( Environment, Social & Governance )

Impact of ESG disclosure and financial

reporting quality on investment efficiency
Nejla Ould Daoud Ellili

Nejla Ould Daoud Ellili is Abstract

based at the College of Purpose – This study aims to examine the impacts of environmental, social and governance (ESG)
Business, Abu Dhabi disclosure and financial reporting quality (FRQ) on investment efficiency.
University, Abu Dhabi, Design/methodology/approach – Several econometric models have been applied to estimate the
United Arab Emirates. impacts of ESG disclosure and FRQ on investment efficiency, using the United Arab Emirates (UAE) as a
sample in 2010–2019. Estimations considered subsamples of underinvestment, overinvestment and low
and high FRQ values.
Findings – Empirical results show a positive relationship between ESG disclosure, FRQ and investment
efficiency, and that this relationship is more important in the underinvestment and high FRQ sub-samples.
Results suggest that ESG disclosure improves transparency, mitigates information asymmetry and
enhances investment efficiency.
Research limitations/implications – The findings could help UAE regulators incorporate ESG
information into reporting and implement effective mechanisms to increase the extent of ESG information
to improve investment efficiency. This study only examined UAE traded companies. Future research
should investigate other factors influencing investment efficiency and conduct comparative studies
across Gulf Cooperation Council countries.
Social implications – This study reveals the significant positive impact of ESG disclosure and FRQ on
investment efficiency. These findings will help companies optimize their ESG information disclosure,
improve the quality of their financial reports and comply with ESG standards. The study aims to develop
knowledge that will not only benefit companies regarding the potential impact of ESG disclosure but also
help national and international society create a better social environment and reduce climate change.
Originality/value – To the best of the authors’ knowledge, this study is the first to examine the
relationship between ESG disclosure, FRQ and corporate investment efficiency. The research
contributes to understanding the financial impacts of ESG disclosure and FRQ and supports regulators’
efforts to enforce ESG disclosure and improve FRQ.
Keywords ESG disclosure, Financial reporting quality, Investment efficiency, Panel data
Paper type Research paper

JEL classification – C33, G32, 1. Introduction

G34
Over time, natural resources are being depleted, and environmental changes are occurring
Received 16 March 2021
more rapidly; consequently, international legal bodies and most developed nations are
Revised 15 September 2021 continuously raising questions about sustainability. In the past decade, sustainability
27 December 2021
Accepted 6 January 2022
disclosure has attracted the interest of many international organizations working toward a
sustainable green economy. These organizations have developed several frameworks, such
Author contributions: The
author conceived and as the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC),
designed the project, collected the Sustainability Accounting Standards Board (SASB), the Carbon Disclosure Project and
the data, performed the
analysis and wrote the paper. the United Nations Global Compact, that provide companies with clear guidance on reporting
Funding: This research was non-financial financial issues such as environmental and corporate social responsibility (CSR)
funded by Abu Dhabi
University, Abu Dhabi, United disclosures. In the United Arab Emirates (UAE), the Securities and Commodities Authority
Arab Emirates.
Conflicts of interest: The author
updated the code of corporate governance, which was initially established in 2009, with new
declares no conflicts of interest. rules including, among others, those pertaining to the sophistication of corporate governance,

PAGE 1094 j CORPORATE GOVERNANCE j VOL. 22 NO. 5 2022, pp. 1094-1111, © Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-06-2021-0209
further protection for shareholders and the promotion of CSR with respect to investing in and
facilitating the financing of sustainable development projects. More recently, in 2019, UAE
financial regulators introduced the environmental, social and governance (ESG) reporting
guide to listed companies to incorporate ESG information into their reporting processes,
improve their transparency and meet their investors’ requirements. Thus far, ESG disclosure
has been implemented on a voluntary basis, but listed companies have been strongly
encouraged to disclose their ESG information.
In recent years, ESG disclosure has played an important role in satisfying investors’ growing
demand for non-financial information, and investors consider it to be strong evidence of
companies’ compliance with non-financial disclosure best practices (such as the GRI, IIRC
and SASB). The importance of ESG disclosure has grown exponentially and attracted the
interest of researchers, financial regulators and rating agencies (e.g. Fitch, Standard and
Poor’s and Moody’s). These agencies have undertaken ESG assessments based on
companies’ disclosed ESG information to obtain scores and ratings and assist the investors
in their financial decisions.
The literature has analyzed different aspects of ESG disclosure. For instance, Ellili (2020),
Sharma et al. (2020) and Suttipun (2021) examined the extent of ESG disclosure and
confirmed that although it is still low level, the extent of this information has been increasing
over the years. Additionally, governance information accounts for the largest part of ESG
disclosure, followed by social and environmental information. More recently, many studies
(Manita et al., 2018; Arayssi et al., 2020; Shakil, 2021; De Masi et al., 2021) have explored the
impact of different corporate governance mechanisms on ESG disclosure. There is no
consensus in the results, and the evidence is mixed, with the association having been found
to be positive, negative or neutral. Furthermore, none of the abovementioned studies
examined the potential impact of ESG disclosure on investment efficiency. This is an
interesting research opportunity because in the UAE, emphasis is on requiring all listed
companies to incorporate ESG information into their reporting processes and improve their
compliance with ESG disclosure best practices. The UAE is the subject of this study for many
reasons. First, it is top-ranked in the Middle East and North Africa region for transparency,
according to the corruption perception index (Transparency International, 2020). Second,
according to the Kearney foreign direct investment (FDI) confidence index, the UAE has
enhanced its appeal for FDIs, moving from an index ranking of 21st in 2017 to 19th in 2020
(Kearney, 2020). This international progress is due to foreign investors’ optimism following the
UAE’s implementation of financial regulation reforms addressing transparency and reporting
quality. Third, the UAE has the highest corporate governance index in the Gulf Cooperation
Council (GCC) region, which indicates that it is implementing the best corporate governance
practices (Pillai and Al-Malkawi, 2016). In addition, there have been many initiatives in the
UAE to increase sustainability awareness. For instance, in 2010, the UAE launched its
national vision 2021 with the aim of realizing a more diversified and knowledgeable economy
by focusing on a sustainable environment, including infrastructure. More recently, in 2017, the
UAE initiated the 2050 national strategy to meet its economic and environmental goals, and
achieve an energy mix that combines renewable, nuclear and clean energy sources. The
focus areas are to increase clean energy’s contribution to the total energy mix from 25% to
50% by 2050 and reduce power generation’s carbon footprint by 70%. Realizing this vision
entails mandatory ESG disclosure for all listed companies. Hence, this study will provide
insight into the extent of companies’ compliance with governmental sustainability initiatives.
Against this background, this study attempted to answer two main questions: Is there any
significant association between ESG disclosure and investment efficiency? Is there any
significant relationship between financial reporting quality (FRQ) and investment efficiency?
Although this study is similar to previous studies on the potential impacts of non-financial
disclosure and FRQ on investment efficiency, it contributes to the existing literature –
particularly to filling the gap in ESG disclosure research – in several ways. First, by

VOL. 22 NO. 5 2022 j CORPORATE GOVERNANCE j PAGE 1095

 considering overall ESG disclosure – that is, comprehensive non-financial disclosure,
including environmental, social and governance information, and not just CSR – this study
goes further than previous studies that only investigated the potential impact of CSR
disclosure on investment efficiency (Leuz and Verrecchia, 2000; Bushman and Smith, 2001;
Healy and Palepu, 2001; Hope and Thomas, 2008; Biddle et al., 2009; Chen et al., 2011;
Gomariz and Ballesta, 2014; Makosa et al., 2020). Second, this study focuses on the
specific potential impact of ESG disclosure on investment efficiency, while previous studies
investigated other impacts, such as on the costs of capital and debt (Ellili, 2020; Raimo
et al., 2021), as well as on financial performance (Farooq, 2015; Atan et al., 2016;
Kengkathran, 2019; Albitar et al., 2020). Listed companies’ ESG disclosure needs to be
further explored, as it is implemented on a voluntary basis. This research will shed light on
the relationship between ESG disclosure and investment efficiency, and recommend
that UAE financial regulators implement effective mechanisms to further improve
compliance with ESG disclosure best practices. The empirical findings will help
UAE regulators incorporate ESG disclosure into reporting processes and improve UAE
listed companies’ investment efficiency. To the best of the author’s knowledge, there is
no existing study dedicated to the relationship between ESG disclosure and investment
efficiency nor is there any other on the relationship between non-financial disclosure and
investment efficiency in the UAE. Hence, this research will provide the first insight into this
topic.
The data indicate that UAE listed companies incorporate ESG into their disclosure
processes. The impact of ESG disclosure and FRQ on investment efficiency was examined
by applying different panel data estimations, and the empirical results reveal a positive
relationship between ESG disclosure, FRQ and investment efficiency. These
results contribute to the empirical literature by presenting a better understanding of the
impact of ESG disclosure and FRQ on investment efficiency. This will help listed
companies enhance the quality of their ESG and financial reports, and efficiently
manage their investment decisions.
The remainder of the paper is organized as follows. Section 2 is a literature review on CSR
disclosure, FRQ and investment efficiency. Section 3 presents the variables, data
and empirical methodology. Section 4 gives the empirical results, and Section 5 concludes.

2. Literature review and hypotheses development

Investment efficiency is defined as a company’s ability to undertake all and only profitable
projects with a positive net present value (NPV) under the condition of no market
antagonisms (e.g. agency costs and adverse selection). Hence, underinvestment is
missing investment opportunities in projects with a positive NPV in the absence of market
antagonism, while overinvestment is undertaking projects with a negative NPV (Myers and
Majluf, 1984). Over time, research has revealed the impacts of non-financial disclosure and
FRQ on investment efficiency.
This study examines the impact of ESG disclosure and FRQ on investment efficiency in a
different institutional context. The literature review is divided into two main parts. The
first discusses the importance of non-financial disclosure and the second sheds light on
FRQ and its association with investment efficiency.

2.1 Non-financial disclosures and investment efficiency

A comprehensive overview of the role of financial disclosure is inevitable when studying the
relationship between non-financial information disclosure and investment efficiency.
Studies have revealed that there are three ways high-quality financial information can
contribute to investment efficiency (Bushman and Smith, 2001; Healy and Palepu,
2001). First, information extracted through financial accounting systems helps
managers identify investment opportunities and determine the optimum output; it
also helps investors
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accurately allocate capital, which can reduce the cost of capital and boost investment
efficiency (Botosan, 1997; Francis et al., 2008; Cheynel, 2013). Second, financial
accounting provides a clear insight into corporate control mechanisms and guides resource
allocation through consistent discipline that prevents managers from expropriating
investors’ wealth. Finally, it reduces investors’ liquidity risks and attracts more funds to the
capital market (Fama and Laffer, 1971; Diamond and Verrecchia, 1991; Baiman and
Verrecchia, 1996; Verrecchia, 2001). Stakeholders have also expressed their concerns
about non-financial information, although any intangible information that does not have
physical value is largely ignored in the financial reporting standards; however, companies’
disclosure of non-financial information would lead to the value creation process (Choi and
Wang, 2009). Resultantly, most financial experts, analysts, investors and all other
stakeholders usually rely on non-financial information to assess firms’ future in terms of
value creation and future cash flow (Orens et al., 2010). Several studies have confirmed that
non-financial information plays a pivotal role in most capital markets, particularly those
related to valuation. For instance, Amir and Lev (1996) investigated US companies to
demonstrate the value creation and relevance of non-financial information, and confirmed
that all non-financial indicators, such as the population size in a telecommunication firm’s
licensed area (as a growth proxy) and market penetration factors (as measures of operating
performance) are extremely value-relevant. Brazel et al. (2009) also focused on US firms to
examine whether auditors can efficiently use the provided non-financial measures (NFMs)
(e.g. the number of employees and retail outlets) to evaluate financial performance and
detect fraudulent financial statements. Results suggest that NFMs can assess fraud risk
and detect fraud. In addition, Dhaliwal et al. (2012) examined the relationship between the
disclosure of non-financial information and forecast accuracy in 31 countries and confirmed
that CSR reports are associated with less errors in analysts’ forecasts. Moreover, Wang and
Hussainey (2013) considered a large sample of UK and Financial Times stock exchange
group-listed companies and confirmed that non-financial information improves the stock
market’s predictive ability regarding future earnings. Besides the important role played by
the non-financial disclosures, the corporate governance improves the transparency
(Torchia and Calabrò, 2016), mitigates any risk of corruption, strengthen the confidence
and maintain the integrity within the companies (Alqooti, 2020), improves the quality of the
financial reporting (Mouselli et al., 2014; Alzeban, 2020), reduces the earnings management
practices (Al-Haddad and Whittington, 2019) and improves the investment efficiency (Ullah
et al., 2020; Agyei-Mensah, 2021).
With regard to the relationship between the non-financial disclosure and financial
performance, Waddock and Graves (1997) introduced good management theory and slack
resources theory. The former asserts that the practices and principles of good management
and CSR efforts are strongly correlated, and that they help companies build good
relationships between existing employees and the community. This would lead to a better
relationship with stakeholders and improve the whole organization’s performance.
Moreover, if a firm positively impacts the community, the government may provide
incentives in the form of tax breaks or by easing the existing regulations, which could
positively impact the firm’s bottom line. Slack resource theory proposes that positive
performance directly produces slack resources, including funds that eventually present
firms and organizations with opportunities to invest heavily in CSR activities. This suggests
that a firm’s financial capability and its ongoing ability to perform determine the scope of its
focus on CSR.
Gibson (2000) further explained that firms are moral agents that should apply CSR
principles to satisfy society’s moral necessities. Friedman (1970) contradicted this by
arguing that a firm’s main purpose is to generate and maximize profits, so the only reason
managers should expend resources on CSR activities is to achieve a definite improvement
in financial performance. In the empirical studies, there is no agreement about the impact of
the CSR disclosure on the financial performance. On one side, some studies reveal that the

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 CSR disclosure is positively associated with the corporate financial disclosure (Van de
Velde et al., 2005; Chen and Wang, 2011; Chijoke-Mgbame et al., 2020), while other studies
reveal a negative impact of the CSR disclosure on the financial performance confirming that
the main objective of the companies is to maximize the profits as well as the shareholders’
return (Sekhon and Kathuria, 2019). The bidirectional relationship between the CSR
disclosure and the financial performance has also been investigated. Hichri and Ltifi (2021)
confirmed that these two variables have a positive and reciprocal impacts on each other.
This result indicates that the CSR activities undertaken by the company improve its financial
performance. In addition, the high financial performance encourages the company is being
highly socially responsible to obtain financial gains later on. More recently, several studies
have examined the extent of other types of non-financial disclosures such as: environmental
disclosure (Alipour et al., 2019; Kilincarslan et al., 2020), governance disclosure (Nobanee
and Ellili, 2021), the overall ESG disclosures (Chouaibi and Affes, 2021; Arif et al., 2021)
and reveal an agreement on the positive trend of these different non-financial disclosures
over the time. While other studies have explored the impact of the overall ESG disclosure on
the company’s performance (Alareeni and Hamdan, 2020; El Khoury et al., 2021) and there
is no consensus in the empirical results. In fact, Alareeni and Hamdan (2020) confirmed that
the ESG disclosure has a positive impact on the operational, financial and market
performances of the US listed companies. While El Khoury et al. (2021) indicated that there
is a non-linear concave relationship between the ESG disclosure and the performance of
the banks operating in the Middle East, North Africa and Turkey region. More particularly,
the low level of ESG increases the bank’s performance. However, if the ESG exceeds an
inflection point, it becomes a destructive activity. This result is explained by the fact that the
high costs of the environmental and social activities of the bank outweigh the benefits.
In the investment efficiency, information asymmetry is one of the principal factors that affect
a company’s proficiency in investing in projects. External investors use private data
advantages to make better decisions about their investment portfolios (Jensen, 1986); data
uncertainty prompts them to require higher returns on their investments, which will limit the
funds provided to companies and lead to underinvestment (Myers and Majluf, 1984).
Financial and non-financial information disclosure helps mitigate data uncertainty and
improve companies’ investment efficiency (Biddle et al., 2009). CSR disclosure, as a
significant type of non-financial information reporting, provides stakeholders with a steady
flow of viable data and information and decreases information asymmetry. This assists firms
in mitigating agency costs, improving financing decisions and enhancing effectiveness
(Jensen and Meckling, 1976).
In the analysis of the impact of information asymmetry on investment efficiency, there are
two possible effects that should be considered: the resource crowding-out effect (Biddle
et al., 2009) and the information communication effect (Makosa et al., 2020). In the former,
data uncertainty might be the reason for organizational issues that could limit companies’
funds and lead to underinvestment. CSR disclosure may drive firms to offer guarantees to
investors who could decrease their required returns and reduce underinvestment.
According to the information communication effect, CSR disclosure is an effective
communication tool that provides external investors with the right information, thereby
reducing information asymmetry and enhancing the company’s investment efficiency.
Recently, Liu and Tian (2021) examined the direct impact of CSR disclosure on investment
efficiency and indicated that their results corroborate agency theory suggestions. They
confirmed that companies disclosing CSR reports reduce agency problems and investment
inefficiency, especially in cases of overinvestment.
The abovementioned studies suggest that CSR disclosure improves company transparency
and moderates the unfavorable impacts of data uncertainty between managers and
external investors. Non-financial disclosure is associated with companies’ continuous efforts
to increase their commitment to the community. All previous studies have highlighted the

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positive impact of CSR disclosure on investment efficiency. CSR disclosure and ESG
disclosure are interchangeable (Gillan et al., 2021), as both types of non-financial reports
include information about companies’ social actions and governance matters. ESG
disclosure includes explicit information about governance, while the CSR report includes
implicit information about governance matters indirectly related to a company’s
environmental and social efforts. Despite this similarity, this study goes beyond CSR
disclosure to consider ESG disclosure, as it is more comprehensive and explicitly includes
the different types of non-financial information: environmental, social and governance.
Based on these arguments, the following hypothesis is proposed:
H1. There is a positive association between ESG disclosure and investment efficiency.

2.2 Financial reporting quality and investment efficiency

FRQ is related to financial and non-financial information that is useful in decision-making
(Herath and Albarqi, 2017). According to the International Accounting Standards Board [1],
FRQ emphasizes financial reporting transparency, which is assessed by the accuracy of
the objectives and the quality of the information disclosed in the firm’s financial reports.
FRQ aims to reduce information asymmetry to encourage investors to infuse companies
with funds. Several studies examined the impact of FRQ on investment efficiency. Financial
reporting reveals firms’ explicit data and decreases information asymmetry among investors
and between the firm and financial analysts. It can subsequently reduce agency costs
between managers and external investors (Myers and Majluf, 1984; Healy and Palepu,
2001). FRQ is usually higher in public companies than in private ones (Ball and Shivakumar,
2005; Burgstahler et al., 2006) and in countries with better investor protection and stronger
law enforcement (Leuz et al., 2003; Holthausen, 2009).
The relationship between FRQ and investment efficiency can be examined in two ways.
First, as Leuz and Verrecchia (2000) confirmed, a company’s commitment to disclosing
significant information reduces information asymmetry and increases the firm’s liquidity.
Information asymmetry between financial analysts and firms may prompt capital providers
to require higher returns, which will increase the cost of capital (Myers and Majluf, 1984).
Consequently, high FRQ improves venture proficiency and financial effectiveness. Second,
as several studies in accounting have proposed, FRQ plays a significant role in decreasing
agency costs to the extent that financial accounting information is considered an important
part of compensation contracts (Lambert, 2001) and is used by investors to control
managers (Bushman and Smith, 2001).
Agency theory provides several mechanisms to reduce ambiguities and asymmetries in
information systems and better supervise managerial activities to reduce managerial
discretion (Bushman and Smith, 2001; Healy and Palepu, 2001; Hope and Thomas, 2008).
Many other studies have also discussed some of these implications, including a decrease
in the cost of capital (Francis et al., 2004; Francis et al., 2005) and reduced access to the
debt market (Bharath et al., 2008). Other studies have examined the direct association
between FRQ and investment efficiency. For instance, Gomariz and Ballesta (2014),
Al’Alam and Firmansyah (2019) and Permatasari and Nengtyas (2020) examined the
impact of FRQ on investment efficiency by considering debt maturity. Their empirical results
corroborate agency theory predictions and confirm that both FRQ and debt maturity
improve investment efficiency quality. Moreover, Gomariz and Ballesta’s (2014) results
reveal that FRQ reduces overinvestment, while debt maturity reduces both underinvestment
and overinvestment.
According to the abovementioned studies, there is a consensus that higher FRQ has many
positive implications for the provided set of information systems. It allows for better
monitoring of managers and makes them more accountable for their actions, as financial
accounting information helps investors differentiate between profitable and non-profitable

VOL. 22 NO. 5 2022 j CORPORATE GOVERNANCE j PAGE 1099

 projects. Hence, FRQ mitigates information asymmetry, reduces financing costs and
decreases overinvestment and underinvestment. Furthermore, FRQ helps managers make
viable investments by allowing them to identify the right projects and gain a more truthful
outlook on the accounting numbers relevant to internal decision-making (Bushman and
Smith, 2001; McNichols and Stubben, 2008).
In a further discussion on the impact of FRQ on investment efficiency, Biddle et al. (2009)
and Chen et al. (2011) explored two inefficient scenarios of underinvestment and
overinvestment. Both concluded that higher FRQ assists companies with underinvestment
by helping them undertake more investments and helps companies with overinvestment
reduce their level of investment. In line with these results, Garcı́a-Lara et al. (2010) found
that conservatism reduces both underinvestment and overinvestment by decreasing the
sensitivity of the available investment cash flow. This study focuses on a different
institutional environment and considers listed companies in an emerging market. Based on
the above arguments, we assume that FRQ improves investment efficiency. Hence, the
second hypothesis is as follows:
H2: There is a positive association between FRQ disclosure and investment efficiency.

3. Data and methodology

3.1 Data
This study examines the potential impacts of ESG disclosure and FRQ on the investment
efficiency of companies traded on Abu Dhabi Securities Exchange and Dubai financial
market during the period 2010–2019. In 2009, UAE financial regulators required all listed
companies to disclose their corporate governance reports, and in 2019, they introduced the
ESG reporting guide. Thus far, ESG information has been disclosed on a voluntary basis.
ESG scores and accounting data were collected from the Bloomberg Terminal. Companies
without ESG scores were excluded from the sample. The final sample includes 30
companies from eight industries (i.e. banks, investment and financial services, real estate,
energy, telecommunications, industrial, consumer staples and transportation).

3.2 Variables
The variables used in this analysis were divided into four groups: ESG disclosure variables
(Section 3.2.1), FRQ (Section 3.2.2), investment efficiency (Section 3.2.3) and control
variables (Section 3.2.4)
3.2.1 ESG variables. In this study, one of the independent variables was ESG disclosure,
measured by the ESG score. It has been confirmed in the previous studies that ESG
disclosure has a positive impact on the company’s performance (Alareeni and Hamdan,
2020; El Khoury et al., 2021) and it is worth it to explore the impact on the investment
efficiency. To examine further this impact, this study also considered separate
environmental, social and governance scores. All scores are between 0 and 100 and are
calculated by Bloomberg from different sources such as annual reports, websites,
corporate governance reports and sustainability or CSR reports. Score definitions are
presented in Table 1.
3.2.2 Financial reporting quality variables. In this analysis, FRQ was another independent
variable included in the investment efficiency analysis. In fact, FRQ reflects the accuracy of
the financial statements, reveals the level of the company’s transparency and provides the
investors with relevant information about the expected cash flows. Following Chen et al.
(2011), Gomariz and Ballesta (2014) and Zhong and Gao (2017), the FRQ variable is
measured using two methods: Dechow and Dichev’s (2002) and Kasznik’s (1999). At the
beginning of these models, the absolute value of the residuals is computed to detect any
difference in the estimations of working capital accruals (WCA) in equation (1) and total

PAGE 1100 j CORPORATE GOVERNANCE j VOL. 22 NO. 5 2022

 Table 1 ESG score variables
Variables Notation Data coverage

ESG score ESG Environmental, social, and governance

information
Environmental score ES Environmental management, water
consumption, carbon emission, energy
consumption, renewable energy, pollution,
biodiversity
Social score SS Employee training and development, human
rights, women in management, employee
turnover, community relations, data protection
Governance score GS Board duality, independent directors, board
size, presence of women on the board,
number of meetings, percentage of
attendance at meetings, shareholders’ rights

accruals (TA) in equation (2). A lower absolute value indicates a lower variation in the
estimation of accruals. Then, the absolute value is multiplied by 1, and a higher value
indicates higher FRQ.
According to Dechow and Dichev (2002), FRQ is measured by multiplying the absolute
value of the residuals of WCA by 1. WCA is expressed as a function of cash flow from
operations (CFO):

WCAi;t ¼ b 0 þ b 1 CFOi; t1 þ b 2 CFOi; t þ b 3 CFOi; tþ1 þ « t (1)

where:
WCA = D in non-liquid current assets – D in current liabilities þ D in short-term bank debt
CFO = (Cash flow from operation/Total assets)  100
According to Kasznik (1999), FRQ is measured by multiplying the absolute value of the
residuals of TA by 1. TA is expressed as a function of the sales, property, plant and
equipment and CFO:

TAI;t ¼ b 0 þ b 1 D Salesi; t þ b 2 PPEi; t þ b 3 DCFOi; t1 þ « t (2)

The two FRQ variables are summarized in Table 2.

3.2.3 Investment efficiency. Following Zhong and Gao (2017) and similar to the FRQ
variable, investment efficiency (INVEFF) is measured by computing the absolute values of
the residuals of the investment model developed by Biddle et al. (2009). In this model, the
absolute value detects all variations related to corporate investment decisions. The negative
residual of equation (3) indicates underinvestment, while a positive residual indicates
overinvestment. Then, the absolute value is multiplied by 1, and a higher value indicates
better investment efficiency.

Table 2 FRQ variables

Variables Notation Measured by

FRQ FRQ-DD Absolute values of the residuals of the WCA model multiplied by 1
(Dechow & Dichev, 2002)
FRQ FRQ-KA Absolute values of the residuals of the TA model multiplied by 1
(Kasznik, 1999)

VOL. 22 NO. 5 2022 j CORPORATE GOVERNANCE j PAGE 1101

 Investment (INV) is a function of the sales growth:

INVi;t ¼ b 0 þ b 1 NEGi; t1 þ b 2 GROWTHi; t1 þ b 3 NEGi; t1  GROWTHi; t1 þ « i ;t

(3)

where:
INV = (Investment expenditures/The beginning value of the assets)  100
NEG = Dummy variable, which takes 1 if sales growth is negative and 0 otherwise
GROWTH = (Ending-of-year sales–beginning-of-year sales)/Beginning-of-year sales  100
3.2.4 Control variables. The control variables are companies’ financial resources, asset
tangibility, leverage, size, age, performance and dummy variables for industries. Table 3
shows detailed measures of the control variables in this analysis.

3.3 Methodology
This study examines the potential impacts of ESG disclosure and FRQ on investment
efficiency. The model is presented as follows:

INVEFFi;t ¼ b 0 þ b 1 ESGi; t1 þ b 2 FRQi; t1 þ b 3 SLACKi; t1 þ b 4 TANGi; t1 þ b 5 LEVi; t1
þ b 6 SIZEi; t1 þ b 7 AGEi; t1 þ b 8 ROAi; t1 þ Industry Dummies þ « i ;t

4. Empirical results
4.1 Descriptive statistics
Table 4 shows descriptive statistics for ESG disclosures, FRQ, investment efficiency and
the control variables. Governance disclosure has the highest score (37.32) because in the

Table 3 Control variables

Variables Notation Measure

Financial resources SLACK Cash/fixed assets

Assets’ tangibility TANG Fixed assets/total assets
Leverage LEV Total liabilities/total assets
Size SIZE Logarithm (total assets)
Age AGE Age of the company
Performance ROA Net income/total assets

Table 4 Descriptive statistics for all variables

Variables Mean Standard deviation Minimum Maximum

ESG 18.60 14.03 2.07 50.44

ES 20.38 14.99 1.79 47.33
SS 24.97 17.98 3.33 57.98
GS 37.32 13.09 8.93 64.29
INVEFF 3.22 16.77 0 28.24
FRQ-DD 2.42 6.47 0 70.27
FRQ-KA 2.04 6.52 0 69.99
SLACK 1.11 1.79 0 14.74
TANG 0.40 0.28 0.02 0.94
LEV 0.64 0.41 0.25 0.93
SIZE 4.47 0.67 2.53 5.91
AGE 21.18 14.90 2 52
ROA 3.71 9.65 30.35 24.15

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UAE, as of 2009, financial regulators require that all listed companies disclose their
corporate governance reports. In addition, the statistics indicate that, on average,
companies have invested efficiently at a level of 3.22% of total assets. The FRQ variables
computed using the two different methods have an average of 2.42 and 2.04, respectively.
The companies in the sample have, on average, a high level of cash and slack (1.11), a low
level of tangibility (0.40) and relatively high leverage (0.64).
Table 5 shows the Pearson correlation coefficients between the different groups of
variables: ESG disclosure, FRQ and control variables. Governance disclosure (EG) is
positively and significantly correlated with investment efficiency. ESG disclosure is
positively and significantly correlated with FRQ (FRQ-KA). ESG disclosure and FRQ (FRQ-
KAS) are positively and significantly correlated with financial resources (SLACK), leverage
(LEV), size, age and company performance (ROA), but negatively and significantly
correlated with tangibility (TANG). The correlation coefficients between the independent
variables are lower than 0.8, confirming the absence of multicollinearity in the regression.

4.2 Main impact of ESG disclosure and financial reporting quality on investment
efficiency
The estimation of the panel data with fixed effects validates the existence of individual effects.
In addition, variance inflation factor (VIF) and Breush–Pagen tests confirm the absence of
multicollinearity and heteroskedasticity, respectively. The Durbin–Watson test detects
autocorrelation. To solve this problem, we estimate the same regression by applying the fixed-
effects and random-effects models and considering first-order autoregressive AR (1)
disturbances. The Hausman test results show that the fixed-effects model is more efficient.
Models (1) and (2) are estimated to examine the impact of ESG disclosure and FRQ on
investment efficiency by considering two measures: FRQ-DD and FRQ-KA. Models (3) and
(4) are estimated to examine further the separate impacts of the different non-financial
disclosures on investment efficiency, considering the two measures of FRQ. Table 6
presents the results of all estimations.
The results of Models (1) and (2) show that overall ESG and both FRQ measures are
positively and significantly associated with investment efficiency, confirming that companies
with higher levels of ESG disclosure and higher-quality financial reporting have a more
efficient investment strategy. These results corroborate agency theory predictions and the
findings of Bushman and Smith (2001), McNichols and Stubben (2008), Biddle et al. (2009),
Gomariz and Ballesta (2014) and Makosa et al. (2020), indicating that reducing data

Table 5 Pearson correlation coefficients

ESG ES SS GS INVEFF FRQ-DD FRQ-KA SLACK TANG LEV SIZE AGE ROA

ESG 1.00

ES 0.949 1.00
 
SS 0.790 0.648 1.00
  
GS 0.665 0.380 0.419 1.00

INVEFF 0.020 0.110 0.002 0.144 1.00
FRQ-DD 0.062 0.060 0.066 0.005 0.026 1.00
 
FRQ-KA 0.138 0.017 0.186 0.099 0.037 0.060 1.00
 
SLACK 0.221 0.269 0.095 0.044 0.027 0.058 0.034 1.00
    
TANG 0.314 0.467 0.120 0.081 0.081 0.058 0.158 0.586 1.00
    
LEV 0.422 0.267 0.299 0.379 0.019 0.015 0.199 0.024 0.048 1.000
      
SIZE 0.142 0.300 0.122 0.251 0.112 0.029 0.174 0.429 0.461 0.004 1.00
     
AGE 0.234 0.294 0.101 0.058 0.098 0.059 0.180 0.504 0.595 0.047 0.601 1.00
ROA 0.068 0.021 0.007 0.032 0.085 0.074 0.040 0.001 0.007 0.100 0.027 0.101 1.00

Note: Significant at the 5% level

VOL. 22 NO. 5 2022 j CORPORATE GOVERNANCE j PAGE 1103

 Table 6 Impact of ESG and FRQ on investment efficiency
Fixed effects AR (1)
Variables (1) (2) (3) (4)
 
ESG 0.0420 (2.64) 0.0919 (3.77)
ES 0.0053 (1.53) 0.0248 (1.48)
SS 0.0027 (1.48) 0.0358 (1.59)
 
GS 0.0072 (2.13) 0.0631 (2.70)
 
FRQ-DD 0.0020 (2.04) 0.0080 (2.59)
 
FRQ-KA 0.0373 (1.83) 0.0797 (1.75)
   
SLACK 0.9129 (1.77) 0.3150 (2.28) 0.0871 (2.12) 0.3892 (2.60)
   
TANG 3.1552 (3.10) 2.6067 (2.96) 2.0130 (3.58) 3.1044 (3.00)
   
LEV 4.7159 (2.79) 4.3728 (2.98) 4.3033 (2.51) 3.8435 (2.69)
   
SIZE 2.0523 (3.77) 1.6113 (2.40) 1.7073 (3.00) 1.2030 (2.73)
   
AGE 0.0145 (2.33) 0.0191 (1.87) 0.0281 (2.49) 0.0320 (2.23)
   
ROA 0.0954 (2.55) 0.0902 (1.83) 0.1555 (2.69) 0.0728 (1.89)
Industry dummies Yes Yes Yes Yes
Prob > F 0.0002 0.0001 0.0006 0.0001
Notes:  Significant at the 10% level;  significant at the 5% level; 
significant at the 1% level

uncertainty and information asymmetry would mitigate agency costs and enhance
companies’ investment decisions. Consequently, more extensive ESG disclosure and higher-
quality financial reporting strengthen companies’ commitments not only to shareholders but
also to the whole community and prompt companies to improve their investment efficiency.
The findings of Models (3) and (4) reveal that only the impact of governance disclosure on
investment efficiency is positive and significant, while social and environmental disclosures
do not have any significant relationship with investment efficiency. This result reveals that
governance disclosure applies more pressure to companies to improve their investment
efficiency and avoid underinvestment and overinvestment. Regarding the control variables,
slack, asset tangibility, age and company performance are all positively and significantly
associated with investment efficiency, while size and leverage negatively and significantly
affect investment efficiency. These results confirm that older companies with abundant
financial resources and tangible assets, as well as good corporate performance manage their
investment decisions more efficiently, while the large size of the companies and high
leverage are considered obstacles to investment efficiency.

5. Robustness analyses
5.1 Impact of ESG disclosure and financial reporting quality in the sub-samples of
underinvestment and overinvestment
To further examine the relationship between ESG disclosure, FRQ and investment
efficiency, the above model was estimated separately in the two sub-samples of
underinvestment and overinvestment. The estimation of the model in the underinvestment
sub-sample with fixed effects confirms the presence of an individual effect. VIF and
Breush–Pagen test results reject multicollinearity and heteroskedasticity, respectively, while
the Durbin–Watson test detects autocorrelation. Hence, first-order autoregressive AR (1)
disturbances have been applied in fixed-effects and random-effects regressions. The
Hausman test results reveal that the fixed-effects regression is more appropriate.
The estimation of the model in the overinvestment sub-sample via panel regression with
fixed effects rejects the individual effect, leading to the application of the pooled estimation.
VIF and Breush–Pagen test results reveal the absence of multicollinearity and
heteroskedasticity, respectively, while autocorrelation was identified using the
Durbin–Watson test and resolved via the Cochrane–Orcutt method. The results of all
regressions are shown in Table 7.

PAGE 1104 j CORPORATE GOVERNANCE j VOL. 22 NO. 5 2022

 Table 7 Impact of ESG and FRQ on investment efficiency in cases of underinvestment
and overinvestment
Underinvestment Overinvestment
Variables (1) (2) (3) (4)
 
ESG 0.0130 (2.41) 0.0020 (2.31) 0.1048 (1.39) 0.0956 (1.07)

FRQ-DD 0.0379 (2.81) 0.4793 (1.40)

FRQ-KA 0.0012 (2.29) 0.0255 (1.37)
   
SLACK 0.1387 (3.81) 0.0841 (2.23) 0.8688 (2.51) 1.5741 (1.87)
   
TANG 5.4127 (3.37) 5.3150 (2.65) 2.5093 (3.09) 2.8998 (3.49)
   
LEV 0.4512 (2.97) 0.4402 (3.55) 4.4759 (1.95) 3.1375 (2.02)
   
SIZE 2.3097 (3.24) 0.4840 (2.81) 0.7647 (1.85) 0.2715 (1.95)
   
AGE 0.3709 (1.83) 0.0138 (3.90) 0.1309 (1.79) 0.1324 (1.68)
   
ROA 0.0214 (2.97) 0.0569 (3.52) 0.0468 (1.99) 0.1822 (2.07)
Industry dummies Yes Yes No No
Prob > F 0.0000 0.0000
R-squared 0.6832 0.5652
Adj R-squared 0.5143 0.3334
Notes:  Significant at the 10% level;  significant at the 5% level; 
significant at the 1% level

The results show that the impacts of ESG disclosure and FRQ differ from one sub-sample to
another. More precisely, ESG and both FRQ measures are negatively and significantly
associated with underinvestment. The respective coefficients of ESG in Models (1) and (2)
in the underinvestment sub-sample are –0.0130 and –0.0020, significant at 5%. The
respective coefficients of FRQ-DD and FRQ-KA are –0.0379 and –0.0012, significant at 1%
and 5%, respectively. These results indicate that the extent of the non-financial information
and the high quality of the financial information are considered to be relevant factors in
reducing underinvestment and would help companies capitalize on all opportunities to
invest in profitable projects. However, the impacts of ESG disclosure and FRQ have positive
but insignificant impacts on overinvestment. The respective coefficients of ESG in Models
(3) and (4) are 0.1048 and 0.0956, and those of FRQ-DD and FRQ-KA are 0.4793 and
0.0255, respectively. This finding reveals that companies with high levels of ESG and FRQ
do not invest in non-profitable projects. Consequently, these companies’ strong
commitment to the community in terms of social, environmental and governance efforts, as
well as their high-quality financial information, constitute a strong guarantee that the
companies will only invest in profitable projects. The results confirm that the roles played by
ESG disclosure and FRQ are more important in overcoming underinvestment and suggest
that companies should increase their level of ESG disclosure and improve the quality of
their financial reporting to ensure that they do not miss opportunities to invest in profitable
projects. Additionally, the results show that low slack, less tangible assets, high leverage, a
small size, a young age and low performance are associated with underinvestment.

5.2 Impact of ESG disclosure on investment efficiency in cases of low and high
financial reporting quality
To further explore the relationship between ESG disclosure and investment efficiency, the
above base model was estimated separately, considering the low and high values of both
measures of FRQ. The low and high FRQ sub-samples were determined based on the
median values. More precisely, following Zhong and Gao (2017), the low sub-sample
includes companies with FRQ values lower than the median value, while the high sub-
sample includes companies with FRQ values higher than the median value. The estimation
of the model in the low FRQ sub-sample with fixed effects confirms the existence of an
individual effect. VIF and Breush–Pagen test results reject the respective problems of
multicollinearity and heteroskedasticity, while the Durbin–Watson test results confirm
autocorrelation. Hence, the model was estimated by considering first-order autoregressive

VOL. 22 NO. 5 2022 j CORPORATE GOVERNANCE j PAGE 1105

 AR (1) disturbances in the fixed-effects and random-effects regressions. The Hausman test
results indicate that the fixed-effects regression is more efficient.
The estimation of the model in the high FRQ sub-sample via panel regression with fixed
effects rejects the individual effect; hence, the pooled estimation was used. VIF and
Breush–Pagen test results reveal the absence of multicollinearity and heteroskedasticity,
respectively, while the Durbin–Watson test results detect autocorrelation, which was resolved
using the Cochrane–Orcutt method. The results of all regressions are shown in Table 8.
The results show that the impacts of ESG disclosure are always positive and significant in both
sub-samples of low and FRQ sub-samples, but in the high FRQ sub-sample, these impacts
are higher and more significant (only for FRQ-KA) than in the low FRQ sub-sample. More
precisely, the respective coefficients of ESG in the models for FRQ-DD and FRQ-KA in the
high FRQ sub-sample are 0.0791 and 0.1003, significant at 5% and 1%, respectively, while in
the low FRQ sub-sample, the respective coefficients are 0.0463 and 0.0463, and both are
significant at the 5% level. These results confirm that ESG disclosure has a slightly stronger
impact on investment efficiency in high FRQ sub-samples, suggesting that companies with
high-quality financial information are aware of the importance of ESG disclosure to improving
transparency, reducing information asymmetry and enhancing investment efficiency.

6. Conclusion
This study examines the impact of ESG disclosure and FRQ on investment efficiency using
a sample of all listed companies in the UAE financial markets during the period 2010–2019.
This research extends previous studies that only considered CSR disclosure. The data
show that companies disclose more information about their governance matters than about
social and environmental matters. In addition, this study considers different sub-samples of
underinvestment and overinvestment, and low and high FRQ. The main empirical results
reveal a positive and significant association between ESG disclosure, FRQ and investment
efficiency, which indicates that compliance with ESG disclosure best practices not only
improves companies’ transparency and reduces information asymmetry but also enhances
investment efficiency. This result suggests that companies’ stockholders and stakeholders
are interested in ESG disclosures, in addition to financial reports.
The findings of this study provide the listed companies on the UAE financial markets with an
important awareness of the advantage of ESG disclosure, not only with regard to enhancing
transparency and increasing compliance with best practices but also to more efficiently
manage their investment decisions. This would help the financial regulatory authorities in the

Table 8 Impact of ESG on investment efficiency in cases of low and high FRQ
Low FRQ High FRQ
Variables FRQ-DD FRQ-KA FRQ-DD FRQ-KA
   
ESG 0.0463 (2.19) 0.0463 (2.42) 0.0791 (2.42) 0.1003 (3.47)
   
SLACK 0.1439 (3.06) 0.2358 (2.64) 0.6190 (2.08) 0.0833 (2.99)
   
TANG 5.8664 (2.53) 6.6913 (3.06) 6.3186 (2.75) 6.8407 (3.12)
   
LEV 2.2791 (2.27) 2.6188 (1.81) 1.7246 (3.05) 0.8871 (3.09)
   
SIZE 0.5889 (3.20) 1.1120 (1.77) 1.4389 (2.23) 0.6101 (2.96)

AGE 0.0187 (1.54) 0 0.0187 (1.41) 0.0278 (1.47) 0.0185 (2.07)
   
ROA 0.0407 (3.06) 0.0407 (3.05) 0.0196 (2.45) 0.0134 (2.53)
Industry dummies Yes Yes No Yes
Prob > F 0.0006 0.0009
R-squared 0.4774 0.5652
Adj R-squared 0.3923 0.3334
Notes:  Significant at the 10% level;  significant at the 5% level; 
significant at the 1% level

PAGE 1106 j CORPORATE GOVERNANCE j VOL. 22 NO. 5 2022

UAE further implement ESG disclosure into reporting processes and apply effective
mechanisms to assist companies in increasing the extent of ESG disclosure to manage their
financial decisions more efficiently.
This study had limitations. First, the small sample used includes all companies listed on the
UAE financial markets that have an ESG score on Bloomberg. Second, this study considers
only the impacts of ESG disclosure and FRQ; it would be beneficial to include other
corporate factors, such as corporate governance, that would affect investment efficiency.
Future research can extend this study by considering corporate governance mechanisms,
such as the ownership structure and the board of directors. Third, this study only examines
companies listed on the UAE financial markets; the scope could be expanded by
considering other GCC countries’ financial markets. This would be an interesting research
opportunity as these countries are experiencing a rapid growth in their financial markets
and a diversification in their economies. In addition, they are making substantial efforts in
attracting the foreign investors. This could be further facilitated by demonstrating a high
compliance with the ESG disclosure best practices as well as a fulfillment of the
environmental, social and governance responsibilities.

Note
1. https://financetrain.com/lessons/iasb-conceptual-framework-for-financial-reporting/

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Corresponding author
Nejla Ould Daoud Ellili can be contacted at: oulddaoudnejla@yahoo.fr

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