Differences in Social‐Cost Disclosures: A Market Test of Investor Reactions

A decision of the US Supreme Court to require enforcement of an environmental standard in the cotton textile industry provides a unique opportunity to observe the market impact of social‐cost disclosures. This research examines the reaction of investors to an exogenous factor which has an impact on a particular group of firms. A valuation‐effects paradigm is applied in the context of the standard market model to evaluate the aggregate assessment of investors to the news that a costly new Occupational Safety and Health Administration requirement would be enforced. Risk‐adjusted returns in a sample of cotton textile firms were observed to decline as a negative investor revaluation occurred. To determine if ex ante disclosure of the potential financial impact of this new environmental standard affected announcement‐period market reaction, subsamples were developed on the basis of the type of reporting provided. The results tend to support the view that market pre‐conditioning occurred. Differential impacts were observable, with less negative investor reaction to quantitative disclosures than to other types of information provided by sample companies. These results suggest that emphasis should be placed on quantitative social‐cost disclosures, and that regulatory authorities might look more closely at present disclosure guidelines to determine if they allow too much reporting variability.