Corporate responses to political costs: an examination of the relation between environmental disclosure and earnings management

Abstract

This study examines the relation between the level of pre-event environmental disclosure and the extent of earnings management in response to regulatory threat. This issue is examined within the context of the earnings management response by intra-industry firms following the December, 1984 chemical leak at Union Carbide’s Bhopal, India plant. The analysis finds that a sample of 40 US chemical firms exhibited significant negative discretionary accruals for 1984. Furthermore, companies with higher levels of pre-event environmental disclosures in their 10-K reports tended to take less negative discretionary accruals. These results are consistent with the argument that corporate management believes environmental disclosure is an effective tool for reducing exposure to potential regulatory costs and that decisions to manipulate earnings are tied to a larger corporate strategy for dealing with political pressures.