Climate Change Risk and Earnings Management

This study provides firm-level evidence to support and augment existing country-level evidence that firms with higher climate change risk (CCR) are more likely to manipulate their earnings. Using a novel, text-based measure of firm-level risk, developed by Sautner et al. (2023), and a large sample of US firms from 2002 to 2022, we demonstrate that firms with higher CCR exhibit greater accruals-based (AEM) and real earnings management (REM), which both result in smoother earnings and are associated with a reduction in stock price volatility and analyst forecast dispersion. While AEM has no observable effect on firm value, REM has a significant negative association with firm value, whatever the level of CCR. However, the practice is negatively affected by the inclusion of equity-based CEO compensation. This particular finding is valuable for investors, who influence executive pay and likely wish to discourage firms from adopting value-destroying strategies to boost current earnings.