Perceived value of sustainability assurance; an investor-based view

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Combined Master Thesis Accountancy & Controlling

Perceived value of sustainability

assurance; an investor-based view

What is the effect of assurance towards sustainability information on the firm value of a

sustainability information-issuing company?

Kees Oonk S2378728

k.h.h.oonk@student.rug.nl

MSc Accountancy and Controlling Faculty of Economics and Business

University of Groningen

Supervisor: M. Looijenga MSc EMA RA

Co-assessors: prof. dr. D.A. de Waard RA & dr. R.B.H. Hooghiemstra RA

Date: June 25th_{, 2018}

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ABSTRACT

This study empirically examines the relationship between assurance towards sustainability information and the firm value of such a sustainability information-issuing company. Through the use of data collected by the Global Reporting Initiative (GRI) and financial data from over 450 companies, this paper longitudinally studies this relationship. The companies for which this effect is studied originate from the US, the UK, the Netherlands and Germany. Further, this paper tries to define the moderating effects of the type of audit firm and the country a company is located in. The results provide evidence for a positive effect on the relationship between the assurance towards sustainability information and firm value. This implies for organizations that receiving assurance towards a company’s sustainability information increases their firm value. In addition, the evidence is found that Big Four audit firms have a less positive influence on the firm value in contrast to non-Big Four firms. Therefore, organizations do not need to be restrained for reputational reasons to choose for a non-Big Four audit firm. Moreover, the results show that companies located in shareholder-oriented countries receive a higher firm value compared to companies from stakeholder-oriented countries.

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1. INTRODUCTION

In recent years reporting on sustainability information by companies has increased largely. In the past companies reported separately from their financial statements on their environmental impact. This period was followed by a more broadened reporting on environmental, social and governance aspects. External assurance towards this sustainability information rose accordingly. In just more than a decade, the number of companies that requested assurance towards their sustainability information increased by nearly 37 percent point (KPMG Report 2005 and 2017; ACCA 2004).

Unlike the legal requirement to disclose financial information frequently, reporting on sustainability is still predominantly voluntary. In the Netherlands, it has been voluntary for a period, but as of 2017 the EU-Directive 2014/95/EU came into force. This directive is now part of the Dutch legislation and obligates public interest organization (including stock listed firms with more than 500 employees) to report on non-financial information such as environmental, social and personnel matters; respect for human rights and the fight against corruption and bribery (The European Parliament and the EU Council 2014). This directive is not only operational in the Netherlands, but in all the 28 European Union member states including Germany and the United Kingdom. Despite the prospective Brexit, the UK still needs to comply with the EU legislation. Besides directives from governmental institutions, stock exchanges also transition from voluntary guidelines to mandatory reporting requirements (KPMG Report 2017, p. 19). Moreover, there is an increasing demand for this non-financial information from investors and other stakeholders since the issue of global warming. A recent KPMG survey (2017) found that 48 percent of the world’s largest companies (G250) acknowledge climate change as a financial risk. In a recent letter by Larry Fink, the CEO of BlackRock put emphasize on this pressing desire for non-financial disclosure. He states in his annual letter to CEOs that activists heavily engage with companies that are not prepared to answer critical questions on for example the effect of new tax legislation and environmental issues on their long-term prospects.

Besides this growing desire for sustainability reporting, there is also criticism on these developments. According to Thijssens, Bollen and Hassink (2016), this voluntary nature of reporting can lead to tension to disclose only good news and neglect the bad news. This so-called window-dressing is not desirable for investors and other stakeholders to be able to measure the true value of a company. In response to this problem, stakeholders are more and more demanding that this sustainability information fairly and truly represents what the company is achieving now and in the future (Gray 2000). To please this demand, the assurance towards this sustainability information increased (Deegan, Cooper & Shelly 2006; O’Dwyer and Owen 2004). This assurance is demanded for its added credibility and incremental information to the reported sustainability statements (Beets & Souther 1999; Clarkson, Fang, Li & Richardson 2013; Kolk & Perego 2010), since these sustainability reports often lacked completeness and consistency according to research by Adams and Evans from 2004. On the other hand,

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4 research by O’Dwyer and Owen (2005) showed that the assurance process of sustainability reports is not fully independent, since there is a high degree of management control over the assurance process. Thus, a clear consensus on the added value of sustainability assurance cannot yet be found.

Back in 2003, a global overview indicated that almost 40 percent of sustainability reports included external assurance compared with only 17 percent ten years earlier (O’Dwyer & Owen 2007). The 2017 KPMG survey found that this percentage is now 67 percent for the largest 250 companies in the world. This clearly shows the urge and pressure felt by companies to provide this credibility to its stakeholders. Figure 1 included below visualizes the steps from no internal reporting system to eventually the external assurance report, where stakeholders are involved in the total assurance process (Park & Brorson 2005). For a company it is not necessary to take all the steps. As an organization you can step in or step out at every stage. In their paper, they raise important questions as: ‘‘Would the third-party assurance lead to the increased credibility?’’ and ‘‘Would increased credibility justify all the resources needed to manage the assurance process?

Figure 1: Model by Park and Brorson (2005)

The research on sustainability assurance is so to speak fairly new. The purpose of this study is to examine how investors value this assurance towards sustainability information, since many investors and other stakeholders may utilize the information from sustainability reports for investment decisions (Beets & Souther 1999). In addition, this research empirically assesses two moderating variables on this relation. First, what effect does the type of audit firm have on the perceived value of sustainability assurance? Distinction is made between Big Four audit firms versus non-Big Four firms. The second moderating relationship concerns the country where a company is located. Differences between a company located in a shareholder-oriented country versus a company from stakeholder-oriented countries are discussed. These topics are addressed by the following research question:

What is the effect of assurance towards sustainability information on the firm value of a sustainability information-issuing company; and to what extent is this effect influenced by the type of audit firm and the country the company is located in?

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5 Cho, Michelon and Patten (2014) studied the relationship between CSR assurance and valuation of the stock market of American listed companies. No association was found between CSR assurance and the market value of companies that issued a CSR report. A reason for this could be that first market perceptions on CSR assurance need to be developed before the CSR assurance market can mature (Cho et al. 2014). Just as Cho et al. (2014), both Fazzini and Dal Maso (2016) and Gürturk and Hahn (2016) also found that assurance does not provide any extra informativeness. However, research by Brown-Liburd, Cohen and Zamora (2014) showed that assurance does increase the value of an organization. So no clear consensus is found yet.

Pflugrath, Roebuck and Simnett (2011) examined whether assured CSR information impacts financial analysts perceived value on credibility. In this case, the credibility of the assurance provider is measured in terms of its trustworthiness and expertise. Pflugrath et al. (2011) find support that CSR information that is assured by a professional accountant (opposed to a sustainability expert) is perceived more credible for a financial analyst. On the other hand, Hodge, Subramaniam and Stewart (2009) stated that there are no significant main effects for the type of assurance practitioner (accounting firm versus specialist consultant) on the report users’ confidence and perceptions of information credibility. From the literature on the auditor choice for financial statements, the general consensus is that organizations with stronger corporate governance systems demand a higher quality of assurance. This reflects in the choice of a Big N auditor over other auditors (Zhou, Simnett & Green 2016). This line of reasoning can be extended to the assurance towards sustainability assurance where this effect is not yet being studied that extensive. If there is no effect as mentioned by Hodge et al. (2009), from a costs perspective it could be more rewarding to choose a Big Four firm. Big Four audit firms can be more credible than non-Big Four firms in assuring sustainability reports, due to the higher litigation risk (Khurana & Raman 2004).

The second moderator in this study is the difference in firm value between a company in a shareholder and a stakeholder-oriented country. The ‘shareholder-oriented’ countries in this research comprise of the United States and the United Kingdom. The ‘stakeholder-oriented’ countries include the Netherlands and Germany. Kolk and Perego (2010) results provide evidence that companies in countries that have a weaker governance system and are more stakeholder-oriented, are more willing to obtain assurance on sustainability reports. Implicating that when assurance is provided over sustainability information, the firm value will be higher valued. Research by Simnett, Vanstraelen and Chua (2009) showed that companies that operate in stakeholder-oriented countries are more likely to choose an auditor as assurer for sustainability reports. They distinct auditors and consultants. The research by Simnett et al. (2009) puts my second moderator more as a moderating variable on my first moderator. I do however believe that the origin of the company has way more impact on the investor believes than just on influencing the choice of the audit firm. Hence, the influence of the company’s origin on the relationship between sustainability assurance and the firm value is of interest for this study.

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6 The further knowledge building on the relation between the presence of sustainability assurance and the firm value of a company is useful for an organization is that sense that it now can be explored whether sustainability assurance adds incremental value to a companies’ disclosure practices. Does sustainability assurance truly increase the firm value and are shareholders therefore better off? Or proves sustainability assurance sole means to satisfy its other stakeholders, such as governments and pressure groups. Also, this research distinct Big Four audit firms from non-Big Four firms that provide assurance towards sustainability information. Audit and consultancy firms can utilize relevant information concerning their current position in the market and their branch quality.

The remainder of this paper is structured as follows: the next chapter explains the theoretical framework and provides a literature review. Arising from this review the hypotheses are developed. Subsequently, a further elaboration on the research methods is provided. Thereafter, the results are presented. Chapter 5 concludes with a conclusion of the results. Discussion points, some limitations and recommendations for further research are given.

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2. THEORY AND LITERATURE REVIEW

Literature on sustainability disclosure and assurance commonly comprises of the agency theory,

the stakeholder theory and the legitimacy theory (Heenetigalam, De Silva Lokuwaduge, Armstrong &

Ediriweera 2015). A fourth theory that can be addressed is the signalling theory (An, Davey & Eggleton 2011).

The agency theory is concerned with the misalignment of interest between the principal and agent. The relationship between these two is based on the assumption that they both act in their best interests and want to maximize their own wealth (An et al. 2011). This perspective where a firm is seen as a nexus of contracts between the principal and agent is consistent with the sustainability disclosure where managerial compensation contracts and debt obligations are determined (Cormier, Magnan & Van Velthoven 2005). Kolk and Perego (2010) stated the following in their paper: “From an agency theory

perspective, the demand for assurance stems from the need to mitigate agency costs associated with information asymmetry with institutional creditors and resultant loss of control due to a lack of observability of managers’ behaviour (Chow 1982).” Information asymmetry is seen as one of the

factors for creating the agency problem. The disclosure of (voluntary) sustainability information could reduce the information asymmetry between the management and shareholders, and more broadly between the organization and its stakeholders (An et al. 2011). Elaborating further on this view, a study by Cuadrado-Ballesteros, Martínez-Ferrero and García-Sánchez (2017) found that the reporting of sustainability information alone is not sufficient to reduce this information asymmetry. It is the assurance towards this information that leads to a lower level of information asymmetry.

The social-political theories like the stakeholder and legitimacy theory are more concerned with the disclosure of sustainability information (Cormier et al. 2005). However, the intertwining relation between the practice of assurance and the attempts to secure legitimacy is viewed as important in order to receive a widespread acceptance of comparable assurance practices in among others sustainability assurance (O’Dwyer, Owen & Unerman 2011). The legitimacy theory as defined by Suchman (1995) is: “[…] a generalized perception or assumption that the actions of an entity are desirable, proper, or

appropriate within some socially constructed system of norms, values, beliefs, and definitions.”

Meaning that a firm copes with several actors and needs to disclose valuable outcomes of a firms operations to society as a whole. Deegan (2002) state that the management of an organization can have several motivations to report on sustainability information. Among others, to comply with legal requirements. To comply with the expectations of the community, to ensure their ‘license to operate’. Or to win particular reporting awards (Deegan & Carrol 1993), in order to receive positive publicity for their organization. Such as the Transparantiebenchmark in the Netherlands. To constrain issues on dressing, the provided assurance towards sustainability information tempers these window-dressing practices. This strengthens an organization’s legitimacy in a different manner.

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8 Where the legitimacy theory has a broader context in focussing on the entire society, the stakeholder theory focuses only on the stakeholders of an organization (An et al. 2011). Freeman (1984) defined a stakeholder as: ‘any group or individual who can affect or is affected by the achievement of

an organization’s objectives’. Freeman (1984) classifies investors, customers and employees as primary

stakeholders and other groups of interest as secondary stakeholders. Firms disclose sustainability information to satisfy the interest of their stakeholder (Freeman 1984). More broadly speaking is corporate sustainability the ability to meet the needs of an organization’s direct and indirect stakeholders without neglecting the interest of the future stakeholders (Dyllick & Hockerts 2002). Since stakeholders have a direct influence on the performance of a company, managers want to inform stakeholders on matters as sustainability in order to reduce firm risk and increase the long-term growth visibility (Schmidheiny 1992).

The fourth and last theory that can be addressed is the signalling theory (An et al. 2011). This theory suggests that there are several solutions to the information asymmetry problem. Management can highlight certain outstanding performances to its stakeholders through for instance sustainability disclosure. Organizations with outstanding qualities can signal their advantages to the rest of the market. This signalling can cause investors to reassess the value of a company and make decisions that are more beneficial for that company (An et al. 2011).

For this research emphasize is put on the agency theory and stakeholder theory, since the assurance towards sustainability information is the focal point and not the reporting on it. According to An et al. (2011), are the legitimacy theory and signaling theory complementary theories to the disclosure practices of an organization.

2.1 Sustainability reporting

Sustainability reporting is the publishing of an organization’s economic, social and environmental impacts caused by its daily operations (GRI 2013). According to the GRI (2013), proves a sustainability report the link between the organization’s strategy and their goals towards sustainable development. Sustainability information commonly complies with external guidelines, such as the GRI standards or the standards of SASB. The Global Reporting Initiative (GRI) is an international independent organization that helps businesses and governments worldwide to communicate and understand their impact on sustainability issues (Global Reporting Initiative 1997) and is based in Amsterdam. The GRI was the first to set worldwide standards for sustainability reporting. The most recent guidelines are the G4 guidelines of the GRI. From 1 July 2018 forward these G4 guidelines are replaced by the GRI Sustainability Reporting Standards, which are already early adopted by some organizations. The SASB is the American equivalent of GRI. The SASB is a standards-setting organization that aims at advancing the disclosure of sustainability information (SASB 2018). However, the SASB does not track companies’ use of the standards nor assurance. They are different than GRI in that way.

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2.2 Sustainability assurance

For a variety of reasons, organizations can seek external assurance. From the agency theory perspective, organizations receive assurance to mitigate the agency costs arising from the information asymmetry (Kolk & Perego 2010). External assurance is defined by the IFAC as follows:‘‘a process in

which a practitioner expresses a conclusion designed to enhance the degree of confidence that intended users can have about the evaluation or measurement of a subject matter that is the responsibility of a party, other than the intended users or the practitioner, against criteria’’. To improve transparency and

credibility of disclosed sustainability information, assurance towards sustainability reports is provided to serve the desires of the stakeholders (Beets & Souther 1999; Kolk & Perego 2010). Another reason could be lower risk and an increased value (GRI 2013). Assurance has a major role in reducing data quality risks and therefore are assured sustainability reports more likely to be relied on. This will increase the value of reporting.

In order to create the most value, an assurance process needs to be an integral part of the entire reporting process. A clear understanding of the agreement between the management and assurance provider is crucial. Three considerations that can shape this understanding are the scope of the assurance engagement, the responsibilities of both parties and the way in which access and evidence are provided (GRI 2013).

Assurors must observe ISAE3000 for the assurance of sustainability information (Rhianon Edgley, Jones & Solomon 2010). This standard deals with assurance engagement other than audits of financial information (IFAC 2013). The ISAE3000 standard is used for a “reasonable/high” level of assurance. Besides the ISAE3000, use is made of the AA1000 AS standard for a “limited/moderate” level of assurance (Cuadrado-Ballesteros et al. 2017). Also, national standards or a combination of the above can be used. These national standards are both general and sustainability specific (GRI 2013). In general, assured information is perceived to be far more credible than non-assured information (Libby 1979; Hodge 2001). Enhanced credibility is provided as a consequence of the assurer being technically and ethically competent in their role, and their independence from the preparer of the information (IAASB 2010a). From a shareholder perspective, external assurance could reduce the threat of litigation and other actions by regulatory bodies for misrepresentation in the sustainability reports (Beets & Souther 1999). Beets and Souther (1999) state that severe problems can occur when companies disclose inaccurate or misleading information, from minor penalties to even bankruptcy. External assurance can mitigate the risk of these events from happening. Hence, it is expected that sustainability reports are perceived as more credible when these are assured.

2.3 Firm value

There are several ways and methods to measure the firm value of a company. Stock prices of firms is a way to determine the value investor give to a company. However, many other factors could be

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10 influencing the stock price. In the research method section, further elaboration is given on the proper design for firm value as a proxy for investors’ value.

The firm value of a company is determined according to the model of Fazzini and Dal Maso (2016). Fazzini and Dal Maso (2016) state the following based on the research by Doidge, Karolyi and Stulz (2007): “[…] in countries with weak institutions, the benefits from an improvement in the governance

structures (i.e. such as voluntary use of assurance services) are quite low, because of the lack of credibility, while, on the contrary, these are higher for firms in developed economies with strong institutions.” Since the data sample consists of companies from developed countries, there is a positive

relationship expected between the assurance towards sustainability information and the effect on firm value.

According to Beets and Souther (1999), many investors are committed to sustainability issues and are therefore willing to invest more in companies that have conducive sustainability records. On the premise that sustainability reporting reduces information asymmetry, Dhaliwal, Li, Tsang and Yang (2011) found that sustainability reporting lowers the cost-of-capital and more investors and analyst’s coverage. These benefits could be amplified by assurance towards sustainability information. As mentioned earlier, sustainability assurance reduces the information asymmetry even further. Brown-Liburd et al. (2014) proved that sustainability assurance caused a higher assessment of stock prices by non-professional investors. The following hypothesis is posited for this reason:

H1: Assurance towards sustainability information increases the firm value of a sustainability information-issuing company.

2.4 Audit firm

Traditionally accountants audit corporate financial statements. However more recently, for the purpose of providing assurance towards sustainability information, there has been an increase in specialist consultants claiming that they also have expertise in this discipline (Hodge et al. 2009). So, in general, there are three types of assurance providers: accountancy/audit firms, engineering firms and sustainability consultants (Cuadrado-Ballesteros 2017). Mock, Strohm and Swartz (2007) found that worldwide 35 percent of sustainability assurance reports were issued by Big Four firms and the remaining 65 percent by other audit firms and consultants. In 2011 (KPMG Report 2011) 71 percent of the G250 market and 64 percent of the N100 market is held by major accountancy organizations that provide assurance towards Corporate Responsibility. Big Four firms perform a major portion of these assurance assignments. Indicated as Big Four firms are: EY, PwC, KPMG and Deloitte. For this research, all other audit and consultancy firms are indicated as non-Big Four firms. Consensus on what type of assurance provider is more credible is hard to find. To begin with, Simnett et al. (2009) state that non-accounting professionals tend to have a higher level of expertise on the subject of sustainability.

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11 Opposing, Pflugrath et al. (2011) found support that a professional accountant is perceived more credible accountant compared to a sustainability expert. However, Hodge et al. (2009) stated that there are no significant main effects for the type of assurance practitioner on the information credibility. Khurana and Raman (2004) and Lawrence, Minutti-Meza and Zhang (2011) state that Big Four auditors provide a higher quality than non-Big Four auditors, due to the protection of the organization’s brand name and to avoid litigations. Also, their size helps Big Four audit firms to better support training facilities, standardization procedures and reviews. Research by Francis, Michas and Seavey (2013) showed that in terms of revenue and professional staff, Big Four firms dominate the market. Which leaves higher barriers for smaller audit firms to enter the market and compete with the Big Four. Francis et al. (2013) found that this market domination by the Big Four does not harm the audit quality. DeAngelo (1981) argued that larger audit firms have provided a higher audit quality, since ceteris paribus, the size of an audit firm alone alters the incentives of an auditor. This would imply that Big Four audit firms are seen as more credible and investors, therefore, are willing to invest more in a company.

H2: The choice for a Big Four audit firm has a positive moderating effect on the relationship between sustainability assurance and the firm value of a company.

2.5 Shareholder versus stakeholder’s perspective

This moderating variable differentiates two types of countries. The ‘shareholder-oriented’ countries are the United States and the United Kingdom, also known as common-law countries. The ‘stakeholder-oriented’ countries are the Netherlands and Germany, which are known as code/civil-law countries (La Porta, Lopez-de-Silanes, Shleifer & Vishny 1997). The literature on corporate governance has allocated countries to the Anglo-American system and Continental Europe and Japanese systems. These systems respectively map onto the shareholder versus stakeholder perspectives (Williams & Aguilera 2008). Yet, studies on CSR and sustainability recently plead for a more nuanced view on this partition. The UK in particular shows increasing similarities with Europe and accompanying contrast to the US. For this research however, I hold onto the traditional view as the UK being part of the Anglo-American system. To distinguish the effect that the country-orientation has on the relationship between sustainability assurance and firm value, the focus is put on the different approaches share- and stakeholders propagate within an organization. First of all, financial reporting is a totally different paradigm than reporting on sustainability (Wallage 2000). Sustainability reporting is not only a matter of disclosure but also a key element of the communication process between the company and its main stakeholders. It is a crucial part of the learning and decision-making process (Zadek 1998). Since it provides a way for stakeholders to check whether their demands are taken into account, where historically in shareholder-oriented countries the focus is more on short-term earnings, which could imply that the sustainability concerns could be neglected to some extent. According to Friedman (1970), shareholder-oriented organizations

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12 have no social or moral responsibilities, and only want to maximize their own profits. Van der Laan Smith, Adhikari and Tondkar (2005) found that the sustainability information that firms from the stakeholder-oriented countries report are of a higher quality since they have more social responsibilities than only maximizing the utility of shareholders.

A study by Williams and Aguilera (2008) provide evidence that a company’s culture, and in particular their country-orientation can influence the sustainability issues in their business operations. In stakeholder-oriented countries, stakeholders have a greater influence on the operations and the financial performance of an organization than in shareholder-oriented countries (Chen 2009). Thus, sustainability assurance which adds credibility to the business operations and disclosure of sustainability information is likely to be more useful for investors to assess the firm’s value in stakeholder-oriented countries than in shareholder-oriented countries.

H3: Sustainability assurance acquiring companies from stakeholder-oriented countries have a higher firm value than companies from shareholder-oriented countries.

To conceptualize all the variables involved, figure 2 presents the conceptual model. This model gives an overview of the relations between the different variables.

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3. METHODOLOGY

To test the hypotheses, the following section discusses the method that is used to conduct this research. A further explanation of the data gathering is provided for each variable. The control variables are explained, which could potentially have an impact on the dependent or independent variables.

3.1 Sample and data collection

The sample for this research covers the years from 2013 until 2016. To test whether assurance towards sustainability reports influences the firm value of a company, data was obtained on a total of 455 companies originating from the United States, the United Kingdom, the Netherlands and Germany. The dataset covers four years, so logically there should be 1.820 observations. However, some companies have been merged, created or delisted during the period of analysis. Therefore, the dataset is not totally balanced. Although it is not uncommon in sustainability assurance research that a dataset is unbalanced (Martínez-Ferrero, García-Sánchez 2016; Simnett et al. 2009). Meaning that not for each and every year information was available. Also due to the absence of financial data of some companies in certain years, this initial dataset was reduced to 1.787 useful observations. The bias caused by this great discard of data is further explained in the discussion section. From these 455 companies, 239 companies (623 year observations relative to 1.787) had assurance over their sustainability report.

GRI provided the complete lists of related data for every year from 2013 until 2016 (Global Reporting Initiative). Per year the number of companies differ, since every year new companies participate in the GRI database. In 2013 the number of companies was worldwide 5,208. Out of this initial dataset, the four countries were filtered that are useful for this research. To be more specific in the following table (table 1) you can find the number of useful companies out of every country that met the requirements. Most companies can be found in the United States and the least in Germany.

Country Number of useful companies

United States 212 United Kingdom 117 The Netherlands 66

Germany 60

Table 1: distribution companies over countries

3.2 Dependent variable: firm value

To measure the dependent variable use is made of the market-to-book ratio, as it is a better explanatory ratio for a setting with pooled data (Fazzini & Dal Maso 2016). This research uses the following formula to determine and can be interpreted as a proxy measure of firm value (Fazzini & Dal Maso 2016):

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14 𝑀𝑡𝐵𝑖,𝑡= 𝛽0 + 𝛽1∗1/𝐸𝑞𝑢𝑖𝑡𝑦𝑖,𝑡+ 𝛽2∗𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠𝑖,𝑡/𝐸𝑞𝑢𝑖𝑡𝑦𝑖,𝑡+ 𝛽3∗𝐸𝑛𝑣_𝐷𝑖𝑠𝑐𝑖,𝑡

+ 𝛽4∗_{𝐴𝑠𝑠𝑢𝑟𝑎𝑛𝑐𝑒}

𝑖,𝑡+ 𝛽5∗𝐸𝑛𝑣_𝐷𝑖𝑠𝑐𝑖,𝑡∗ 𝐴𝑠𝑠𝑢𝑟𝑎𝑛𝑐𝑒𝑖,𝑡+ 𝜀𝑖,𝑡

This formula is based on the model developed by Ohlson (1995). Where MtBis the market capitalization of a firm divided by the book value of the equity. 1/Equity is the inverse ratio of the book value of equity of a firm. Earnings/Equity is the ratio between the earnings of a firm and its book value of equity. Assurance is the dummy variable, that takes a value of 1 if the company’s sustainability report were subject to an external and independent assessment, and a value of 0 otherwise (Fazzini & Dal Maso 2016). Env_Disc are in Fazzini and Dal Maso’s model (2016) the transformations of environmental disclosure scores.

For this research, the total shareholders’ equity and the total earnings of a company are gathered through Compustat. The data is retrieved in two steps. First, all the financial data of the American companies are gathered. Through Compustat, one can easily choose which data to retrieve from their database. Thereafter, all the data for the other three countries are gathered. For some companies in the GRI database, there is no financial information available in Compustat. For those companies, the necessary information is manually gathered through their annual reports. To check for consistency the figures of AEGON in both Compustat and their annual report are compared. With some minor deviation, both databases are considered complete and reliable to merge.

The Env_Disc variable in the model by Fazzini and Dal Maso (2016) is not applicable to this research. Since the environmental disclosure of a company is not truly measurable and not necessary for this study. The firm value (FV) model used for this research is the following:

𝐹𝑉𝑖,𝑡 = 𝛽0 + 𝛽1∗1/𝐸𝑞𝑢𝑖𝑡𝑦𝑖,𝑡+ 𝛽2∗𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠𝑖,𝑡/𝐸𝑞𝑢𝑖𝑡𝑦𝑖,𝑡+ 𝛽4∗𝐴𝑠𝑠𝑢𝑟𝑎𝑛𝑐𝑒𝑖,𝑡+ 𝜀𝑖,𝑡

The firm value was winsorized with a 2 standard deviation cut-off. This means that the value of the outliers is altered to that of the closest non-outlier. The closest non-outliers are both the average value minus two times the standard deviation and the average plus two times the standard deviation. The lower limit was set to -14,92 and the upper limit was set to 16,78.

3.3 Independent variable: sustainability assurance

To determine if a company received assurance on its sustainability report or annual report according to the standards of GRI, the GRI Sustainability Disclosure Database is consulted. This database includes all the sustainability reports that the GRI is aware of. Companies can register their reports themselves onto the database in order to get additional exposure internationally. This research solely uses the GRI database, since this is the most complete and up to date database on sustainability disclosures relevant

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15 to this study1_{. As mentioned before, the SASB does not track the use of the standards nor assurance by}

companies itself. However, there were sufficient American companies available in the GRI database. Moreover, the Dow Jones Sustainability Index reports more specifically on Economic, Social and Governmental (ESG) figures and is not as user-friendly as the GRI database.

The GRI dataset clearly shows per company and per year if they obtained assurance over their sustainability report. Just simply with a “Yes” or “No”. This was converted into a dummy variable, where a “Yes” is equal to 1 and a “No” is equal to 0. This converting is used in more previous research (Simnett et al. 2009; Kolk & Perego 2010).

3.4 Moderating variable: Big Four vs. non-Big Four audit firms

Information on the assurance provider and more specifically a Big Four versus non-Big Four assurance provider can also be found in the GRI database. First, the data file showed what the type of assurance provider was. Distinction was made between an accountant, engineering firm or small

consultancy/boutique firm. The next column provided an overview of the assurance provider. Useful for

this moderating function is the distinction between Big Four and non-Big Four firms. The non-Big Four group consisting of audit firms as well as engineering firms and small consultancy firms. In the data file, the following Big Four audit firms are present: PricewaterhouseCoopers (PwC), Ernst & Young (EY), KPMG and Deloitte. The other non-Big Four firms are: BDO, Bureau Veritas, DNV, Lloyds, Net Balance, SGS, Two Tomorrows and Other (with no further specification).

3.5 Moderating variable: shareholder versus stakeholder’s countries

Similar to the study by Cuadrado-Ballesteros et al. (2017) distinction is made between stakeholder and shareholder-oriented countries. A dummy variable is created for this variable. The stakeholder countries are the Netherlands and Germany. If a company has its legal base in one of these two countries it receives the value 1. The shareholder-oriented countries are the United States and the United Kingdom, and in this case a company receives the value 0.

3.6 Control variables

The control variables that are included in this research are company size (SIZE), the industry the company is operating in (INDU) and year effects (YEAR). Control variables are used to make sure that the dependent variable firm value is indeed explained by the independent variable sustainability assurance. Company size (SIZE equal to the natural logarithm of the total assets) is the first control variable used in this research. The total assets of the companies are also winsorized with a cut-off of 2 times the standard deviation. The lower limit was set to zero since there is no such thing as negative

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16 total assets, and the upper limit was set to 631.421.

Next, I control for the industry a company is operating in. In the dataset, there are 37 different sectors classified. To get a better overview, these sectors were merged into 2 types of industries. The first industry group consists of “risky” sectors. The following six sectors are identified as risky:

chemicals, energy, energy utilities, financial services, mining and water utilities. This separation is

based on research by Simnett et al. (2009), where support is found that the demand for sustainability assurance is strongest in finance, mining and utilities industries. Simnett et al. (2009) argue that the environmental and social risks are the greatest in these industries. The second “non-risky” group consists of the remaining 31 sectors.

The last control variable is the year dummy. This variable controls for the year in which assurance is provided towards the sustainability report. The year in which the sustainability audit report is issued leads, for the reason that not all the fiscal years align with the calendar years. To get unity in the dataset I followed the publication year set by GRI. For every year a dummy variable is created.

3.7 Data analysis

To assess possible multicollinearity issues a correlation matrix is comprised. The analysis of the sample is done by a T-Test, to check for differences in the variety to the mean. A linear regression was executed to conduct whether the hypotheses can be accepted or not. In the table below an overview is given on the description of variables and their corresponding labels. In the proxy column, a brief description of the specific variable is given.

Table 2: Description of variables

Variable Label Proxy

Dependent variable

Firm value FIRMVAL The firm value of a company.

Independent variable

Sustainability assurance SUSASS The presence of assurance towards the sustainability report of a company.

Moderating variables

Type of Audit Firm TYPEAUD The type of audit firm. Were distinction is made between Big Four versus Non-Big Four audit firms. Country Orientation COUNTORI A measure of the historical orientation of a country,

namely shareholder versus stakeholder-oriented.

Control variables

Company size SIZE The size of a company measured by its total assets. Company’s industry INDU The type of industry a company is operating in. Year of publication YEAR The year in which the audit report towards the

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17 Based on the method of regression, the following model is established:

𝐹𝐼𝑅𝑀𝑉𝐴𝐿𝑖𝑡 = 𝛽0 + 𝛽1∗𝑆𝑈𝑆𝐴𝑆𝑆 + 𝛽2∗𝑆𝑈𝑆𝐴𝑆𝑆∗𝑇𝑌𝑃𝐸𝐴𝑈𝐷 + 𝛽3∗𝑆𝑈𝑆𝐴𝑆𝑆∗𝐶𝑂𝑈𝑁𝑇𝑂𝑅𝐼 + 𝛽4∗𝑆𝐼𝑍𝐸 + 𝛽5∗𝐼𝑁𝐷𝑈 + 𝛽6∗𝑌𝐸𝐴𝑅 + 𝜀𝑖𝑡

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18

4. RESULTS

In this chapter, the results are explained. First, the descriptive statistics of the variables are displayed. Subsequently, a correlation matrix is provided to show the correlations between the different variables. Thereafter, the regression analysis is explained. Lastly, additional analyses are provided.

4.1 Descriptive statistics

The descriptive statistics for all the variables are displayed in table 3. The average firm value of a company is 0,692 with a standard deviation of 1,572. Out of all the observations, 35 percent of the firms receive assurance towards their sustainability information. This percentage is not in line with the number given by the KPMG Survey (2017), where this percentage was 67 percent for the largest 250 companies in the world. Sixty percent (0,21/0,35) of all these assurance statements came from a Big Four firm. Out of all the observations, 27% was classified as a company from a stakeholder-oriented country.

The total assets of a company are on average 86.370 million EUR, with a minimum of 4,84 million EUR and maximum of 2.671.318 million EUR. This dataset does not only comprise of world’s largest entities. Some smaller companies are also included in this research. The table shows that 32 percent of the companies operate in an industry that is classified as “risky”.

Table 3: descriptive statistics

Label N Mean Std. Deviation Minimum Maximum

FIRMVAL 1787 0,692 1,572 -14,924 16,781 SUSSASS 1787 0,35 0,476 0 1 AUDFIRM (BIG4) 1787 0,21 0,406 0 1 COUNTORI (STAKEH) 1787 0,27 0,446 0 1 SIZE (TOTASS) 1787 86.370 272.850 5 2.671.318 INDU (RISKY) 1787 0,32 0,468 0 1

A comparison of the number of assurance statements delivered by the different Big Four audit firms is depicted in table 4 below. This table clearly shows that PwC has the biggest share in assurance statements provided and Deloitte has the smallest share out of all the Big Four firms.

Table 4: distribution of the sustainability assurance amongst Big Four firms

Deloitte 42

EY 94

KPMG 103

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19 In table 5 an overview of the industry types per year is given. The statistics for these four years are all very similar to each. They all have an approximately 25 percent share in the dataset. The table also shows that the non-“risky” industries are overrepresented. This proportion is caused by the fact that only six sectors form the “risky” industry group, where the other 31 sectors form the non-“risky” industry group.

Table 5: an overview of industry types per year

Year “Risky” industry No Yes 2013 306 145 2014 305 146 2015 304 145 2016 291 145 4.2 Correlation matrix

In order to learn whether a mutual relationship exists among the variables use is made of the Pearson correlation matrix. In table 6 multiple significant correlations exist. These could potentially lead to multicollinearity issues. If a correlation is greater than .70 attention needs to be paid to this relation. They only correlation that is greater than .70 is the relation between the type of audit firm on the presence of sustainability assurance. That these two variables are strongly correlated is also expected. Because there must have been an assurance statement when the audit firm is given. The VIF (variance inflation factor) score of the relation presented in the next section will bring more clarity. Further, there are no other multicollinearity problems.

Table 6: Pearson correlation matrix

Variable 1 2 3 4 5 6 1. Firm value 1 2. Sustainability assurance .338** ₁ 3. Audit firm .206** _.701** ₁ 4. Country orientation .052* _.284** _.437** ₁ 5. Company size .069** _.174** _.113** _-.073** ₁ 6. Industry -.012 .089** _.068** _.030 _.303** ₁ Notes: N = 1787 / * p < .05, ** p < .01 (two-tailed)

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4.3 Regression analysis

Table 7 gives an overview of the results from the linear regression analysis for the tests of the three hypotheses. Model 1 only shows the relation between the control variables and the firm value. The presence of sustainability assurance was added in model 2. The next model, model 3 concerns H2. In this model, the type of audit firm comes into play. More specifically whether a Big Four firm assured the sustainability information. An interaction variable or cross product is created for a proper measurement of the relation. Model 4 shows the relationship between sustainability assurance and firm value, including the moderating effect of the country where a company is located. For this regression that meant whether a company was located in a stakeholder-oriented country or not. Also for this relation an interaction variable created. Model 5 shows the full model, where all the variables are included. So the relationship between the sustainability assurance and firm value with both the moderating variables and control variables.

The prediction for H1 had a positive relationship between the presence of sustainability assurance and the value of a firm. The result from table 7 shows that there is a significant positive association (β = 1.114, p < .01), which support H1. Model 3 studies H2, which predicted a positive moderating effect of a Big Four firm over a non-Big Four firm on the relationship between sustainability assurance and firm value. A significant negative relationship was found (β = -.232, p < .1), resulting in a rejection of H2. Due to multicollinearity issues, the Big Four variable was excluded from the analysis. For a visual insight into H2, a plot was made that clearly shows a higher level of firm value for companies receiving sustainability assurance from non-Big Four firms (appendix A; figure 3). H3 is shown in model 4. Again, a positive moderating effect was predicted on the relation between sustainability assurance and firm value, when a country was located in a stakeholder-oriented country. Table 7 shows however that there is significant negative relationship (β = -.355, p < .05), rejecting H3. A second plot (appendix A; figure 4) was made to show the higher firm value for companies in shareholder-oriented countries. Both plots show two lines originating from an almost identic spot. This is in conformity with the indifference of the firm value when there is no sustainability assurance present. In every model, there is controlled for year fixed effects. This is necessary for the reason that the firm value of a company can vary between years for reasons other than described in this model.

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Table 7: Regression results

Variable Model 1 Model 2

(H1) Model 3 (H2) Model 4 (H3) Model 5

Coeff. Std. err. Coeff. Std. err. Coeff. Std. err. Coeff. Std. err. Coeff. Std. err.

Intercept .111 .192 .156 .181 .159 .181 .212 .185 .207 .185 SIZE .146*** _.045 _.046 _.043 _.045 _.043 _.030 _.044 _.032 _.044 INDU -.121 .083 -.166** _.078 _-.164** _.078 _-.156** _.078 _-.156** _.078 Independent variables SUSASS 1.114*** _.075 _1.252*** _.104 _1.275*** _.095 _1.301*** _.108 Moderating variables SUSASS x AUDFIRM -.232* _.121 _-.071 _.140 SUSASS x COUNTORI -.355** _.164 _-.320* _.179 R-square .007 .004 2.34* 1.50 .117 .114 39.17*** 1.50 .119 .115 34.15*** 2.01 .121 .117 30.55*** 2.90 .121 .117 27.17*** 3.44 Adjusted R-square F-value Highest VIF

Year fixed effects Yes Yes Yes Yes Yes

Notes: N=1787 / ***, ** and * represent significance level at respectively 1, 5 and 10 percent (based on two-sided testing, except for H1, H2, and H3).

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4.4 Additional analysis

Using the Chi-square test the relation between the type of audit firm and the location where a company is located was conducted. This test was performed given the presence of sustainability assurance. In the cross table (table 8) below you find an overview of the amounts of audits in both the stakeholder as the shareholder-oriented region by either Big Four or non-Big Four audit firms. Striking is the reverse ratio of Big Four versus non-Big Four audits per region. In stakeholder-oriented countries, there are clearly more Big Four audits than non-Big Four audits towards sustainability information. In shareholder-oriented countries, there is a bigger dominance by non-Big Four firms (including engineering and small consultancy firms). There is a significant relationship between the type of audit firm and the location where a company is located, given the presence of sustainability assurance. Chi-square (1) = 160,10, p = .00. This means that in stakeholder-oriented countries sustainability assurance is more often provided by a Big Four audit firm (87,4%) than by a non-Big Four firm (12,6%). Also, in shareholder-oriented countries sustainability assurance is more often provided by a non-Big Four firm (62,6%) than by a Big Four audit firm (37,4%).

Table 8: Results of Chi-square test and descriptive statistics for audit firm dominance by region

Stakeholder-oriented Shareholder-oriented

Big Four 243 (87,4%) 129 (37,4%)

Non-Big Four 35 (12,6%) 216 (62,6%)

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5. CONCLUSION AND DISCUSSION

In this last section, the findings concerning the results are clarified. Based on these findings the implications for the relevance of this research are discussed. Finally, limitations and recommendations for further research are given.

5.1 Findings

The question upon which this research was built is: ‘What is the effect of assurance towards

sustainability information on the firm value of a sustainability information-issuing company; and to what extent is this effect influenced by the type of audit firm and the country the company is located in?’

This question addresses, besides the increasing mandatory nature of sustainability reporting, the value of receiving assurance towards an organization’s sustainability information. This paper provides new insights as this research covers a multiple years period and includes the distinction between audit firms (non-Big Four versus Big Four). By means of a multiple regression analysis answers were found concerning the three underlying hypotheses.

The statistics from this research do not exhibit the distinct increasing trend in assurance towards sustainability information. The 35 percent which received assurance towards their sustainability information is far-off compared to the 67 percent for the KPMG survey (2017). It must be said that the 67 percent concerned the 250 largest companies in the world. In this research smaller companies were also included.

The results from the regression analysis showed that hypothesis 1 is supported. This means that assurance towards sustainability information has a positive effect on the firm value of a company. This is in line with the literature arguing that assured information is perceived as more credible than non-assured information (Libby 1979; Hodge 2001). Moreover, Beets and Souther (1999) stated that investors are willing to invest more in companies that have beneficial sustainability records since they are committed to sustainability issues. Also, investors valuate a company higher when there is a presence of assurance towards sustainability information, as proved by Brown-Liburd et al. (2014).

The second hypothesis, predicting the interaction effect of the type of audit firm in combination with the issuance of assurance towards sustainability information, is not supported. This is not in line with the academic reasoning used when stating the hypothesis. There is to some extent grounded academic evidence that points in the direction of Big Four firms, and more specifically non-accounting professionals having more expertise in the field of sustainability (Simnett et al. 2009). Moreover, Hodge et al. (2009) found that there are no significant main effects between the different assurance providers, indicating an equal chance for both Big Four and non-Big Four groups to have a higher firm value outcome is this research than the other.

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24 The third and last hypothesis, concerning the moderating effect of the company’s country orientation, is also not supported. There is an opposite effect resulting from the regression analysis. This implies that sustainability assurance for companies in shareholder-oriented countries has a greater positive influence on the firm value compared to companies in stakeholder-oriented countries. This opposite effect could be caused by a general higher level of firm value of companies from these shareholder-oriented countries.

5.2 Implications

The implications for the theoretical foundation are that this study continues to the further knowledge building on assurance towards sustainability information and on characteristics that can influence the relation to the firm value of an organization. The results from the first hypothesis are in line with the reasoning of the agency theory. Stating that assurance reduces the information asymmetry created by the principal and agent (Cuadrado-Baleesteros et al. 2017). Which leads to a higher assessment of the value of a firm (Brown-Liburd, Cohen and Zamora 2014). By studying the moderating effect of the type of audit firm, this research filled a gap within the literature. The stakeholder theory ought to explain the expected higher firm value from companies from stakeholder-oriented countries. However, the results show that there is an opposite effect observable. As mentioned above, a reason for this is not easy to find and will give an incentive for extensive future research.

It can be of practical relevance for companies to know that assurance towards sustainability information indeed provides incremental firm value. In a time where the reporting of sustainability information is becoming more mandatory, the assurance towards this information is rewarding. It thus gives benefits for both the shareholders and stakeholders of a company. On the other hand, where the General Meeting often choose a Big Four firm as their auditor as they provide higher quality (Lawrence et al. 2011), the opposite is true when it comes to the assurance of sustainability information. Where the non-Big Four firms lead to a higher firm value. From a costs perspective, it could thus be more rewarding to choose a non-Big Four audit firm or consultancy firm instead of a Big Four audit firm (Hodge et al. 2009).

5.3 Limitations and recommendations

Whilst interpreting the results, limitations to this research must be taken into consideration. First of all, I would like to address the relatively limited scope of this research. The available resources in this research setup were of a restricted magnitude.

The model used for calculating the firm value (Fazzini & Dal Maso 2016) is just one way of computing the for firm value. Models and measurements used in other studies could potentially have different outcomes in calculating the proxy for firm value.

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25 A problem with cross-section data that has also been stated by Smith (2015) is that in databases some current companies are excluded. Smith (2015) also addresses the issue when two or more databases are combined, some companies fall ‘between the cracks’. These companies then do not overlap in the databases. In this research, this was the case with the databases of the GRI and Compustat. Several companies were not included in one of the two data files.

Potential issues with time-series data are that some companies might be merged in a certain year of the sample period. As was, for example, the case with the Dutch Ahold and the Belgian Delhaize. They merged in the summer of 2016. In this research, the base company was Ahold for 2013, 2014 and 2015. For the year observation of 2016, the equivalent company was the merged Ahold Delhaize.

Another issue might be the classification of the industries. Because there is no single accepted definition of an industry type (Smith, 2015). Another way of grouping the sectors could potentially control the analysis in a different way.

The final limitation given is the ranking of the UK under the shareholder-oriented countries. As previous research proved, the UK starts to show increasing similarities with Europe and accompanying contrast to the US. The UK is one of the countries that is leading the way in corporate sustainability. This could also partly explain the opposite outcome of the third hypothesis, claiming that shareholder-oriented countries have a higher positive influence on the firm value.

Recommendations for future research could be to integrate the scope and level of assurance into the research. When integrating these variables, the characteristics of an assurance report towards sustainability information can be studied, instead of just solely the presence of an assurance statement towards sustainability information.

Another recommendation is to extend or choose other countries, to get a more thorough view on the differences between stakeholder and shareholder-oriented companies. An extension of the number of countries will increase the external generalizability of a comparable research. As for choosing other countries, insight can be obtained on the upcoming trends in sustainability reporting and assurance in for example Japan and Brazil (KPMG 2017).

To better assess whether assurance towards sustainability information indeed affects the firm value of an organization, an experimental research design can be exploited. In such a research two or more groups will separately assess the firm value of a fictional company, that is operating under different conditions.

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APPENDICES

Appendix A: plots for visualizing hypotheses 2 and 3

Figure 3: interaction sustainability assurance with audit firm on for firm value (hypothesis 2)

Figure 4: interaction sustainability assurance with country orientation on for firm value (hypothesis 3)

No Sustainability

assurance

Sustainability assurance

F

irm

valu

e

Non Big Four Big Four

No Sustainability

assurance

Sustainability assurance

F

irm

valu

e

Shareholder oriented Stakeholder oriented

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Perceived value of sustainability assurance; an investor-based view

Combined Master Thesis Accountancy & Controlling