The (mis)alignment of financial reporting and non-financial reporting integrity

Abstract

Purpose: By linking verified non-compliance of financial outcomes disclosures with non-verified disclosures of information related to social and environmental outcomes, we can assess their relationship and gain insight into the potential incentives driving Environmental, Social and Governance (ESG) disclosures. The aim of this study is to assess the credibility of non-financial reporting by examining whether companies that demonstrate greater compliance with ESG disclosure requirements also place more emphasis on "true and fair" or "fair" financial reporting. Methodology/approach: The study analyzed a sample of listed companies for the peri-od from 2019 to 2022, using a logistic regression with a modified audit opinion as the outcome variable and the ESG score as the primary explanatory variable. Findings: The results show a negative relationship between ESG disclosure scores and modified audit opinions, suggesting that companies with lower ESG disclosure scores are more likely to receive a modified audit opinion. Companies with higher ESG scores are less likely to receive a modified audit opinion than other companies. In addition to ESG scores, a modified audit opinion is also significantly related to the Big Four, profitability and solvency. Research limitations/implications: Our research sample is limited to the Croatian capital market with a relatively small number of observations, and the ESG score measurement is based on the methodology of the Croatian Financial Services Supervisory Authority, which is applicable to the Croatian environment. The generalization of our results should, therefore, be taken with caution. Originality/value: Given the relatively high frequency of modified audit opinions in our institutional setting, we are able to estimate the association between ESG performance and modified audit opinion more accurately than in alternative settings where modified audit opinions related to non-compliance with accounting standards are ra-ther rare. In addition, this study contributes to the existing literature by examining how ESG disclosure compliance is related to the audit opinion in an environment where firms do not face potentially severe financial consequences of a modified audit opinion.

Keywords

• non-financial reporting
• financial reporting
• audit opinions
• ESG disclosures
• financial reporting quality
• modified audit opinion