How Sustainability Audits Impact Audit Effort Choices

We analyse how the introduction of mandatory audits of sustainability reports conducted by the auditor of the financial report changes audit effort and quality choices. In our model, the auditor decides on effort allocation between a financial audit and a sustainability audit. Our analysis reveals that, in a competitive market, legislators may not consistently drive higher financial (sustainability) audit efforts solely through increased litigation payments for financial (sustainability) audit errors. Based on the cost structure, there exists either a substitutive effect or a complementary effect; that is, increasing litigation for errors in the financial audit increases the financial audit effort while simultaneously increasing or decreasing the sustainability audit effort and vice versa. In both scenarios, an overall improvement in audit quality is observed with increased litigation. We extend our analysis to a two-provider setting, where the above results hold structurally under some conditions. The overall audit quality can be higher or lower than in the one-provider setting. These findings represent novel insights not previously explored in the existing literature.