Companies that submit to an audit see their emissions rise. And that’s OK

How can investors accurately identify which companies are making true progress in reducing carbon emissions?

In a confusing era of greenwashing accusations, inconsistent ESG indexes and ratings, and a move by the U.S. Securities and Exchange Commission to pause implementation of its climate disclosure rules, MIT researchers have identified an important indicator for likely long-term emissions reductions: third-party auditing.

They found that companies that opt to verify their emissions via third-party auditors initially have higher carbon emissions and intensities than their peers. However, they ultimately make more reductions compared with companies that don’t audit.

This is important news for companies that genuinely want to reduce emissions and for investors who want to back businesses making a serious commitment to low-carbon business models.

“Sometimes, investors focus a little bit too much on the number of CO₂ emissions, and that’s not useful. Instead, they should look at how the company actually plans to reduce CO₂ emissions,” said Florian Berg, a research scientist with the MIT Sloan Sustainability Initiative. Enlisting outside assurance is one indication of serious intent, he said.

To reach their findings, the researchers used data from 2016 to 2021 from the global sustainability tech platform Clarity AI that was culled from 30,000 of the world’s largest companies reporting emissions data. Berg conducted the research with study co-authors Jaime Oliver Huidobro, lead data scientist at Clarity AI, and MIT Sloan professor Roberto Rigobon.

Here are four key takeaways from their research paper, “On the Importance of Assurance in Carbon Accounting”:

With accurate data comes accurate reduction. Companies that use independent auditors exhibit significant emissions declines, despite initially higher emissions totals. Among this cohort, total emissions declined by 7.5% year over year, and carbon intensity declined by 3.3% year over year.

“The really interesting part is that those companies choose to obtain assurance, so most likely they’re good players — and even the good players discover that their absolute emissions are initially at least 13.5% higher than previously anticipated, and their carbon intensities are an average of 9.5% higher,” Berg said.

Third-party auditing conveys seriousness about emissions reduction. Investor perception matters, and those companies that provide accurate emissions data, even if it’s unflattering, go on to set appropriate targets and reduce their future emissions.

“It’s a signal,” Berg said. “You’re only going to obtain assurance as a company if you’re a leader in showing that you’re taking CO₂ emissions seriously. We saw that self-selection here means that companies that verify and obtain assurance also seem to, on average, reduce CO₂ emissions more than anyone else, even those companies that set explicit SBTi targets.”

The Science Based Targets Initiative encompasses corporate emissions-reduction goals aimed at limited global warming, covering direct and indirect emissions. Adopting them can signal commitment, but Berg said that the pledge can be hollow without auditing. “It can be a marketing thing,” he said.

Third-party auditing focuses on the now, not the future. Berg explained that many companies have committed to net-zero targets. However, “if the target is set for 2040 or 2050, that’s a long time from now. The company might actually be happy to have a target, but that’s not really reducing emissions” with accuracy in the short term, he said.

Adding auditing to the mix offers immediate accountability.

“The most important thing is, does the company make a serious effort to change operations, to change the way they work to really reduce CO₂ emissions in the long run?” Berg asked. Investors can use assurance as a signal to identify firms that are serious about reducing their CO₂ emissions, he said.

Smaller companies need audits too. The researchers found that smaller companies that don’t verify their emissions might project favorable assumptions based on future plans to reduce emissions. Their intentions might be good, but investors should beware: Fund managers who prioritize unaudited reported carbon emissions could end up overlooking companies that are serious about their carbon reductions in the long run, and this applies to companies of all sizes.

“It makes sense to also include smaller companies in the scope of companies that need to obtain assurance for their carbon emissions. Without accurately reported data from all companies, comparing firms will be an impossible hurdle,” Berg said.

The bottom line?

“Just because a company reports higher CO₂ emissions, that doesn’t mean it’s actually a worse player,” Berg said. “Since emissions assurance is voluntary, companies that engage it in are most likely good players. Setting targets is marketing; getting third-party assurance reveals intent.”

Read next: 3 ways tech leaders can help companies reduce emissions