"Comply or Explain" and the Future of Nonfinancial Reporting

Although investor demand for material “environmental, social, and governance” (ESG) information that can be readily used in financial analysis continues to grow, many firms and their advisors have concerns about the potential costs and benefits of new disclosure mandates. This Article argues that a “comply or explain” approach to ESG reporting could be a more effective alternative to new line-item mandates, on the one hand, and reliance on voluntary ESG reporting on the other.

This Article first surveys empirical research across many of the jurisdictions that have implemented a comply-or-explain approach and finds that comply-or-explain principles have proven effective in improving corporate governance practices and enhancing corporate transparency, particularly in the markets that most resemble the United States. The Article then draws on this comparative experience to propose principles that could guide the Securities and Exchange Commission (SEC) in incorporating a comply-or-explain approach to ESG reporting within the current U.S. financial reporting framework. It concludes by suggesting specific elements that could be incorporated in new ESG disclosure standards on a comply-or-explain basis.