Corporate accountability requires transparency, and a key tool in this is the sustainability report. Designed to promote transparency and allow stakeholders to hold corporate boards accountable over their sustainability performance, the approach has gained considerable global traction; according to KPMG, 96% of the world's largest companies now report on sustainability.
However, for sustainability reports to be useful, they need to be credible. If they are nothing more than a corporate blue or green wash, then instead of promoting transparency and accountability they end up misleading stakeholders and eroding confidence and trust.
For sustainability reports to be useful, they need to be credible
Corporate boards are aware of this issue and many are voluntarily seeking external assurance. This has given rise to a new market for sustainability assurance services.
To explore the effectiveness of such services, we examined the quality of sustainability assurance engagements undertaken by the top 100 listed companies on the Australian Securities Exchange (ASX) and New Zealand Stock Exchange (NZX) from 2017 to 2019. We also investigated if the audit committee influences the quality of the engagements.
Our study examined the contents of published sustainability assurance statements and evaluated these by comparison against the requirements of internationally recognised sustainability reporting and assurance standards ISAE3000, AA1000AS and the Global Reporting Initiative.
We found that that 96% of ASX companies engaged in sustainability reporting. In comparison, reporting among NZX companies lagged behind, at only 56%. In terms of sustainability assurance, however, a mere 35% of listed Australian entities opted to secure third-party assurance over their reports, compared with just 11% for New Zealand.
Companies with stronger corporate governance mechanisms improve the quality of sustainability assurance engagements
In terms of assurance providers, 98% of listed companies in Australia and 79% in New Zealand preferred to use accounting firms (primarily from the Big Four). EY held the highest market share in Australia, while Deloitte dominated the New Zealand market with 47%.
The growth in the Big Four's market share can be partly attributed to their acquisition of two sustainability assurance consultants, namely Net Balance by EY and Banarra by KPMG. Importantly, 73% of Australian listed companies preferred to use their financial auditors. This may be due to a desire to ensure knowledge crossover. However, this was not the case in New Zealand, where 53% of sustainability assurance engagements were undertaken by accounting firms who were not the reporters’ financial auditors.
With respect to quality, we did not find any significant differences between statements, although we did observe a marginal improvement over the period. The low quality can be attributed to the voluntary nature of the exercise, where assurers and assurees are free to set the scope and objectives of engagements, including the level of compliance with internationally recognised standards.
In a voluntary setting, some reporting managers may aim to simply tick the box by procuring basic assurance that satisfies users who are unable to distinguish between high- and low-quality engagements. Alternatively, if reports contain data that cannot be backed by evidence then it is likely that low-quality assurance engagements will be secured. If the reporter is not committed, then it is unlikely that data can withstand rigorous external assurance.
From the assurer’s perspective, some providers may simply seek to develop new sources of revenue by entering new markets but remain reluctant to take on high reputational and legal risks.
Finally, we observed that companies with stronger corporate governance mechanisms play an important part in improving the quality of sustainability assurance engagements. Audit committees are responsible for overseeing corporate reporting, audit and assurance engagements and internal control and risk management.
While the presence of audit committees alone does not positively impact sustainability assurance quality, if they include directors who are independent, who have industry experience and regularly attend meetings, then they will play a positive role in improving the quality of sustainability assurance engagements.
We recommend that stock exchanges and government regulatory bodies should introduce tougher regulations encouraging large, listed entities to secure assurance over their sustainability disclosures.
Further, the scope and objectives of these engagements should be regulated to ensure high-quality assurance work.
Finally, we encourage reporters to strengthen their audit committees by ensuring that directors are independent, have industry experience and actively participate in the committee's functioning.