Environmental initiatives and earnings management

Purpose: The purpose of this paper is to provide initial evidence on the association between environmental initiatives and earnings management. Prior literature documents firms participating in environmental initiatives to report relatively stronger financial performance. Moreover, firms with superior performance have been shown to engage in greater levels of earnings management. A natural question that arises is to what extent do firms with environmental initiatives engage in earnings management to report better financial performance? Design/methodology/approach: The study draws on two theoretical frameworks, external monitoring and internal corporate culture, to predict an inverse association between environmental initiatives and earnings management. The authors test this prediction using an earnings management regression model, estimating discretionary accruals using the modified-Jones approach. Findings: The study finds that firms with environmental initiatives exhibit lower earnings management proxied by absolute and income-increasing total discretionary accruals. The authors further find pollution prevention and climate related initiatives to help explain this inverse association. The results imply that firms practising environmental responsibility report better financial performance, with the most likely reason being due to real economic performance rather than through earnings management techniques. Originality/value: This study provides initial evidence on the association between environmental initiatives and earnings management, an area of importance to all stakeholders in a market with increasing interest in corporate environmental performance and its implications.