Companies with strong environmental, social and governance (ESG) track records tend to perform better than their peers after being required to adopt stricter auditing standards, according to a new study from researchers at Nagoya University. The research is the first to directly examine the relationship between companies’ sustainability practices and the introduction of “key audit matters” (KAMs), a transparency measure designed to give investors clearer insight into corporate risks.

ESG refers to the environmental, social and governance criteria increasingly used to assess how responsibly companies operate. Strong ESG performance signals long-term commitment to sustainability, ethical oversight and stakeholder engagement, qualities that investors often associate with higher organisational quality. As global markets place growing emphasis on transparency and accountability, ESG performance has become an essential factor shaping how firms are evaluated.

In 2015, the International Auditing and Assurance Standards Board recommended that auditors disclose KAMs, defined as the most significant issues identified during an audit. The goal was to improve the usefulness of audit reports by helping investors better understand a firm’s financial and operational risks. In Japan, companies with high ESG scores generally paid higher audit and consulting fees after KAMs were introduced, reflecting more intensive scrutiny. However, these same firms also outperformed their peers in both accounting and market-based measures.

Co-author Hu Dan Semba, Associate Professor at Nagoya University’s Graduate School of Economics, emphasised that transparency alone does not create trust. Paying for more expensive audits does not automatically enhance credibility, he explained. Still, when firms have already demonstrated a genuine commitment to sustainability, transparent auditing strengthens that signal and is rewarded by the market.

Japan offered an obvious setting to study these dynamics. Publicly listed firms were allowed to voluntarily adopt KAM reporting in fiscal year 2019, one year before it became mandatory in 2020. This created what researchers describe as a natural experiment, enabling them to observe which firms chose early adoption, what it cost them and how they performed afterwards. The research team analysed data from 1,065 Japanese firms between 2009 and 2023.

Only twenty-four non-financial firms opted for early adoption, but those that did were significantly more likely to have strong ESG scores. According to the researchers, volunteering to disclose KAMs before it was required suggested confidence in the underlying corporate quality. These companies did incur higher audit and non-audit fees during the early phase, mainly due to more rigorous examinations and additional advisory work to address issues uncovered by auditors.

The study also points to cultural factors that may help explain this behaviour. Drawing on scholarship on Japanese business traditions, the authors suggest that voluntary transparency aligns with the concept of “sanpo-yoshi”, a principle developed by Omi merchants that stresses mutual benefit for sellers, buyers and society. Notably, firms that adopted KAMs early paid lower audit fees once disclosure became mandatory, suggesting that early transparency enabled them to identify and manage risks more efficiently.

From 2020 to 2023, companies with higher ESG scores showed stronger accounting performance and market returns following the implementation of mandatory KAM. While transparency appeared to improve overall firm performance, the effect was clearly more substantial for sustainability-focused firms. As KAM reporting becomes more widespread internationally, the findings suggest that companies with established ESG practices are best positioned to benefit from stricter transparency requirements. The results were published in the Managerial Auditing Journal.

More information: Maretno Agus Harjoto et al, Sustainability and financial disclosure: role of ESG in key audit matters adoption, Managerial Auditing Journal. DOI: 10.1108/MAJ-01-2025-4663

Journal information: Managerial Auditing Journal Provided by Nagoya University