In recent years, global companies have moved to enhance their role as good corporate citizens by disclosing Corporate Social Responsibility (CSR) data in their financial accounts and official documents.
Alongside the rise of CSR reporting, many companies have begun to use environmental, social and governance performance (ESG) measures to compensate top executives as part of incentives tied to bonus pay. Meeting targets can lead to a potential $200,000 windfall in extra compensation for some chief executive officers, a new study has found.
A new study, CSR Restatements: Mischief or Mistake?, conducted by Dr Rebecca Bachmann from Macquarie University's
Department of Accounting and Corporate Governance and Associate Professor of Accounting Helen Spiropoulos from the University of Technology Sydney, was recently published in the Journal of Management Accounting Research.
The researchers examined 674 CSR reports, as well as compensation and other data publicly available in 1567 annual reports, from a range of top 500 ASX-listed companies between 2004 and 2020.
CSR reporting is largely unregulated across the globe and annual performance data is typically disclosed voluntarily. Because of this, there is significant variability in how CSR information is reported, leading to criticism that the information provided may be unreliable and inconsistent.
Many countries, including Australia, are in the process of adopting sustainability reporting standards recently issued by the International Sustainability Standards Board (ISSB).
Investigating whether the use of CSR performance measures in CEO compensation contracts is linked with the 'restatements' of CSR performance data, the new research findings suggest that some companies are retrospectively changing the performance data to enable top bosses to meet CSR-related bonus targets.
The irony is striking – what was intended to be a mechanism to drive positive environmental and social change may instead act as an incentive to manipulate sustainability performance.
By making the previous year’s figures look worse than originally reported, it becomes easier to declare that comparative performance has improved in the current year, Dr Bachmann says. Fuelling this behaviour is the current practice of stating CSR-related performance targets in broad terms such as “improve gender diversity” or “decrease workplace injury rates”.
"Assume a company reports its gender diversity is at 30 per cent in 2022," Dr Bachmann says.
"A year passes and in 2023 the firm now says it has changed the way it measures gender diversity and as a result restates the figure for 2022 to be 20 per cent instead of the originally reported 30 per cent.
"By making the 2022 performance look worse, it becomes easier to claim that an improvement in gender diversity occurred in 2023. So, if the 2023 gender diversity target now sits at 25 per cent, the company can say that it has improved the target from 20 per cent the previous year, when in reality it would have decreased by five per cent if the 2022 target hadn’t changed.
"The irony is striking – what was intended to be a mechanism to drive positive environmental and social change may instead act as an incentive to manipulate sustainability performance."
Reliability in reporting
The new research findings show that CEO bonus contracts with CSR targets saw an increase in the likelihood of restatements, particularly when social performance measures are included in CEO compensation contracts. The inclusion of CSR performance measures in CEO compensation contracts could create an incentive to invest in more accurate CSR measurement systems in the future, authors say.
“Currently, there is significant discretion in how ESG performance is measured and reported, and one way to show improved performance in the current year, is to adjust, or restate, last year’s score to reflect worse performance relative to this year,” says Associate Professor Spiropoulos.
“If restatements were due to errors or improvements in measurement systems, there should be no bias in the direction of restatements – they could make performance look better or worse.”
Of the total line-items restated, almost 70 per cent were due to measurement change, whereas only 15 per cent were a correction of a previous error.
- More solar panels needed on rented rooftops
- Managers need menopause training to protect profits and retain women in senior jobs
The new study found firms which include sustainability targets within the CEO’s compensation contract on average attribute 16 per cent of bonus pay towards these targets, meaning that meeting a performance target related to CSR can boost the CEO’s bonus by $200,000 on average.
Overall, the results suggest that compensation provides an incentive to manipulate CSR performance by making retrospective changes to the way CSR metrics are measured, and that CEOs’ bonus compensation is higher in the presence of restatements that improve the current year’s performance.
Dr Rebecca Bachmann is a Lecturer in the Department of Accounting and Corporate Governance at Macquarie Business School.
Helen Spiropoulos is an Associate Professor of Accounting at University of Technology Sydney.
