Carbon Risk and Real Earnings Management

48 Pages Posted: 17 Mar 2021 Last revised: 3 Apr 2021

See all articles by Abu S. Amin

Abu S. Amin

Central Michigan University

Ashrafee T Hossain

Memorial University of Newfoundland (MNU) - Faculty of Business Administration

Tharindra Ranasinghe

American University

Mingyue Zhang

University of Toronto - Rotman School of Management

Date Written: March 1, 2021

Abstract

A growing body of literature finds that firm-level carbon emissions are associated with a number of adverse outcomes such as higher firm risk, lower firm value, higher option premiums to cover downside tail risk, and declines in future profitability. Given these adverse effects, this paper examines whether carbon emissions affect the financial reporting decisions of firms. Consistent with firms attempting to report higher income in periods of high carbon emissions, possibly in the hope of offsetting some of the negativity associated with the latter, we find the carbon emissions and real earnings management (REM) of firms to be positively associated. Providing evidence of a causal link, we find this relationship to have weakened following the largely exogenous event of the 2016 election of President Trump, which significantly decreased the cost of carbon emissions for firms. In cross-sectional tests, we find the relationship between carbon emissions and REM to be stronger (weaker) for firms located in states with more stringent (less stringent) enforcement of environmental regulations. Further, this relationship is weaker (stronger) for firms with stronger (weaker) corporate governance. We also find that the presence of more short-term oriented transient institutional investors exacerbates the association between carbon emissions and REM. The paper contributes to the literature on both the determinants of REM and firm-level consequences of carbon emissions.

Keywords: Carbon risk; climate risk; earnings management; real activities

Suggested Citation

Amin, Abu S. and Hossain, Ashrafee T and Ranasinghe, Tharindra and Zhang, Mingyue, Carbon Risk and Real Earnings Management (March 1, 2021). Rotman School of Management Working Paper No. 3794941, Available at SSRN: https://ssrn.com/abstract=3794941 or http://dx.doi.org/10.2139/ssrn.3794941

Abu S. Amin

Central Michigan University ( email )

329 Sloan Hall
Mt Pleasant, MI Michigan 48858
United States
9897747621 (Phone)
9897746456 (Fax)

Ashrafee T Hossain

Memorial University of Newfoundland (MNU) - Faculty of Business Administration ( email )

St. John's, Newfoundland A1B 3X5
Canada

Tharindra Ranasinghe (Contact Author)

American University ( email )

United States

Mingyue Zhang

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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