Carbon disclosures and information asymmetry: Empirical evidence on the importance of text in understanding numerical emission allowance disclosures

Abstract

Carbon disclosures are essential for investors to evaluate firms’ efforts to combat climate change. In this study, we focus on a specific type of carbon disclosures—namely, emission allowance disclosures—that capture how firms implement emission reductions under the European Union emission trading system (EU ETS). Given the continuously changing institutional features of the EU ETS and the lack of authoritative guidance on how firms should account for emission allowances in their financial statements, it is exceedingly difficult for investors to understand numerical emission allowance disclosures and to compare them across—and even within—firms. Motivated by this criticism, we hypothesize and find that textual disclosures complementing numerical emission allowance disclosures are associated with lower information asymmetries between firms and their investors. Further analyses show that textual disclosures that: (i) describe the accounting approach, and (ii) contain institutional information on the EU ETS, respectively, are particularly important for improving the information environment of numerical emission allowance disclosures. Overall, our findings suggest that text can improve the understanding of numbers in a carbon disclosure context. Therefore, our study not only contributes to the (industrial ecology) literature but also has important implications for regulators, policymakers, investors, financial analysts, and firms.