Ethical Transformation: Organisational Integrity through Sustainable Control Systems

By Adam Arian and Ambika Zutshi

Today, socially responsible companies embrace their obligations through corporate social responsibility. However, an organization that truly wants to integrate ethical practices into its daily operations should focus on implementing sustainable control systems (SCSs).

The demand for ethical behaviour and genuine transparency in corporate reporting is rising, calling for concrete actions from corporate leaders. Our study finds that integrating sustainable control systems (SCSs) within management control systems enhances corporate disclosure honesty and integrity (Arian, 2024). This is done by promoting the culture of ethics across every organisational level, reducing the potential for earnings manipulation, and building a valuable intangible asset: trust.

Public demand for integrity in corporate financial and non-financial disclosure has increased significantly since the pandemic. Companies have faced criticism for using non-financial disclosure to capture public legitimacy, painting a rosier picture of their operations than reality warrants.

What are Sustainable Control Systems?

An organisation that truly wants to embed ethical practices into its everyday internal processes needs to look at sustainable control systems (SCSs).

Sustainable control systems are internal processes designed to embed sustainability into the fabric of an organisation (Johnstone, 2019; Beusch et al., 2022). These control systems provide action plans and guidance for aligning employee behaviours with organisational objectives across environmental, economic, and social sustainability dimensions. The premise is to integrate sustainability principles into the structure and operation of organisational control systems that eventually promote social responsibility, minimising environmental damage and improving economic efficiency. Unlike the broader corporate social responsibility (CSR) concept, which includes various voluntary actions addressing social and environmental concerns, SCSs focus on internal organisational systems to integrate sustainability principles.

Earnings Management

Earnings management (EM) refers to the unethical behaviour of corporate executives in manipulating official financial reports to present desired results and meet public or market expectations. These actions result in misleading stakeholders about the actual financial health of the company, its operational stability, and further commitment to sustainability. These behaviours negatively impact the integrity of corporate reports, damage reputation, and diminish stakeholder trust, which can eventually result in substantial legal consequences. Additionally, these unethical behaviours compromise corporate accountability, crucial to sustainability and long-term business growth.

Findings

A study of more than 7,000 US-listed firms between 2007 and 2021 found evidence of positive implications of integrating SCSs within management control systems (Arian, 2024). Firms with solid SCSs mainly show lower earnings manipulation. This reduction in earnings management enhances the quality and transparency of corporate earnings, which is crucial for maintaining investor trust and ensuring long-term financial stability. These firms also demonstrated improved non-financial disclosure behaviours, aligning with the principles of accountability and transparency.

How about Corporate Governance?

While SCSs focus on integrating sustainability principles into operational processes, corporate governance provides the overarching structure that ensures that these principles are upheld throughout the organisation. Corporate governance plays a significant role in the effective implementation of SCSs. Robust governance frameworks emphasise accountability, transparency, and stakeholder engagement, which are essential for enhancing a company’s ethical conduct.

Effective corporate governance promotes a culture of responsibility and ethical behaviour, optimising decision-making processes among managers and positively impacting the structure and effectiveness of the SCS (Arian, 2024). This aligns with the previous research on the positive impact of corporate governance on financial performance and ethical behaviour (Saona et al., 2020). Governance mechanisms, such as independent board oversight and rigorous audit practices, help ensure that SCSs are effectively integrated into the organisation’s strategic core. This integration leads to more accurate and reliable financial reporting and reduces the likelihood of unethical managerial behaviours.

Practical Strategies for Companies

Several practical strategies can be used to effectively implement SCSs that help align sustainable development goals (SDGs) with management policies and practices. The first is to engage stakeholders, such as employees, customers, and suppliers, in corporate sustainable initiatives. These collaborations for commitment to sustainable practices enhance the credibility of corporate disclosure. Secondly, the improvement in financial reporting transparency constructs trust relationships with stakeholders. This can be reinforced via appropriate communications of corporate sustainability efforts, ensuring accurate reflection of corporate performance. Thirdly, aligning management practices with sustainability goals is important. Integrating sustainability objectives into performance measures and reward systems motivates employees at all levels to contribute to the company’s sustainability initiatives. Lastly, strengthening governance frameworks supports the implementation of SCSs. This involves establishing robust structures such as independent board oversight, comprehensive risk management practices, and rigorous audit procedures.

By integrating SCSs into their management control systems, companies can enhance ethical behaviour, improve financial reporting transparency, and achieve better financial outcomes. For instance, companies that effectively integrate SCSs can enhance their corporate reputation, increasing customer loyalty, employee retention, and investor confidence. Transparent and accurate financial reporting builds stakeholder trust. Companies prioritising social sustainability and ethical practices are more likely to attract and retain loyal customers, committed employees, and supportive investors. Last but not least, companies can achieve higher financial stability by reducing earnings management and improving earnings quality. This stability is crucial for sustaining growth and navigating economic uncertainties.

Robust governance frameworks emphasise accountability, transparency, and stakeholder engagement, which are essential for enhancing a company’s ethical conduct.

In conclusion, integrating sustainable control systems within management control systems is critical in enhancing earnings quality and promoting ethical corporate conduct. Strong corporate governance frameworks further reinforce these benefits by fostering a culture of accountability and transparency. As businesses navigate the complexities of the modern economic landscape, adopting SCSs and robust governance practices will be essential for achieving sustainable success and building lasting stakeholder trust.

The key for companies looking to implement these strategies is to start with a clear commitment to social sustainability, engage stakeholders meaningfully, and continuously refine their governance structures to support these efforts. By doing so, organisations can improve their financial performance and contribute to a more sustainable and ethical business environment.

About the Authors

Dr. Adam Arian is a lecturer at the Peter Faber Business School at Australian Catholic University, specialising in corporate sustainability, climate change, management accounting, business strategies, and risk assessment. His research delves into sustainable business practices and effective risk management strategies, significantly contributing to the academic community. Dr Arian’s publications and studies focus on promoting ethical corporate behaviour and transparency. His recent study on aligning management control systems with sustainable control systems offers practical insights for businesses aiming to integrate sustainability into their core operations, ensuring long-term success and integrity.

Prof. Ambika Zutshi holds a Bachelor of Environmental Sciences, a Master of Environmental Management, and a Doctor of Philosophy. Her current research is focused on corporate social responsibility, business ethics, higher education, supply chain management, and stakeholder relationships. She has over 100 publications in journals and book chapters. Ambika is currently an Australasian Associate Editor of The European Business Review, Emerald, and is an editorial board member of The International Journal of Consumer Studies and the Editorial Advisory Board of Management of Environmental Quality.

References

• Arian, A. (2024), “Sustainability and earnings quality: The role of management control systems”, Advances in Management Accounting, forthcoming.

• Beusch, P., Frisk, J.E., Rosén, M. & Dilla, W. (2022), “Management control for sustainability: Towards integrated systems”, Management Accounting Research, Vol. 54, p. 100777.

• Johnstone, L. (2019), “Theorising and conceptualising the sustainability control system for effective sustainability management”, Journal of Management Control, https://doi.org/10.1007/s00187-019-00277-w

• Saona, P., Muro, L. & Alvarado, M. (2020), “How do the ownership structure and board of directors’ features impact earnings management? The Spanish case”, Journal of International Financial Management & Accounting, Vol. 31 No. 1, pp. 98-133.