Sustainability performance and earnings management: institutional and regulatory perspectives

This study investigates the effect of companies sustainability performance on their future earnings management. Applying moral licensing theory, we predict that sustainability performance decreases accruals, while increases real earnings management. We analyse a dataset comprising of 47,186 firm-year observations from 44 countries during 2002-2021. We use a two-stage Heckman approach to address potential endogeneity and conduct supplementary fixed-effects regression tests for separate periods of before-after crisis and regulatory effectiveness, quality and enforcement. Our findings suggest that firms with superior sustainability performance have an impact on decreased (increased) accrual-based (real) earnings management. We also found a greater impact of sustainability initiatives by companies in countries with lower regulatory effectiveness, lower regulatory quality standards, and mandatory government regulation. This study is the first in encompassing SDGs practices through advanced testing, analysis and offering insights into the implications of government regulation on management decisions on earnings. Our research provides practical contributions for policymakers to evaluate ongoing efforts and development of corporate ESG-related policies as well as investors in using earnings information. © 2024 Elsevier B.V., All rights reserved.