Without the use of third-party auditors in carbon reporting, companies report lower, but unreliable, emissions

New MIT Sloan research, based on Clarity AI data, finds that companies that don’t receive external assurance are not actually making carbon emissions reductions despite setting targets, and furthermore, even small companies should have third party audits

Cambridge, MA, March 26, 2024 — Before companies even think about planning to reduce their carbon emissions, there’s an important first step that many are missing: getting third party validation of their reporting. Accurately reported carbon emissions are a critical indicator for actually reducing climate impacts. 

In new research based on data from Clarity AI — a global sustainability tech platform — Florian Berg, research scientist at the MIT Sloan School of Management, Jaime Oliver Huidobro, lead data scientist at Clarity AI, and Roberto Rigobon, professor at the MIT Sloan School of Management, found that companies that verify their emissions by third-party auditors initially demonstrate higher carbon emissions (13.7%) and intensities (9.5%) — but ultimately make more reductions in the future — than those that do not externally verify their data.

“While Science Based Target initiatives (SBTi) alone do not signal carbon dioxide emission reductions, we found that obtaining assurance from third-party auditors does correlate with cutting back on CO2 emissions in the future,” said Berg. “For investors seeking to invest sustainably in businesses genuinely seeking to transition to low-carbon business models, an important indicator is whether they externally verify their emissions.”

Engaging in emissions auditing is crucial for companies to accurately measure their CO2 emissions and make strides in reducing their future carbon intensity. Only those companies that verify their emissions demonstrate a significant and economically meaningful decline in their absolute emissions and carbon intensity over time — the analysis included more than 30,000 listed companies and leveraged Clarity AI machine learning models to impute data. Total emissions amongst this group declined by 7.5% year-over-year, while their carbon intensity declined by 3.3% year-over-year.

Companies that do engage third-party auditors, while they may show higher current emissions, take actionable steps to reduce their future carbon emissions. This indicates that companies that pay for third-party assurance signal to stakeholders and distinguish themselves from companies that seem to not have any intentions to reduce carbon emissions. However, the setting of SBTi— which define and promote best practices in emissions reductions and net-zero targets in line with climate science — themselves may not be useful to those seeking to invest in the low-carbon transition.

“Accurate and actionable data are becoming increasingly crucial for regulators and investors, but this research shows the underlying data can be unreliable,” said Oliver. “As regulation catches up with the industry, AI tools, combined with human expertise, will be essential for fund managers to allocate investment capital towards companies making material changes to make their business more sustainable.”

Smaller companies are just as responsible as larger organizations for reporting accurate emissions, for these numbers impact future reduction efforts and investor relations. Smaller companies that do not verify their emissions might use more favorable assumptions based on efforts to reduce them in the future, which can have important implications for fund managers and ESG raters — taking unaudited reported carbon emissions at face value will penalize companies serious about their carbon reductions in the long run.

As such, Berg, Oliver, and Rigobon call for mandatory assurance, even for smaller companies. The lack of an accurate, regulated reporting system interferes with retaining an accurate sense of emissions, for those that obtain assurance for their carbon emissions report on average a 9.5% higher carbon intensity than peers without assurance. As opposed to those who do not audit their emissions, companies that provide accurate emissions reporting actively set appropriate targets and reduce their future emissions.

“These findings make regulations such as the Securities and Exchange Commission climate disclosure rule or the Corporate Sustainability Disclosure Regulation in Europe— both  requiring companies to disclose emissions — important for investors to compare emissions data across companies,” said Oliver. 

“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, working to reduce carbon emissions will forever be an impossible hurdle,” concluded Berg.