The impact of carbon risk on real earnings management

Abstract

Carbon risk has aroused widespread concern in society. With the implementation of carbon policy and the development of carbon market, the research on the impact of carbon risk on corporate financial behavior has become an important academic frontier issue. We examine the impact of carbon risk on firms’ real earnings management before and after the Paris climate change agreement, signed by China in 2016. A difference-in-differences model is deployed by using a sample of Chinese A-share listed companies. We find that high-carbon-intensive firms engage in significant upward real earnings management compared to low-carbon-intensive firms to offset the negative impact of carbon risk by conveying the message of good corporate development to investors after signing the Paris Agreement. The above research findings still hold after the robustness tests. Further heterogeneity analyses show that the impact of carbon risk on firms’ real earnings management is greater in the sample of non-state-owned firms. The above impact is more significant in firms with weaker corporate governance, implying that strong corporate governance constrains managers from engaging in real earnings management. Therefore, policymakers and regulators should pay attention to the ‘strategic response’ to earnings management of carbon-intensive firms, taking into account the nature of property rights, corporate governance to reasonably improve the policy design and regulatory direction.