The Impact of ESG Disclosure ESG Performance and ESG Risk on Audit Fees and Non Audit Fees in the South African Quasi Mandatory Regime
This study analyzes South African JSE-listed firms from 2006 to 2024 and finds that while higher ESG disclosure and performance increase audit fees but decrease non-audit fees, higher ESG risk leads to lower audit fees yet higher non-audit fees, reflecting distinct auditor responses to disclosure quality versus risk exposure in a quasi-mandatory regulatory environment.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
In the modern business world, companies are no longer judged solely on their profits. Investors, regulators, and the public increasingly demand to know how a company treats the environment, how it treats its workers, and how its leaders behave. This broader set of concerns is known as ESG, standing for Environmental, Social, and Governance. When a company shares information about these areas, it is called disclosure; when it actually performs well in these areas, it is called performance; and when it faces potential problems or failures in these areas, it is called risk. Just as a company pays an auditor to check its financial books for accuracy, it now faces pressure to have its ESG claims checked as well. This creates a new question for the financial world: does being open and responsible about these non-financial issues make the cost of getting an audit go up or down? Does it change the price of other services, like consulting, that companies buy from their auditors?
A team of researchers set out to answer these questions by looking at companies listed on the Johannesburg Stock Exchange in South Africa. This region offers a unique setting because its rules for reporting are not strictly forced by law in the traditional sense, nor are they purely voluntary. Instead, companies operate under a "quasi-mandatory" system. They must follow a set of governance codes and explain if they do not, creating a strong pressure to report on these issues without a single, rigid statute forcing every detail. The researchers gathered data from nearly 200 companies over a period spanning from 2006 to 2024. They looked at how much these companies spent on their main financial audits and how much they spent on other services, such as tax advice or sustainability consulting, while measuring the companies' levels of ESG disclosure, performance, and risk.
The study found that when a company provides more detailed information about its ESG activities, the cost of its main audit goes up. This happens because the auditor has to check more ground. Verifying complex data about carbon emissions, labor practices, and ethical governance requires more time and effort than checking a standard balance sheet. The researchers observed that the more a company disclosed, the higher the audit fee became, suggesting that transparency adds a layer of complexity that auditors must navigate. However, the story changes when looking at other services. Companies that disclosed more information actually spent less on non-audit services. It appears that when a company is already transparent and has strong internal systems in place to track these issues, it does not need to hire outside experts as often to help it figure out what to report or how to fix gaps. The clarity of the company's own reporting reduced the need for external advice.
The researchers also examined how a company's actual performance in these areas affected costs. Surprisingly, companies with strong ESG performance paid higher audit fees. This contradicts the idea that good behavior always makes things cheaper and easier. Instead, the auditors seemed to view these strong commitments as a sign of greater complexity. When a company promises a lot in terms of sustainability and ethics, the auditor must work harder to ensure those promises are real and not just words. Consequently, the audit fee increased to cover the extra work required to verify these high standards. Yet, just as with disclosure, strong performance led to lower costs for non-audit services. Companies that were already doing well in these areas did not need to buy as much consulting help, as their internal capabilities were sufficient to handle the reporting requirements.
Finally, the team looked at ESG risk, which measures how vulnerable a company is to problems like environmental fines, labor disputes, or governance scandals. The results here were distinct. Companies with higher ESG risk paid lower fees for their main audits. This suggests that auditors in this specific market have not yet started charging extra for these types of risks in their standard audit fees. The researchers noted that auditors might not be fully integrating these non-financial risks into their traditional pricing models yet. However, the same high-risk companies paid significantly more for non-audit services. When a company faces potential trouble in these areas, it turns to its auditors and other consultants for help to fix the problems, manage the reputation damage, and ensure it meets regulatory standards. The risk itself did not make the main audit more expensive, but it did drive up the cost of the specialized help needed to manage the crisis.
These findings paint a clear picture of how the market for business assurance is evolving in South Africa. Being open and responsible about ESG issues increases the cost of the primary audit because there is more to check, but it decreases the need for expensive outside consulting because the company is already doing the work internally. Conversely, when a company faces high risks in these areas, it does not necessarily pay more for the main audit, but it does pay a premium for the extra help required to clean up the mess. The study suggests that as these reporting requirements become more established, the way companies and auditors price these services will continue to shift, with transparency becoming a key factor in determining where the money is spent.
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