Greenhouse gas emissions and quality of financial reporting: evidence from the EU

Purpose - Our study delves into the association between greenhouse gas (GHG) emissions and the quality of financial reporting. Our investigation focuses on understanding how firms’ GHG emissions would impact discretionary accruals and real earnings management. We also test the moderating role of a large board size, and CEO as a board member. Finally, we conduct various robustness checks to ensure the robustness and validity of our findings. Design/methodology/approach - We conducted a study on 476 European companies across 17 countries and various industries between 2005 and 2018. We use panel data estimations, and multiple methods to account for emissions and address endogeneity issues in our tests. Findings - Our findings indicate that greenhouse gas emissions increase earnings management, as measured through discretionary accruals and real earnings management. This leads to lower quality financial reporting. We also find that a larger board size moderates the relationship between GHG emissions and financial reporting, resulting in greater financial transparency. Research limitations/implications - Our findings provide evidence that firms’ GHG emissions, despite stricter emission regulations in the European Union (EU), would be positively associated with real earnings management. This finding calls for more research in different regions to understand if this is a global trend. Practical implications - Our results have important implications for financial reporting, corporate governance, and climate change mitigation. For example, high GHG emissions not only indicate polluting firms but might also serve as a signal for identifying firms engaged in earnings management. Originality/value - Although previous research has examined the relationship between greenhouse gas emissions and the financial performance of firms, to the best of our knowledge, no prior study has investigated whether firms’ GHG tends to manipulate their financial reporting. We also contribute to the literature regarding the determinants of the quality of financial reporting through earnings management literature. Lastly, we provide novel evidence from the EU area, where strict EU climate policy should have affected financial reporting.