The two sides of corporate social responsibility and the quality of internal control audit opinions

• Published date: 01 January 2024
• Author: Belen Blanco,Encarna Guillamón‐Saorín,Andrés Guiral
• Date: 01 January 2024
• DOI: http://doi.org/10.1111/ijau.12328

ORIGINAL ARTICLE

The two sides of corporate social responsibility and the quality

of internal control audit opinions

Belen Blanco

1

| Encarna Guillam

on-Saorín

2

| Andrés Guiral

3

1

The University of Adelaide, Adelaide,

Australia

2

Universidad Carlos III de Madrid, Getafe,

Spain

3

Yonsei University, Seoul, South Korea

Correspondence

Andrés Guiral, Yonsei University School of

Business, 50 Yonsei-ro, Seodaemun-gu, Seoul

120-749, South Korea.

Email: andres.guiral@yonsei.ac.kr

Funding information

Belen Blanco acknowledges financial

assistance from the Spanish Ministry of

Innovation and Science (Grant Number:

ECO2013-48328 and ECO2016-77579) and

the research support from The University of

Adelaide. Encarna Guillam

on-Saorín

acknowledges financial support from the

Spanish Ministry of Innovation and Science

(Grant Number: ECO2013-48328 and

ECO2016-77579) and the Madrid

Government Region (Grant Number: S2015/

HUM-3417).

Although corporate social responsibility (CSR) activities provide a strong signal of

management integrity, the involvement of the client in irresponsible CSR should alert

the auditor to the risk of material misstatement. Framing management integrity

assessments by relying on responsible CSR activities can lead to auditors' unintended

alignment with their clients' preferred outcomes. Motivated by the increasing fre-

quency of clean internal control opinions (ICOPs) regarding clients that subsequently

misstate, we explore whether auditors' overreliance on responsible CSR influences

the quality of ICOPs. We find that clients' CSR involvement is associated with fewer

adverse ICOPs, but this CSR effect is asymmetric because it is only explained by

responsible CSR activities and not by irresponsible CSR activities. Importantly, the

‘good side of CSR’is associated with fewer adverse opinions being issued to mis-

stated clients. Additional analyses show that only irresponsible CSR activities

increase the risk of financial misstatements. Our findings provide support for the

Public Company Accounting Oversight Board's warning that certain conditions

inherent in the audit environment, such as the assessment of management integrity,

can lead to auditors unconsciously favouring confirming evidence (represented by

responsible CSR activities) instead of relying on disconfirming evidence (represented

by irresponsible CSR activities) that could raise issues about management's integrity

and ethical commitment.

KEYWORDS

corporate social responsibility, internal control opinion, irresponsible activities, misstatements,

Type II error

JEL CLASSIFICATION

M41, M42

1|INTRODUCTION

Section 404(b) of the Sarbanes–Oxley Act (SOX) requires auditors to

attest to and report on the management's assessment of its internal

control's effectiveness (Gal & Akisik, 2020). However, both the US

Securities Exchange Commission (SEC) and the Public Company

Accounting Oversight Board (PCAOB) have publicly expressed con-

cern regarding auditors' systematic failure to identify and report inter-

nal control material weaknesses, potentially leading to a reduction in

adverse internal control opinions (ICOPs) (PCAOB, 2012a;

SEC, 2009). Studies show a low rate of adverse ICOPs together with

an upward trend in the frequency of clean ICOPs regarding companies

that subsequently misstate, that is, Type II errors (DeFond &

Lennox, 2017).

Previous research finds that a client's engagement in corporate

social responsibility (CSR) constrains earnings management and

maintains transparency in financial reporting (Guo et al., 2016; Kim

et al., 2012). Although CSR generally signals management integrity

Received: 30 October 2021 Revised: 25 June 2023 Accepted: 14 July 2023

DOI: 10.1111/ijau.12328

226 © 2023 John Wiley & Sons Ltd. Int J Audit. 2024;28:226–250.wileyonlinelibrary.com/journal/ijau

and ethics, a negative association between CSR involvement and

ICOPs does not necessarily imply improved audit quality. Indeed, the

PCAOB (2012b) has warned that certain conditions inherent in

the audit environment can lead to unconscious bias that may cause

auditors to process information to accommodate the client's prefer-

ences rather than the interests of external users. In particular, the

assessment of management integrity can lead auditors to uncon-

sciously favour confirming evidence (represented by responsible CSR

activities) instead of relying on disconfirming evidence (represented

by irresponsible CSR activities)

1

that could raise issues about the

management's integrity and ethical commitment (Doty, 2013;

PCAOB, 2013,2016).

Audit Analytics (2019) provides descriptive evidence of the dra-

matic decline in adverse opinions during 2004–2010. Its report shows

that the highest percentage of adverse opinions occurred in 2004

(15.9%) and was at its lowest point in 2010 (3.5%). After the PCAOB

increased its scrutiny of internal control audits from 2010, auditors

responded by increasing the issuance of adverse ICOPs to 6.7% in

2016. However, the number of misstated companies with clean ICOPs

announcing subsequent restatements remains very high (DeFond &

Lennox, 2017; Rice et al., 2015). DeFond and Lennox (2017) find that

the Type II error rate consistently grew from 80.1% in 2005 to 96.2%

in 2010. This evidence is interpreted by both regulators and the

accounting industry itself as a lack of professional scepticism (Center

for Audit Quality, 2010; PCAOB, 2008).Auditing standards also

emphasize that, when assessing a client's control environment,

auditors must evaluate management integrity and ethical values to

assess source credibility relating to client-supplied evidence (Asare

et al., 2013). A lack of management integrity should strongly influence

auditors' judgments (Hurtt et al., 2013) and alert them to potential

financial misstatements (Kizirian et al., 2005). A client's involvement in

irresponsible CSR activities is positively associated with increased

audit fees and higher risks of financial misstatement and adverse

financial performance (Frost et al., 2022; Garcia et al., 2021; Koh &

Tong, 2013). Thus, the client's involvement in irresponsible CSR activi-

ties, that is, the ‘bad side of CSR’, should draw the attention of audi-

tors critically assessing the potential presence of material weaknesses.

In this regard, irresponsible CSR activities are likely to be a strong sig-

nal of poor management integrity, and, hence, it should be weighted

by auditors when assessing their clients' internal controls.

Auditors may use biased information evaluation and processing

to justify more lenient audit outcomes when client pressure motivates

them to reach client-preferred audit conclusions (Cohen et al., 2022;

Piercey, 2011). Archival and behavioural research has shown that

auditors facing client pressure are prone to confirmation bias, that is,

the tendency to assign more weight to confirming evidence than to

disconfirming evidence related to client-preferred outcomes (Cassell

et al., 2022; Guiral et al., 2011). In this paper, we investigate whether

framing management integrity assessments using CSR activities can

lead to the auditors' unintended alignment with their clients' preferred

outcomes by overweighting responsible CSR activities and suppres-

sing the sceptical consideration of the bad side of CSR, that is,

observed irresponsible outcomes that are likely to signal the risk of

material misstatement.

2

To do this, we follow the theory that respon-

sible and irresponsible CSR actions are different and independent

because a company can take a responsible CSR action and also an

irresponsible CSR one (Garcia et al., 2021; Mattingly &

Berman, 2006). Environmental, social and governance (ESG) rating

agencies consider responsible and irresponsible CSR scores separately

and relate them to different scopes and actions that drive different

stakeholders' reactions (Jia et al., 2022). Thus, we consider responsible

and irresponsible CSR as independent constructs rather than

opposite ones.

Using a sample of US firms between 2004 and 2016 and consis-

tent with confirmation bias, we document that the negative associa-

tion between clients' CSR involvement and ICOPs is explained only by

the ‘good side of CSR’, but not by its bad side, creating a CSR asym-

metry effect, particularly for less-auditable company-level material

weaknesses. Finally, our findings suggest that this CSR asymmetric

effect is associated with poor audit quality in terms of issuing fewer

adverse opinions to clients that subsequently restate a concurrent

misstatement. Additional analyses show a significant positive associa-

tion between the bad side of CSR and the risk of a future restatement,

which rules out the alternative explanation of a negative association

between the good side of CSR and subsequent financial restatements.

This evidence suggests that the good side of the auditor's client

involvement in CSR can negatively affect the quality of ICOPs.

We add to the auditor ICOP literature by providing evidence that

auditors can be prone to overreliance on responsible CSR information

to justify client-preferred audit outcomes. Second, our study responds

to a call for further research to explore how the assessment of man-

agement integrity can reduce auditors' scepticism when assessing

material weaknesses (Asare et al., 2013). Third, we propose the impor-

tance of examining the client's responsible and irresponsible activities

separately to better explain the mechanisms through which CSR

inputs and CSR outcomes can influence auditors' decisions to issue

an adverse ICOP. Together, our findings provide support for the

PCAOB's warning that certain conditions inherent in the audit envi-

ronment, such as the assessment of management integrity, can lead

auditors to unconsciously favour confirming evidence (represented by

responsible CSR activities) instead of relying on disconfirming evi-

dence (represented by irresponsible CSR activities) that could raise

issues about the management's integrity and ethical commitment.

2|BACKGROUND AND HYPOTHESIS

DEVELOPMENT

2.1 |Management integrity assessments: The

good and bad sides of CSR

Management integrity assessments should strongly influence auditors'

judgments (Hurtt et al., 2013) and alert them to potential financial

misstatements (Kizirian et al., 2005).

3

Professional scepticism requires

auditors to frame their management integrity assessments regarding

managers' potential dishonesty (Bowlin et al., 2015). A lack of

BLANCO ET AL.227