Environmental performance, carbon performance and earnings management: Empirical evidence for the European capital market

Abstract

The purpose of this study is to examine the relationship between environmental performance, carbon performance and earnings management. This analysis includes panel regressions as empirical‐quantitative (archival) research methods and looks at the 2014–2018 financial years of companies listed on the STOXX Europe 600 (1,509 firm‐year observations). Environmental (carbon) performance proxies are included as independent variables, and with two earnings quality measures, accrual‐based earnings management (ACC) and real earnings management (REM) as dependent variables. Our findings align with prior research on sustainability performance and indicate that environmental (carbon) performance reduces ACC but increases REM. After including Granger causality tests, we find no indications of a bidirectional relationship. This analysis makes a key contribution to prior studies as this appears to be the first on the relationship between environmental (carbon) performance and earnings management in the European capital market. The study has major implications for business practice, regulators and research. Managers might use environmental and carbon strategies for greenwashing policies as this change in earnings management can be hardly detected by other stakeholders.

Climate change mitigation: Carbon assurance and reporting integrity

“…Our contribution lies in the evidence regarding the relationship between carbon assurance, as a specific form of sustainability assurance, and earnings management. Our study also extends Velte (2021) who explores the impact of carbon performance on earnings management, albeit in a regulated context, and Bui, Moses, and Houqe (2020) by focusing on assurance of carbon disclosure. Overall, by providing evidence of carbon‐related governance and carbon disclosure on earnings management, our study adds to the understanding of the relationship between firms' carbon management decisions and financial reporting quality.…”

Firms and climate change: a review of carbon risk in corporate finance

“…Moreover, Lemma et al [48] confirm that South African firms with higher carbon risk exposure (carbon intensity) tend to engage in earnings management activities, thus reducing financial reporting quality. Supported by agency theory, Velte [49] finds that carbon performance reduces accrual-based earnings management (ACC) but increases REM. The author argues that managers use carbon strategy as a device to mask earnings behaviour and tend to adopt a hidden earnings management policy by shifting from ACC to more opaque REM.…”

Do shareholders reward or punish risky firms due to CSR reporting and assurance?

“…Although CSR disclosure constitutes a signal or orientation toward sustainable and ethical practices, the proliferation of nonfinancial information has been criticized by investors (Dumay et al, 2015). In recent years, several organizations with prior experience in CSR reporting have been involved in environmental and social scandals (Casonato et al, 2019; Velte, 2021). In this sense, the rise of new phenomena, such as greenwashing, sustainable development goals washing, and impression management, has prompted new reflections on the legitimacy effects related to the disclosure of nonfinancial information (Dumay et al, 2015; Wang et al, 2018).…”