July 1997

Social Auditing: Oxymoron or Wave of the Future?

by Curtis C. Verschoor and Jon H. Entine

It is difficult to believe that a certified New Age model of "caring capitalism" like Wild Planet Toys could have anything in common with the hard-nosed folks that run British Telecom. But they do. Both are experimenting with one of the trendiest of trends in corporate governance, social auditing.

In fact, more than a dozen companies are drawing up or in the process of implementing a social audit of the impact of their business on stakeholders. The motivation is only partly altruistic; most of these companies have come to the conclusion that businesses that understand their impact on key stakeholders can mold a healthier, more productive corporate culture. In other words, a regular social audit can actually strengthen the bottom line.

Major corporations in the US first began considering social audits in the 1970s, mostly as a response to the nascent consumer and environmental movements. Business faced attacks for allegedly turning out unsafe consumer products or dumping pollutants. Consultants like Abt Associates applied a rudimentary mixture of cost accounting and stakeholder theory to corporations like Shell Oil, General Mills, Bertelsman AG and Bank of America. The public disclosure aspects were viewed largely as a by-product. Major corporations soon abandoned social audits due to difficulty in quantifying social aspects of corporate behavior and a lack of consensus about what to measure.

In the past decade, however, there has been a resurgence of interest in social auditing driven by the so-called 'green business' and 'ethical investment' communities that come to prominence with highly publicized boycotts of firms doing business in South Africa. The net of corporate social performance criteria has expanded to include issues like diversity, philanthropy, community service and the environment.

Ben & Jerry's Homemade, a vocal leader of the New Age entrepreneurial business community, is the highest-profile US company to employ social auditing concepts . Ben & Jerry's annual social study has gone through several iterations under several consultants, most notably Paul Hawken. In 1995, professing to want a more structured and quantitative approach, Ben & Jerry's retained the London-based New Economics Foundation (NEF) to conduct its version of a social audit.

NEF has developed social audit methodology based primarily on stakeholder surveys, focus groups and interviews. Its strategy encourages a company to create specific measurement criteria. In this way, a company can monitor its progress in meeting the goals or "social mission" it sets for each stakeholder group. This helps to identify critical social and ethical information needs of management and stakeholders generally. These corporate "best practices" also help facilitate what has been called "ethical strategic planning."

In the past year, NEF established The Institute of Social and Ethical Accountability, which is designed as a central resource for social auditors. The Institute is debating standards for ethical reviews and for credentialing reviewers, and is joining with the European Institute for Business Ethics to sponsor the First Euroconference on Social and Ethical Accounting, Auditing and Reporting this fall.

Although pioneering, the NEF stakeholder survey approach has drawbacks. It does not measure actual ethical behavior so much as stakeholder perceptions. Its verification statement is based on the financial statement opinion expressed by public accountants and has limited usefulness to stakeholders. The one-sentence 66-word standard opinion on the completeness of the report it has helped a company prepare is confusing, may contain many qualifications and does not describe specific verification procedures.

Additionally, there is a serious question whether NEF's wide-ranging responsibilities, from conducting surveys and focus groups for the client to summarizing and interpreting and disclosing results is consistent with serving as independent verifier of the overall report. Ben & Jerry's says that these and other issues prompted it not to renew its contract with NEF for 1996.

The most critical weakness in the approach of NEF and most other social audits is the lack of emphasis on corporate governance and control systems designed to provide assurance that high-minded codes of conduct serve more than just a public relations function. A social audit should review the corporate culture including the effectiveness of codes of conduct. Because of efforts to "flatten" organizations by empowering individuals instead of relying on traditional hierarchical control systems, a resilient ethical culture emphasizing teamwork and goal congruence is becoming even more important.

To date, there are approximately a half dozen social audit models that have been or are currently in use:

• social balance sheet which prevailed in the 1970s;

• social performance index similar to ethical investment scorecards which assign rankings or numerical ratings to social issues;

• independent social assessments such as the early Ben & Jerry's reviews or "The 100 Best Companies" series;

• stakeholder surveys, a dimension of the NEF approach;

• benchmarking by objectives, also employed by NEF and more commonly in environmental audits;• disclosure reports which evaluate companies on their disclosure of critical information of stakeholder concern.

Social researchers at the University of Quebec at Montreal led by Leo Paul Lauzon have pioneered a ‘disclosure’ screen that has been voluntarily adopted by some nonprofits and corporations and has been endorsed by the Certified Management Accountants Association of Canada.

Corporations may be well served to carefully consider which of the various approaches, individually or in tandem, are best suited to address their internal needs and public disclosure objectives. It is imperative that a social audit go beyond a review of a company's stated mission. A successful social audit requires a company to demonstrate its commitment to publicly disclose information about company operations and its responsiveness to solve problems uncovered by the audit. There are also indications that management emphasis of ethical qualities as an important part of a company's governance and control structure is strongly and positively associated with measures of corporate performance in both financial and non-financial dimensions. Most critically, a social and ethical evaluation should appraise the effectiveness of control mechanisms, how the company monitors its ethical compliance and whether an independent corporate board exercises ethical oversight.

Dr. Curtis C. Verschoor is Ledger & Quill Research Professor in the School of Accountancy at DePaul University, Chicago