Analyzing the nexus between sustainability disclosure regulation and capital allocation efficacy: decoding the channel effects of financial reporting quality

Purpose Building on the global surge in sustainability legislation, this study aims to examine the nexus between environmental, social and governance (ESG) reporting laws and the capital allocation efficacy (CPAE) of regulated firms. The study also unveils the mediating role of financial reporting quality in transmitting the effect of sustainability regulation on CPAE. Design/methodology/approach Indian regulators have enforced the “Business responsibility and sustainability reporting” (BRSR) framework, which serves as an external shock for the research design. Accordingly, a sample of 976 listed companies from 2019 to 2025 is analyzed using a quasi-natural experiment approach with a difference-in-differences research design. The study also performs several robustness tests, including propensity score matching, a placebo test and alternative measurements of key variables. Findings The findings reveal a significant positive impact of ESG regulation on CPAE through the mediating role of improved financial reporting quality. The results suggest that ESG legislation enhances the quality and reliability of financial disclosures, reduces information asymmetry and thereby improves CPAE. Moreover, the findings indicate that the positive effect of ESG statutes is more pronounced among emission-intensive sectors. Research limitations/implications Given the limited research on the financial consequences of sustainability regulation, this study offers significant implications for both theory and practice. The findings also enable policymakers to promote the adoption of ESG practices among corporate managers by highlighting the positive relationship between ESG regulation and corporate outcomes. Originality/value Despite the growing prevalence of mandatory ESG reporting, empirical evidence on corporate responses to such regulations remains largely underexplored. This study provides pioneering evidence on the mechanisms underlying the financial consequences of ESG regulation and advances the extant literature by incorporating the legislative dimension of sustainability reporting.