Further details of the method employed,
and results for the first-stage regressions, are provided in
Appendix A.
Descriptive Statistics
Our sample is drawn from firms included in the ASX 200
on 30 June of each year between 2003 and 2005.9 The
potential sample of 600 firms was reduced for several
reasons. First, in order to estimate firms’ cost of equity
capital, analyst forecasts for earnings one and two years
ahead, and for dividends one year ahead were required.
Further, even where forecasts were available the modified
PEG model was only defined for certain combinations
of implied earnings growth and dividends. Estimates
of ke were only available for 529 firm years. There was
insufficient stock return data to estimate equity betas
for 49 firm years. Finally, we truncated our sample at
the second and 98th percentiles of the distribution of
estimated cost of equity, which, when applied to our
already reduced sample, eliminated a further 30 firm
years. Our final sample thus comprises 450 firm years.10

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson Firm Value and the Quality of Sustainability Reporting

Table 2 Descriptive statistics

Panel A: Pooled descriptives

Mean SD 25% Median 75% Min. Max.

Continuous and ordinal variables
Ke 0.116 0.038 0.095 0.109 0.123 0.065 0.381
B toM 0.566 0.299 0.350 0.520 0.760 0.000 1.450
SIZE (Ln) 21.328 1.986 20.260 21.190 22.250 −2.520 26.400
SIZE ($M) 12,400 44,200 639 1,640 4,600 51.000 293,000.000
Beta 0.961 0.676 0.500 0.900 1.300 −0.300 3.600
POLEXP 1.447 1.399 0.000 1.099 2.485 0.000 5.565
CLARKIND 1.251 1.081 0 1 2 0 4
P 7.158 7.471 2.250 4.525 8.980 0.790 35.540
BV 3.011 3.404 1.147 1.893 3.452 0.092 27.857
EPS 0.461 0.518 0.158 0.291 0.540 −0.099 3.212
FROE 0.066 0.038 0.050 0.064 0.079 −0.005 0.205
AEPS 0.359 0.627 0.014 0.187 0.505 −1.228 0.954
Dichotomous variables
AWARDS 0.108 0.328
FINES 0.062 0.241
SUSTAIN 0.204 0.404
CLARKBIN 0.149 0.356
Energy 0.049 0.216
Materials 0.138 0.345
Industrials 0.149 0.356
Consumer Discretionary 0.160 0.367
Consumer Staples 0.082 0.275
Financials 0.233 0.423
Health Care 0.102 0.303
IT 0.031 0.174
Utilities 0.042 0.201
Telcos 0.013 0.114
Panel B: Descriptives by sustainability reporting quality

Firm years where SUSTAIN = 0 Firm years where SUSTAIN = 1

p-value (diff.
Mean Med SD Mean Med SD in means)
Ke 0.115 0.109 0.033 0.115 0.108 0.033 0.563
BtoM 0.572 0.520 0.314 0.546 0.505 0.238 0.221
SIZE [ln(TA)] 21.121 20.910 2.001 22.184 22.175 1.695 <0.001
Total Assets ($M) 8,880 33,200 1,230 26,200 71,500 4,290 <0.001
BETA 0.97 0.80 0.70 0.90 0.90 0.57 0.200
POLEXP 1.267 1.099 1.306 2.147 1.869 1.527 <0.001
FINES 0.025 0.000 0.157 0.206 0.000 0.407 <0.001
AWARDS 0.067 0.000 0.261 0.271 0 0.471 <0.001
P 6.686 4.120 7.214 9.032 6.340 8.188 0.006
BV 2.837 1.672 3.391 3.681 2.974 3.387 0.037
EPS 0.425 0.267 0.491 0.604 0.385 0.577 0.002
FROE 0.092 0.062 0.269 0.074 0.070 0.042 0.495
AEPS 0.346 0.170 0.631 0.407 0.231 0.588 0.412

SUSTAIN = dummy variable equal to 1 if firm classified by CAER as providing acceptable sustainability disclosures, 0 otherwise; CLARKIND =
sustainability disclosure score from modified Clarkson index; CLARKBIN = dummy variable = 1 if CLARKIND > = 3, 0 otherwise; BtoM =
book-to-market ratio; SIZE = natural log of total assets; BETA = equity beta; POLEXP = natural log of the number of times the corporation
or any of its subsidiaries appears in the published proceedings of Commonwealth and state parliaments during the year; P = stock price;
BV = book value per share; EPS = median forecast earnings one year ahead; FROE = EPS / current stock price; AEPS = EPS – (BV x
Ke). Other variables represent GICS sectors. FINES = 1 if the firm reported that it had been fined or otherwise sanctioned for a breach
of significant environmental regulations, otherwise 0; AWARDS = 1 if the firm reported that it had received an award for sustainability
performance, otherwise 0.

Descriptive statistics regarding the distributions of the
continuous and dichotomous variables are presented in
Table 2.
Our measures of sustainability reporting quality,
SUSTAIN and CLARKIND, are closely related. Firms
classified by CAER as providing acceptable sustainability
disclosures (SUSTAIN = 1) have a mean CLARKIND
score of 2.23, while other firms (SUSTAIN = 0) have
a mean CLARKIND score of 0.997. Of the firms
for which SUSTAIN = 1, approximately 60% had a


C 2013 CPA Australia Australian Accounting Review 77
Firm Value and the Quality of Sustainability Reporting K. Bachoo, R. Tan & M. Wilson

Table 3 Correlation matrix

Ke SUSTAIN CLARKIND CLARKBIN BtoM BETA SIZE EPS P BV
Ke 1 −0.014 0.012 −0.045 0.125 0.209 −0.138 −0.111 −0.075 −0.062
SUSTAIN 1 0.464 0.438 −0.035 −0.044 0.219 0.141 0.033 0.019
CLARKIND 1 0.753 0.038 −0.085 0.139 0.023 0.063 0.072
CLARKBIN 1 0.026 −0.077 0.135 0.044 0.084 0.083
BtoM 1 −0.075 0.19 −0.261 −0.155 0.021
BETA 1 0.004 0.117 −0.062 −0.03
SIZE 1 0.44 −0.072 0.041
EPS 1 0.394 0.146
P 1 0.692
BV 1

Ke = cost of equity capital; SUSTAIN = dummy variable equal to 1 if firm classified by CAER as providing acceptable sustainability
disclosures, 0 otherwise; CLARKIND = sustainability disclosure score from modified Clarkson index; CLARKBIN = dichotomous recoding of
CLARKIND, = 1 where CLARKIND > = 3, SUSTAINxSENS = 1 if SUSTAIN = 1 and firm is a member of energy, materials or industrials sector,
0 otherwise; CLARKINDxSENS = CLARKIND if firm is a member of energy, materials or industrials sector, 0 otherwise; CLARKBINxSENS = 1
if CLARKBIN = 1 and firm is a member of energy, materials or industrials sector, 0 otherwise; BtoM = book-to-market ratio; BETA = equity
beta; SIZE = natural log of total assets; EPS = median forecast earnings one year ahead; P = stock price; BV = book value per share.

CLARKIND score of 3 or 4. In panel B of Table 2 we
report descriptive statistics conditioned on the value of
SUSTAIN . From this table, it is clear that firms with
high-quality sustainability reporting (SUSTAIN = 1)
are larger (SIZE), have greater political visibility
(POLEXP), and are more likely to have incurred
fines or other sanctions for breaching environmental
guidelines (FINES) or received awards (AWARDS) for
sustainability-related reasons than firms with low-
quality sustainability reporting (SUSTAIN = 0).11 For
this reason, our additional tests address the potential
selection biases implied. In particular, we test our main
regression model on sub-samples defined by SIZE, and
include political exposure (in addition to indicators
of environmental performance and expected financial
performance) in the first stage of our endogeneity
corrected regressions.
The correlation between variables is reported in
Table 3. Aside from variables that are collinear by con-
struction (interaction terms) and the main components
of the Ohlson model (P, BV, EPS), no correlations
exceed 30% for variables included in any single model.
Variance inflation factors (VIFs) were calculated to test
for the presence of significant multicolinearity among
our independent variables. No VIF exceeded 5.0, and all
VIFs associated with our test variables were less than 2.0,
suggesting that multicolinearity presents no problems
for the interpretation of our results.
Results
Table 4 reports the results of our tests of the overall
relationship between cost of equity and sustainability
reporting. In panel A, we report results using our primary
measure of sustainability reporting quality (SUSTAIN )
provided by CAER. Column 1 of this table reports results
of tests of H1 based on our full sample of firm years. The
model is reasonably well fitted, with an R2 of 22.3%.
All of our control variables are significant and of the
predicted sign. The coefficient on SUSTAIN is negative
and significant (B = −0.0116; p = 0.031), supporting
our hypothesis that the cost of equity is lower for
firms with higher-quality sustainability reporting. Thus,
it appears that the market pays a slight premium for
the equity of firms with higher-quality sustainability
disclosures. Thus, there appears to be a potential price
reward for quality reporting.
In columns 2 and 3, we divide our sample at the yearly
median value of SIZE, and repeat the regression specified
in equation 2. It is clear from these two regressions
that our key result holds only with respect to large
firms, with the coefficient for SUSTAIN negative and
significant in this model (B = −0.0083, p = 0.022).
In the regression estimated on the sample of small
firms, no significant association between cost of equity
and SUSTAIN is detected. These results reflect the
likelihood that larger firms’ behaviour is subjected to
greater public scrutiny (Watts and Zimmerman 1978),
and therefore behaviour judged as socially responsible
is more likely to be rewarded. This result may also
partially reflect the fact that a smaller proportion of
smaller firms have high-quality sustainability reports,
and thus the estimation of the regression is noisier for this
sub-sample.
In column 4, we present the results of our endogeneity
corrected model of cost of equity. We use a Heckman-
type approach, first regressing SUSTAIN against factors
expected to affect the likelihood of a firm issuing high-
quality sustainability reports, including forecast financial
performance (FROE), environmental performance (the
incidence of fines or other sanctions for breaching
environmental regulations and receipt of awards for sus-
tainability performance) and political exposure (proxied
by the number of times a corporation or any of its
subsidiaries was mentioned in Commonwealth or state

78 Australian Accounting Review 

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson Firm Value and the Quality of Sustainability Reporting

Table 4 Regressions of cost of equity against sustainability reporting quality

(1) (2) (3) (4) (5)
VARIABLES All firms Large firms Small firms Endogeneity corrected Sensitive industries
Panel A: Sustainability classification provided by CAER
∗∗ ∗∗ ∗∗∗
SUSTAIN (−) −0.0116 −0.0083 −0.0003 −0.0281 0.0034
(0.031) (0.022) (0.485) (0.003) (0.630)
∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗
BtoM (+) 0.0225 0.0098 0.0492 0.0210 0.0226
(0.001) (0.190) (0.000) (0.000) (0.001)
∗∗ ∗ ∗∗ ∗∗
BETA (+) 0.0084 0.0013 0.0071 0.0070 0.0088
(0.017) (0.400) (0.042) (0.006) (0.009)
∗ ∗∗ ∗
SIZE (−) −0.0019 0.0043 −0.0023 −0.0009 −0.0020
(0.096) (0.031) (0.148) (0.202) (0.098)
∗∗
SUSTAINxSENS (−) −0.0263
(0.035)
∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗
Constant 0.1298 −0.0092 0.1882 0.1162 0.1240
(0.000) (0.832) (0.001) (0.000) (0.000)
Observations 450 223 224 450 450
R-squared 0.223 0.153 0.318 0.232 0.238
Panel B: Sustainability index based on Clarkson et al. (2008)
∗∗∗ ∗∗∗ ∗∗ ∗∗
CLARKIND −0.0044 −0.0024 −0.0042 −0.0104 −0.0014
(0.002) (0.001) (0.024) (0.015) (0.122)
∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗
BtoM 0.0239 0.0108 0.0488 0.0244 0.0237
(0.000) (0.151) (0.000) (0.002) (0.001)
∗∗ ∗∗∗ ∗∗ ∗∗
BETA 0.0086 0.0019 0.0098 0.0075 0.0084
(0.016) (0.341) (0.005) (0.021) (0.022)
∗∗ ∗ ∗
SIZE −0.0015 0.0037 −0.0031 −0.0018 −0.0021
(0.078) (0.040) (0.156) (0.066) (0.099)
∗∗∗
CLARKINDxSENS −0.0081
(0.005)
∗∗∗ ∗∗ ∗∗∗ ∗∗∗
Constant 0.1439 0.0057 0.1360 0.1502 0.1314
(0.000) (0.894) (0.012) (0.000) (0.001)
Observations 450 223 227 450 450
R-squared 0.223 0.148 0.359 0.204 0.232
Panel C: Dichotomous sustainability classification based on Clarkson et al. (2008)
∗∗ ∗∗ ∗∗∗
CLARKBIN −0.0130 −0.0059 −0.0100 −0.0406 −0.0017
(0.017) (0.008) (0.169) (0.003) (0.318)
∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗
BtoM 0.0240 0.0113 0.0480 0.0247 0.0243
(0.000) (0.139) (0.000) (0.000) (0.000)
∗∗ ∗∗∗ ∗∗∗ ∗∗
BETA 0.0086 0.0020 0.0098 0.0067 0.0084
(0.014) (0.335) (0.005) (0.009) (0.020)
∗ ∗∗ ∗
SIZE −0.0022 0.0038 −0.0030 −0.0014 −0.0022
(0.076) (0.019) (0.161) (0.098) (0.071)
∗∗∗
CLARKBINxSENS −0.0207
(0.004)
∗∗∗ ∗∗ ∗∗∗ ∗∗∗
Constant 0.1390 0.0011 0.1305 0.1383 0.1305
(0.000) (0.980) (0.017) (0.000) (0.000)
Observations 450 223 227 450 450
R-squared 0.225 0.147 0.358 0.227 0.233

SUSTAIN = dummy variable equal to 1 if firm classified by CAER as providing acceptable sustainability disclosures, 0 otherwise; CLARKIND =
sustainability disclosure score from modified Clarkson index; CLARKBIN = 1 if CLARKIND > = 3, 0 otherwise; BtoM = book-to-market
ratio. BETA = equity beta; SIZE = natural log of total assets; SUSTAINxSENS = 1 if SUSTAIN = 1 and firm is a member of energy, materials
or industrials sector, 0 otherwise; CLARKINDxSENS = CLARKIND if firm is a member of energy, materials or industrials sector, 0 otherwise;
CLARKBINxSENS = 1 if CLARKBIN = 1 and firm is a member of energy, materials or industrials sector, 0 otherwise. All models include
unreported industry fixed effects. Regressions reporting in column 4 of panels A and C include the inverse Mills ratio from first-stage
regressions reported in Appendix A. Standard errors are adjusted for clustering by firm and year. p-values (in parentheses); ∗∗∗ p < 0.01,
∗∗
p < 0.05, ∗ p < 0.1 are one-tailed if coefficient is of predicted sign, otherwise two-tailed.


C 2013 CPA Australia Australian Accounting Review 79
Firm Value and the Quality of Sustainability Reporting
parliaments). From this first-stage probit regression,
we calculate the inverse Mills ratio (IMR) for each
observation, which reflects the innate likelihood that
the particular case will be associated with high-quality
sustainability reporting. We then include the IMR in our
second-stage cost of equity regression (untabulated) to
control for possible selection bias. Statistical comparison
of coefficients for the standard OLS and endogeneity
corrected regressions (Durbin-Wu-Hausmann tests)
suggest that each of our sustainability reporting proxies
are endogenous (p < 0.001). After controlling for this
endogeneity through the Heckman approach, the
coefficient on SUSTAIN remains significantly negative
(B = −0.0281, p = 0.003).12
Finally, in column 5, we test for a difference in
the relation between cost of equity and sustainability
reporting quality according to the sensitivity of firms’
operations to sustainability issues. We add an additional
regressor (SUSTAINxSENS), representing an interaction
between SUSTAIN and a dichotomous variable (SENS),
equal to 1 if the firm is a member of the energy,
materials or industrial sectors. We detect significant
associations between cost of equity and SUSTAINxSENS
(B = −0.0263, p = 0.035), and no significant association
between our main effect (SUSTAIN ) and cost of equity.
Further, the sum of the coefficients for the main
effect and SUSTAINxSENS is significantly negative (p =
0.0231). Collectively, these results imply that there is a
negative association between cost of equity and sustain-
ability reporting quality in ‘sensitive’ sectors, but not in
other sectors, and that the difference in the association
between ke and sustainability reporting quality across
these sectors is significant. Given the implications of
the behaviour of firms in the energy, materials and
industrial sectors for serious environmental concerns
such as global warming, it is not surprising that firms
in this sector have issues of substance to report and
experience greater market reaction to their disclosure
practices. This market reaction need not be the result
of demand from concerned ethical investors, or the
demand of other investors concerned with the impact
of environmental legislation on such firms. It is also
plausible that investors interested purely in financial
returns perceive a greater risk attaching to the future
performance of firms that presently disclose very little
regarding their contribution to sustainability. While
firms in the industrial sector arguably contribute less
directly to environment degradation, member firms such
as those in the transport and construction industry
groups are significant users of fossil fuels, and, in the
case of transport firms, are reasonably well known to the
public.
In panels B and C, we replicate our main tests using
proxies for the quality of sustainability reporting derived
from the schema of Clarkson et al. (2008). In panel B, we
report the results of regressions in which CLARKIND is
80 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
employed as our reporting quality proxy. The coefficient
for CLARKIND is negative and significant (B = −0.0044,
p = 0.002), consistent with a lower cost of equity
accruing to firms with higher sustainability reporting
quality. CLARKIND also demonstrates a significant
negative association with cost of equity in the regression
estimated on for both large (B = −0.0024, p = 0.001)
and small firms (B = −0.0042, p = 0.030). In our
endogeneity corrected model (column 4), CLARKIND
remains significantly negative (B = −0.0104, p = 0.015).
Furthermore, when the sustainability sensitivity of the
firms’ operations is taken into account (column 5) we
report a significant difference between ‘sensitive’ firms
and others.
In panel C, we employ a binary coding (denoted
CLARKBIN ) derived from our Clarkson index score
(CLARKIND), equal to 1 if CLARKIND is greater than or
equal to 3, and 0 otherwise. Our results (column 1) yield
a significant negative coefficient for CLARKBIN (B =
−0.0131, p = 0.017) in our main test (column 1).
CLARKBIN is also significantly negatively associated
with cost of equity for the large firm sample (B =
−0.0059, p = 0.008), the endogeneity corrected model
(B = −0.040, p = 0.003), but is not significant for small
firms. Finally, the interaction between CLARKBIN and
sustainability sensitivity is significantly negative (B =
−0.0207, p = 0.004).
Expected future performance regression results
Table 5 reports the results of our Ohlson-type
regressions, which we use to examine whether there is
evidence of an association between market expectations
of long-term performance and sustainability reporting
quality. Centrally, we should observe a significant
positive coefficient for our measures of superior
reporting quality if these are associated with a reduced
market expectation that firms will suffer long-term losses
as a consequence of sustainability-related activities.
Our main model (column 1) tests the relation
between our proprietary measure of reporting quality
(SUSTAIN ) and the market’s expectation of future
performance. The model has an R2 , of 82.6%, similar
to comparable US studies such as Clarkson et al.
(2010). The coefficients for book value and abnormal
earnings are positive and significant. The coefficient for
SUSTAIN is positive and significant (B = 0.8938, p =
0.006), consistent with the hypothesis that the expected
future performance of firms with higher sustainability
reporting quality is systematically higher than that for
other firms, after controlling for current abnormal
earnings. This may result from the market ascribing
a lower likelihood of future sustainability-related cash
outflows, such as restoration costs and fines, for high-
quality reporters. Importantly, this effect is detected after

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson Firm Value and the Quality of Sustainability Reporting

Table 5 Ohlson regressions of stock price against book value, abnormal earnings and proxies for sustainability reporting
quality

(1) (2) (3) (4) (5) (6)

SUSTAIN with CLARKIND with CLARKBIN with
VARIABLES SUSTAIN sensitive industries CLARKIND sensitive industries CLARKBIN sensitive industries
∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗
BV 1.0109 1.0027 1.0086 1.0082 1.0288 1.0147
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗ ∗∗∗
AE 7.2441 7.2346 7.2817 7.2877 8.4943 7.2709
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
∗∗
SUSTAIN (B3 ) 0.8938 0.1714
(0.006) (0.286)
∗∗
SUSTAINxSENS (B4 ) 1.2294
(0.027)
CLARKIND (B3 ) 0.1729 0.2022
(0.211) (0.131)
CLARKINDxSENS (B4 ) −0.0649
(0.808)
CLARKBIN (B3 ) 0.0039 0.1816
(0.498) (0.260)
CLARKBINxSENS (B4 ) −0.2916
(0.760)
∗∗∗ ∗∗∗ ∗∗∗
Constant 0.8343 1.0775 0.6095 0.5225 0.5694 0.9867
(0.005) (0.000) (0.139) (0.194) (0.275) (0.000)
Observations 450 450 450 450 450 450
R-squared 0.826 0.826 0.824 0.824 0.818 0.824
F-test of B3 + B4 = 0 0.0048 0.6693 0.9138
(p-value)

BV = book value per share; AE = forecast EPS one year ahead less book value per share times the cost of equity capital; SUSTAIN =
dummy variable equal to 1 if firm classified by CAER as providing acceptable sustainability disclosures, 0 otherwise; CLARKIND =
sustainability disclosure score from modified Clarkson index; CLARKBIN = dichotomous recoding of CLARKIND, = 1 where CLARKIND > = 3;
SUSTAINxSENS = 1 if SUSTAIN = 1 and firm is a member of energy, materials or industrials sector, 0 otherwise; CLARKINDxSENS = CLARKIND
if firm is a member of energy, materials or industrials sector, 0 otherwise; CLARKBINxSENS = 1 if CLARKBIN = 1 and firm is a member of
energy, materials or industrials sector, 0 otherwise.

accounting for differences in cost of equity between
high-quality sustainability reporters and other firms.
In column 2 we add industry sector dummy variables,
and an interaction between SUSTAIN and SENS (where
SENS indicates membership of the environmentally
sensitive sectors: energy, materials and industrials).
Similar to our cost of equity results, the main effect for
SUSTAIN is insignificant (B = 0.1714, p = 0.286), but the
interaction term SUSTAINxSENS is significantly positive
(B = 1.2294, p = 0.027), and the sum of coefficients
for SUSTAIN and SUSTAINxSENS is also significantly
positive (B = 1.4009, p = 0.005), indicating that the
impact of sustainability reporting quality on expected
future performance is concentrated in environmentally
sensitive sectors.
In columns 3 and 4 we repeat the analysis above, using
our ordinal measure of reporting quality, CLARKIND.
In the main test CLARKIND is not significantly
associated with current stock price (B = 0.1729, p =
0.211), failing to support H2. Further, the results in
column 4 include insignificant coefficients for both
the main effect (B = 0.2022, p = 0.131) and the
interaction term CLARKINDxSENS (B = −0.0649,
p = 0.808), and the sum of the coefficients for
CLARKIND and CLARKINDxSENS (B = 0.1373, p =
0.669) is also insignificant, indicating that our self-
constructed index is not associated with superior ex-
pected future performance in environmentally sensitive
industries. Finally, columns 5 and 6 report the results
of Ohlson-type regressions using CLARKBIN as our
proxy for sustainability reporting quality. This proxy
generates a similar combination of results to those
reported in columns 3 and 4 – there is no association
between our author-constructed dichotomous measure
of sustainability reporting quality and expected future
performance.
In the interests of brevity, we do not tabulate the results
of endogeneity corrected regressions for our expected
future performance models. Endogeneity corrected
results for models based on our proprietary measure of
reporting quality (SUSTAIN) are substantively similar
to the tabulated OLS results. For regressions using our
author-constructed measures of reporting quality there
is a significant positive coefficient (p < 0.05) for our
sustainability reporting quality measures (CLARKIND
and CLARKBIN ); however, there is no evidence that
that this relationship is stronger for environmentally
sensitive industries. It is likely that firm-size effects


C 2013 CPA Australia Australian Accounting Review 81
Firm Value and the Quality of Sustainability Reporting
explain much of the difference in results observed
with respect to the OLS and endogeneity corrected
regressions for the CLARKIND and CLARKBIN models.
While the OLS Ohlson model does not control for
firm size, SIZE is included as an instrument in the
first stage of our endogeneity corrected models.13 To
further investigate this issue, we re-estimated our OLS
models excluding the lowest quartile (and lowest two
quartiles) of firms ranked by SIZE. These tests reported
significant positive coefficients for all three sustainability
reporting quality proxies (SUSTAIN, CLARKIND and
CLARKBIN ), but there was only an increased effect of
reporting quality for sensitive industries in models using
our proprietary reporting quality measure. Because
SUSTAIN is a measure prepared by experts with a
deep understanding of the nature and scope of a firm’s
sustainability-related activities, it is not surprising that
this measure is associated with more consistent results
than our author-constructed reporting quality proxies.
Untabulated sensitivity tests
We conducted numerous untabulated sensitivity tests,
which are summarised below:
– Alternative controls for firm size. Because cost
of equity, expected future performance and firms’
reporting quality are sensitive to firm size, and it
is likely that a single continuous variable (SIZE)
will control for this effect imperfectly, we tested
numerous alternative model specifications. Adding
non-linear functions of SIZE had no significant effect
on our model fit, or on our key results. Using the
natural log of the market value of equity or total
revenues as our proxy for SIZE leaves all of our key
results unaffected.
– Controls for current and forecast performance in
cost of equity regressions. We included (alternately)
the current level of actual earnings per share deflated
by stock price and (alternately) the one-, two-, three-
and four-year ahead forecast EPS deflated by stock
price as additional regressors in our cost of equity
regressions (equation 2). We then estimated equation
2, including the two-year ahead forecast EPS (the
limit of the forecast horizon used in cost of equity
calculations) and analyst forecast earnings growth
between years 2 and 4. All of our key results held at
similar or greater levels of significance.
– Alternative risk controls. We re-estimated our cost
of equity models using firm distress as proxied by
Zmijiewski’s Z-score, and firm leverage, in addition
to, and in place of, BETA. We then added (singularly
and in combination) BETA, Z-Score and Leverage
to our Ohlson-type regressions. In each of these
regressions our key results remained unchanged.
82 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
– Exclusion of firms with low cost of equity. Dhaliwal
et al. (2011) argue that firms with already low cost
of equity are less likely to benefit from high-quality
reporting. Consequently, we re-estimated both our
cost of equity and Ohlson-type regressions using a
sample that excluded the bottom quartile of firms
ranked by cost of equity. All test variables remained
significant at similar confidence levels.
– Exclusion of firms that made no disclosure under
s299(1)(f). Section 299(1)(f) requires firms to
disclose their performance in relation to any specific
and significant environmental regulation to which
they are subject. Approximately 14% made no
disclosure under this provision. We repeated all of
our tests using a sample that excluded these firms.
Our key results remained substantively unaffected.
– Exclusion of firms incorporated outside Australia.
We repeated our regressions excluding firms incor-
porated outside Australia (and thus not subject to the
Corporations Act). Our results were not substantively
affected.
– Further sustainability performance tests. We re-
estimated both our cost of equity and expected future
performance regressions using samples that exclude
firms that incurred fines or other sanctions for
breaching environmental regulations (an indicator
of poor performance), and those who reported the
receipt of awards for sustainability-related issues
(an indicator of good performance). Our key
test variables remained significant at similar or
stronger confidence levels. We then re-estimated
our endogeneity corrected regressions, including the
proxies for financial and sustainability performance
(but not political exposure) in the second stage
regressions (as well as in the first stage). While all
performance proxies were significant in the first-stage
regression, none were significant in the second-stage
regression, and the coefficients for our test variables
were substantively unaffected.
– Alternative measures of cost of equity. We replicated
our tests using the original PEG model, and a PEG
model in which growth is estimated from earnings
forecasts three and four years ahead (rather than one
year and two years ahead). This latter specification,
while reducing sample size, is less noisy because
the difference between earnings forecasts three and
four years ahead is less likely to be contaminated
by seasonal earnings behaviour. Our key results held
using these alternative cost of equity measures.
– Sector-specific effects. We replaced our tests of the
variable impact of sustainability reporting quality
on cost of equity and expected future performance
across sensitive and non-sensitive industries, with
tests using a series of interactions between SUSTAIN
and each industry sector dummy variable. For

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson
the cost of equity model, significant effects were
reported in the energy and industrials sectors, but not
materials. When we repeated this analysis with our
endogeneity correction, all interactions in sensitive
industries were significant in the predicted direction.
For the Ohlson-type models, the interaction between
sustainability reporting quality and industry was
significant for materials and industrial firms, but
insignificant for energy firms.
– Alternative control for time effects. Rather than
cluster standard errors by firm and year, we
re-estimated our regressions with firm-clustered
standard errors, and dummy variables representing
the year of the observation. This left our main
results for both cost of equity and expected future
performance unaffected.
– Endogeneity correction applied to sensitive in-
dustry model. We replicated our cost of equity
regressions reported in column 5, including the same
endogeneity corrections that were applied to our
main tests. Our results were substantively unaffected,
with the significance of our test variables greater than
those tabulated.
– Alternate proxies for abnormal earnings in Ohlson
models. We re-estimated our Ohlson models using
the following alternate proxies for expected abnormal
earnings per share: current actual earnings per share;
current actual earnings per share minus book value
per share times cost of equity; forecast EPS two, three
and four years ahead; forecast EPS two, three and
four years ahead less book value per share times cost
of equity. All model variants produced similar results
to those tabulated.
Conclusion
This paper has provided the first quantitative evidence of
the association between Australian firms’ sustainability
reporting practices and firm value, as measured by
the ex ante cost of equity capital and expected
future performance. We report a significant association
between the quality of firms’ sustainability disclosures
and the ex ante cost of equity capital, and a significant
positive association between sustainability reporting
quality and expected future performance. We find that
both of these effects are robust to endogeneity controls,
and are largely concentrated in industry sectors for which
environmental performance is of particular relevance.
Our evidence is consistent with the proposition that
markets value high-quality sustainability reporting, and
that it is the environmental component of sustainability
reporting that is most closely related to firm value.
Our results have clear implications for reporting
entities, investors and regulators, in Australia and in
other countries with similarly developed capital markets.
From a reporting entity’s perspective, the fact that

C 2013 CPA Australia
Firm Value and the Quality of Sustainability Reporting
markets appear to reward meaningful sustainability
disclosures, even where those disclosures may include the
reporting of cash outlays, may induce more widespread
adoption of comprehensive sustainability reporting.
Similarly, regulators representing a societal demand for
greater CSR may expect to experience less political
opposition from corporate interests than attempts to
increase the level of mandatory sustainability reporting,
if it can be argued that private economic benefits
may accrue to improved sustainability reporting. The
implications of our results for investors are mixed. On
one hand, responsible investors may perceive a greater
level of assurance that the firms in which they have
invested have lower risk than investments in otherwise
similar firms. Conversely, the lower ex ante cost of capital
attaching to such investments implies that investors have
paid a premium for their investment.
Our results are also relevant to the scholarly
community. Our paper is the first to reconcile
measures of sustainability reporting quality used in the
academic literature with similar measures employed by
professional information providers. We demonstrate a
reasonably close correlation between our hand-collected
measure of sustainability reporting quality, based on
Clarkson et al. (2008), and CAER’s classification of firms
according to the same underlying construct. Further, we
report similar associations between cost of equity and
each of these sustainability reporting measures in many
of our model variants.
There are limitations to our findings. First, we focus
on just two measures of sustainability reporting quality,
and all such measures are necessarily noisy. However,
our primary measure of reporting quality has the
advantage of being prepared by an independent specialist
organisation, and as such is arguably a sound proxy for
the information actually used by responsible investment
funds when constructing their portfolios.
Second, while we control for potential endogeneity
affecting the relationship between firm value and firms’
sustainability reporting behaviour, all such attempts de-
pend on the specification of the models used. If any of our
predictors of disclosure quality (financial performance,
sustainability performance, political exposure) are also
correlated with errors from our second-stage firm value
models, our endogeneity controls may be imperfect.
However, given the results in Dhaliwal et al. (2011) and
Clarkson et al. (2011), we believe that the endogenous
determination of sustainability reporting quality is most
likely to be biased against, rather than in support of, our
results.
Acknowledgements
The authors wish to thank CAER – Corporate Analysis
Enhanced Responsibility for access to their proprietary
data regarding the sustainability reporting performance
Australian Accounting Review 83
Firm Value and the Quality of Sustainability Reporting
of Australian firms, and the considerable assistance
provided by their staff. They particularly acknowledge
the assistance of Duncan Paterson (CEO) and Philip
Sloane (Head of Research). The authors also wish
to thank Louise Lu for access to her data regarding
corporate political exposure. The authors also gratefully
acknowledge feedback received from Neil Fargher and
participants at the 2011 AFAANZ Conference and in
the seminar programs at Deakin University and the
Australian National University. The views expressed in
this article are those of the authors and are not necessarily
those of BHP Billiton Ltd.
Notes
1 Whether estimation risk is diversifiable has been the subject
of a protracted and currently unresolved debate in the
analytical literature. Easley and O’Hara (2004) propose a finite
economy model in which ‘uninformed’ investors demand a
premium return because they recognise that their information
disadvantage relative to that of ‘informed’ investors will induce
an over-representation of ‘bad news stocks’ in their portfolios.
The return premium should increase with the extent to which
informed investors’ total information set is dominated by private
information. Hughes et al. (2007) argue that if Easley and
O’Hara’s (2004) assumption of a finite economy is relaxed,
estimation risk does affect the cross-section of firm costs of
capital. Finally, Lambert et al. (2007) use a model in which
the precision of accounting information potentially affects real
future production decisions, and under certain conditions, the
risk attaching to this effect is not diversifiable. For a more
thorough review of this issue, see Artiach and Clarkson (2011).
2 Dejean and Martinique (2009) find no relationship between
French listed firms’ environmental disclosures and cost of equity
in 2006. Their measure of cost of equity, based on the capital
asset pricing model, incorporates an ex ante forecast market risk
premium. However, cross-sectional variations in cost of equity
are singularly a function of firm betas. The paper does not specify
the window over which betas are estimated.
3 This organisation was formerly known as the Centre for
Australian Ethical Research.
4 We initially coded these disclosures according to whether they
appeared in the directors’ reports or elsewhere. This additional
criterion was of little use in discriminating between firms.
The results reported in Table 2, therefore, represent aggregate
disclosures.
5 A number of alternative models require longer-horizon forecasts
(e.g., EPS four and five years ahead) than the modified PEG
model employed here. The use of these models would drastically
reduce our sample, due to data availability.
6 The small number of observations per subject, and the low
within-subject variability of the SUSTAIN variable rendered the
use of firm fixed effects and ‘changes’ models problematic. All
regressions reported in this paper were re-estimated on single-
year samples, and coefficients were broadly consistent across
years, although significance was necessarily lower due to the
lesser sample size in the single-year regressions.
7 We considered including a single linear control for sustainability
performance. The National Pollutant Inventory (NPI) reports
facility-by-facility emissions data for fixed facilities (e.g.,
factories, mines). However, this data reports the physical mass
of emissions of 93 different pollutants separately, and the NPI
explicitly warns that ‘the various NPI substances have distinct
properties and levels of toxicity and it is therefore meaningless
84 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
to add together emissions of different substances’ (NPI 2011).
While a risk index for pollutants is made available by the NPI, the
risk weightings provided are not defined on a per kilogram basis,
and thus cannot meaningfully be used to aggregate emissions
of various pollutants. Further, the correlations between similar
use measures of environmental performance (the Toxic Release
Inventory) and reporting quality documented by Clarkson et
al. (2010) are modest insignificantly different from zero, and
the inclusion of the linear environmental performance proxy
does not substantively change the reported coefficients for
environmental reporting quality in Clarkson et al. (2010). Our
use of indicators of proxies for both good (AWARDS) and bad
(FINES) follows Plumlee et al. (2010).
8 We thank Louise Lu for access to her data regarding
political exposure. This data were collected by searching
the online parliamentary Hansard records of all Australian
parliaments, using company (and subsidiary) names as search
terms.
9 The sample period reflects the availability of comparable data
provided by CAER.
10 While our Ohlson-type regressions do not require data for BETA,
we estimate these models using the same samples as the cost of
equity regressions in the interests of comparability. Our Ohlson
model results are not sensitive to this decision, or to the inclusion
of BETA as a control in these models.
11 While there is also a difference in undeflated forecast EPS, there
is no significant difference in forecast financial performance
(FROE) between high-quality and low-quality reporters.
12 We also used maximum likelihood estimation to estimate the
first and second stages of the endogeneity corrected model
simultaneously. An F-test of rho, the correlation between
the errors of the two equations, confirmed the presence of
endogeneity (p < 0.001). The coefficients for our test variables
remained significant at similar confidence levels to two-stage
results tabulated.
13 When estimating endogeneity corrected regressions for our
Ohlson models, we omitted the financial performance in-
strument (FROE), as diagnostic (Sargan) tests suggested that
this variable was endogenous to the errors in the Ohlson
model. The coefficients for the remaining instruments tabulated
in Appendix A were not substantively affected, and Sargan
tests found no evidence that any of these instruments were
endogenous.
Appendix A – Endogeneity Corrected
Models
Equation 5 describes the first-stage regressions used in
our endogeneity corrected models:
REPTQUAL = a + B 1 FROE + B 2 POLEXP + B 3 FINES
+ B 4 AWARDS + B 5 SIZE + B 5 BETA
+ B 6 BtoM + INDUSTRIES + ε (5)
Where: REPTQUAL = a proxy for sustainability re-
porting quality (SUSTAIN, CLARKIND or CLARKBIN );
FROE = median analyst forecast one-year ahead
earnings per share deflated by current stock price;
POLEXP = natural log of the number of times the
corporation or any of its subsidiaries appears in the
published proceedings of Commonwealth and state
parliaments during the year; FINES = 1 if the firm

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson Firm Value and the Quality of Sustainability Reporting

reported that it had been fined or otherwise sanctioned References

for a breach of significant environmental regulations,
otherwise 0; AWARDS = 1 if the firm reported that it Akerlof, G. 1970, ‘The Market for “Lemons”: Quality,
had received an award for sustainability performance, Uncertainty and the Market Mechanism’, Quarterly Journal
otherwise 0. Other variables are as defined in Table 2. In of Economics, 84, 3: 488–500.
measuring FINES, we do not require that the firm report Al-Tuwaijri, S.A., Christenson, T.E. and Hughes, K.E.
the amount of the fine or other sanction levied, simply 2004, ‘The Relations Among Environmental Disclosure,
that the firm reports that it has breached a significant Environmental Performance and Economic Performance: A
environmental regulation. Simultaneous Equations Approach’, Accounting, Organizations
Equation (5) is estimated by probit regression where and Society, 29, 5–6: 447–71.
REPTQUAL is dichotomous (SUSTAIN or CLARKBIN ),
Artiach, T. and Clarkson, P. 2011, ‘Disclosure, Conservatism
and as the first stage of a two-stage least squares and the Cost of Equity Capital: A Review of the Foundation
regression where REPTQUAL represents CLARKIND Literature’, Accounting and Finance, 51, 1: 2–49.
(column 2). For SUSTAIN and CLARKBIN models,
the inverse Mills ratio (a function of the probability Barry, C.B. and Brown, S. 1985, ‘Differential Information
and Security Market Equilibrium’, Journal of Financial and
that the dependent variable equals 1) from equation
Quantitative Analysis, 20, 4: 407–22.
5 is included in the OLS regressions of equation
2 to control for endogenous determination of the Bewley, K. and Li, Y. 2000, ‘Disclosure of Environmental
test variable. For CLARKIND regressions, the fitted Information by Canadian Manufacturing Companies: A
values from equation 5 replace the actual values Voluntary Disclosure Perspective’, Advances in Environmental
of CLARKIND in OLS regressions of equation 2. Accounting and Management, 1: 201–26.
Results for the first-stage regressions are reported in Bhattacharya, N., Daouk, H. and Welker, M. 2003, ‘The World
Table 6. All models have reasonable fit, with R2 ranging Price of Earnings Opacity’, Accounting Review, 78, 3: 641–78.
between 28.8% and 44.95%, and at least two of the
Blacconiere, W. and Patten, D. 1994, ‘Environmental Legis-
instrumental variables included are significant in each lation and Market Reaction to Environmental Information’,
model. Both proxies for environmental performance Journal of Accounting and Economics, 18: 355–77.
are positive and significant in all models, suggesting
that extreme environmental performance (either good Botosan, C.A. 1997, ‘Disclosure Level and the Cost of Equity
Capital’, Accounting Review, 72, 3: 323–49.
or bad) increases the likelihood that a firm will
produce high-quality environmental reports. Sargan Botosan, C.A. and Plumlee, M.A. 2005, ‘Assessing Alternative
tests confirmed the exogeneity of our instrumental Proxies for the Expected Risk Premium’, Accounting Review,
variables in all two-stage models estimated. 80, 1: 21–53.
Botosan, C.A., Plumlee, M.A. and Wen, H. 2012, The
Table 6 First-stage regressions for endogeneity corrected Relation Between Expected Returns, Realized Returns, and
models Firm Characteristics, Contemporary Accounting Research,
forthcoming.
(1) (2) (3)
VARIABLES SUSTAIN CLARKIND CLARKBIN Burritt, R. 2002, ‘Environmental Reporting in Australia:
∗
FROE (?) −1.1810 −0.2860 −2.6038 Current Practices and Issues for the Future’, Business Strategy
(0.309) (0.096) (0.240) and the Environment, 11: 391–406.
∗∗∗
POLEXP (+) 0.2451 0.0173 −0.0611
(0.001) (0.301) (0.416) Centre for Australian Ethical Research (CAER) 2005, The
AWARDS (?) 1.0713
∗∗∗
0.7701
∗∗∗
0.8129
∗∗∗
State of Sustainability Reporting in Australia, Commonwealth
(0.000) (0.000) (0.000) Department of Environment and Health, Canberra.
∗∗∗ ∗∗∗ ∗∗
FINES (?) 0.9482 0.6400 0.6873
Cheng, C.S.A., Collins, D. and Huang, H.H. 2006, ‘Shareholder
(0.004) (0.000) (0.016)
BtoM −0.2571 0.1568 0.2169 Rights, Financial Disclosure and the Cost of Equity Capital’,
(0.490) (0.292) (0.533) Review of Quantitative Finance and Accounting, 27, 2: 175–
∗∗∗ ∗ ∗
BETA −0.4477 −0.1237 −0.2880 204.
(0.010) (0.069) (0.068)
∗∗∗ ∗∗ Clarkson, P., Fang, X.H., Li, Y. and Richardson, G. 2010,
SIZE 0.2449 0.0280 0.1974
(0.001) (0.297) (0.014) ‘The Relevance of Environmental Disclosures for Investors
Constant −5.9868
∗∗∗
2.1674
∗∗∗
−3.8270
∗∗
and Other Stakeholder Groups: Are Such Disclosures
(0.001) (0.002) (0.037) Incrementally Informative?’, Working Paper, Social Science
Industry fixed effects Yes Yes Yes Research Network.
Observations 450 450 450
Pseudo R2 (R2 ) 0.4495 0.3892 0.2881 Clarkson, P., Richardson, G. and Vasvari, F. 2008, ‘Revisiting
the Relation Between Environmental Performance and
pval in parentheses Environmental Disclosure: An Empirical Analysis’, Accounting,
∗∗∗
p < 0.01, ∗ ∗ p < 0.05, ∗ p < 0.1 Organizations and Society, 33, 4–5: 303–27.


C 2013 CPA Australia Australian Accounting Review 85
Firm Value and the Quality of Sustainability Reporting
Clarkson, P.M., Overell, M.B. and Chapple, L. 2011,
‘Environmental Reporting and its Relation to Corporate
Environmental Performance’, ABACUS, 47, 1: 27–60.
Claus, J. and Thomas, J. 2001, ‘Equity Premia as Low as
Three Percent? Evidence from Analysts’ Earnings Forecasts for
Domestic and International Stock Markets’, Journal of Finance,
56, 5: 1629–66.
Coles, J.L., Loewenstein, U. and Suay, J. 1995, ‘On Equilibrium
Pricing Under Parameter Uncertainty’, Journal of Financial and
Quantitative Analysis, 30, 3: 347–64.
Commonwealth of Australia 2006, Parliamentary Joint
Committee on Corporations and Financial Services: Corporate
Responsibility: Managing Risk and Creating Value, Common-
wealth of Australia, Canberra.
Connors, E. and Silva-Gao, L. 2008, ‘The Impact of
Environmental Risk on the Cost of Equity Capital: Evidence
from the Toxic Release Inventory’, Working Paper, University
of Massachusetts.
Cormier, D. and Magnan, M. 1999, ‘Corporate Envi-
ronmental Disclosure Strategies: Determinants, Costs and
Benefits’, Journal of Accounting, Auditing and Finance, 14, 4:
429–51.
CPA Australia 2005, Confidence in Corporate Report-
ing 2005. Available at: http://www.cpaaustralia.com.au/cps/
rde/xbcr/SID-3F57FEDF-CD81A6F3/cpa/CICR.pdf, last ac-
cessed 20 October 2008.
CPA Australia 2007, Confidence in Corporate Report-
ing 2007. Available at: http://www.cpaaustralia.com.au/cps/
rde/xbcr/cpa-site/Confidence_CorpRep_2007.pdf, last ac-
cessed 20 October 2008.
D’Antonio, L., Johnsen, T. and Hutton, R. 2000, ‘Socially
Responsible Investing and Asset Allocation’, Journal of
Investing, 9, 3: 65–72.
Department of Environment and Heritage (DEH) 2000, A
Framework for Public Environment Reporting, Commonwealth
of Australia, Canberra.
Dhaliwal, D.S., Li, O.Z., Tsang, A.H. and Yang, Y.G.
2011, ‘Voluntary Non-financial Disclosure and the Cost of
Equity Capital: The Case of Corporate Social Responsibility
Reporting’, Accounting Review, 81, 1: 59–100.
Diamond, D. and Verrecchia, R. 1991, ‘Disclosure, Liquidity
and the Cost of Capital’, Journal of Finance, 46, 4: 689–721.
Dowling, J. and Pfeffer, J. 1975, ‘Organizational Legitimacy:
Social Values and Organizational Behavior’, Pacific Sociological
Review, 18, 1: 122–36.
Easley, D. and O’Hara, M. 2004, ‘Information and the Cost of
Capital’, Journal of Finance, 59: 1553–83.
Easton, P. 2004, ‘PE Ratios, PEG Ratios, and Estimating
the Implied Expected Rate of Return on Equity Capital’,
Accounting Review, 79, 1: 73–95.
Elkington, J. 1998, Cannibals with Forks: The Triple Bottom
Line of 21st Century Business, New Society Publishers,
Gabriola Island, British Columbia.
86 Australian Accounting Review
K. Bachoo, R. Tan & M. Wilson
Figge, F. 2005, ‘Value-based Environmental Management:
From Environmental Shareholder Value to Environmental Op-
tion Value’, Corporate Social Responsibility and Environmental
Management, 12: 19–30.
Francis, J., LaFond, R., Olsson, P. and Schipper, K. 2004, ‘Cost
of Equity and Earnings Attributes’, Accounting Review, 79, 4:
967–1010.
Freedman, M. and Wasley, C. 1990, ‘The Association Between
Environmental Performance and Environmental Disclosure
in Annual Reports and 10k’s’, Advances in Public Interest
Accounting, 3: 183–93.
Frost, G. and English, L. 2002, Mandatory Corporate
Environmental Reporting in Australia: Contested Introduction
Belies Effectiveness of its Application. Available at: http://www.
australianreview.net/digest/2002/11/frost.html, last accessed
29 July 2011.
Gamble, G.O., Hsu, K., Jackson, C. and Tollerson, C.D.
1996, ‘Environmental Disclosure in Annual Reports: An
International Perspective’, International Journal of Accounting,
31, 3: 293–331.
Gebhardt, W.R., Lee, W.C. and Swaminathan, A. 2001,
‘Towards an Implied Cost of Capital’, Journal of Accounting
Research, 39, 1: 135–76.
Global Reporting Initiative (GRI) 2006, Sustainability
Reporting Guidelines 3.0, Global Reporting Initiative,
Amsterdam.
Gode, D. and Mohanram, P. 2003, ‘Inferring the Cost of
Capital using the Ohlson-Juettner Model’, Review of Accounting
Studies, 8, 3: 399–431.
Gray, R., Kouhy, R. and Lavers, S. 1995, ‘Corporate Social and
Environmental Reporting: A Review of the Literature and a
Longitudinal Study of UK Disclosure’, Accounting, Auditing
and Accountability Journal, 8, 2: 47–77.
Handa, P. and Linn, S.C. 1993, ‘Arbitrage Pricing with
Estimation Risk’, Journal of Financial and Quantitative
Analysis, 28, 1: 81–100.
Hughes, S.B., Anderson, A. and Golden, S. 2001, ‘Corporate
Environmental Disclosures: Are They Useful in Determining
Environmental Performance?’, Journal of Accounting and Public
Policy, 20, 3: 217–40.
Hughes, J., Liu, J. and Liu, J. 2007, ‘Information Asymmetry,
Diversification, and the Cost of Capital’, The Accounting
Review, 82, 3: 705–29.
International Integrated Reporting Committee (IIRC) 2011,
‘Integrated Reporting. Available at: http://www.theiirc.org, last
accessed 6 September 2012.
Lambert, R., Leuz, C., and Verrecchia, R. 2007, ‘Accounting
Information, Disclosure and the Cost of Capital’, Journal of
Accounting Research, 45, 2: 385–420.
Lindblom, C. 1994, The Implications of Organizational
Legitimacy for Corporate Social Performance and Disclo-
sure, Critical Perspectives on Accounting Conference, New
York.

C 2013 CPA Australia
K. Bachoo, R. Tan & M. Wilson
Murray, A., Sinclair, D., Power, D. and Gray, R. 2006, ‘Do
Financial Markets Care about Social and Environmental
Disclosure? Further Evidence and Exploration from the
UK’, Accounting, Auditing and Accountability Journal, 19, 2:
228–55.
National Environmental Protection Council Panel (NEPC)
2012, Understanding NPI Data. Available at: http://www.npi.
gov.au/data/data-explanation.html, last accessed 6 September
2012.
Ohlson, J. and Juettner-Nauroth, B. 2003, ‘Expected EPS and
EPS Growth as Determinants of Value’, Review of Accounting
Studies, 10, 2–3: 349–65.
Patten, D. 2002, ‘The Relation Between Environmental
Performance and Environmental Disclosure: A Research
Note’, Accounting, Organizations and Society, 27, 8:
763–73.
Patten, D.M. and Trompeter, G. 2003, ‘Corporate Responses
to Political Costs: An Examination of the Relation Between
Environmental Disclosure and Earnings Management’, Journal
of Accounting and Public Policy, 22, 1: 83–95.
Plumlee, M., Brown, D., Hayes, R.M. and Marshall, R.S.
2010, ‘Voluntary Environmental Disclosure Quality and Firm

C 2013 CPA Australia
Firm Value and the Quality of Sustainability Reporting
Value: Further Evidence’,Working Paper, Social Science Research
Network.
Richardson, A.J. and Welker, M. 2001, ‘Social Disclosure,
Financial Disclosure and the Cost of Equity Capital’,
Accounting, Organizations and Society, 26, 7–8: 597–616.
Sharfman, M.P. and Fernando, C.S. 2008, ‘Environmental Risk
Management and the Cost of Capital’, Strategic Management
Journal, 29, 6: 569–92.
Stanny, E. and Ely, K. 2008, ‘Corporate Environmental
Disclosures about the Effects of Climate Change’, Corporate
Social Responsibility and Environmental Management, 15:
338–48.
Terreberry, S. 1968, ‘The Evolution of Organizational
Environments’, Administrative Science Quarterly, 12, 4:
590–613.
Watts, R.L. and Zimmerman, J.L. 1978, ‘Towards a Positive
Theory of the Determination of Accounting Standards’, The
Accounting Review, 53, 1: 112–34.
Wiseman, J. 1982, ‘An Evaluation of Environmental Disclosures
Made in Corporate Annual Reports’, Accounting, Organizations
and Society, 7, 1: 53–63.
Australian Accounting Review 87