Net zero target: implications for real earnings management

Abstract

Purpose This study aims to investigate the impact of country net zero target commitment on real earnings management (REM) of listed firms in response to global climate change risk. In addition, this study also examines the moderating effect of corporate social responsibility (CSR) on the relationship between country net zero target commitment and REM. Design/methodology/approach This study uses a sample of 249,711 firm-year observations of listed firms across 71 countries from 2011 to 2021. Following prior literature, the authors use four measures of REM: abnormal cash flow from operations, abnormal discretionary expenses, abnormal production costs and the sum of the three aforementioned measures. Findings The authors find that REM is higher in firms headquartered in countries that have committed to a net zero target. Moreover, the authors document that REM activities are less prevalent when firms voluntarily commit to a net zero target and demonstrate high CSR performance. Results suggest that these firms are better equipped to navigate the regulatory changes imposed by their headquarter countries. Research limitations/implications The findings are informative to the firms’ insiders, investors and regulators in relation to the potential risks that arise due to managers’ discretionary choice in using REM as a strategy to achieve both the net zero target preparations and the desired earnings outlook. More importantly, the findings provide insights to investors and analysts in helping them to assess the true value of firms. In particular, many countries are now racing to achieve a net zero target, which may cause economic trade-offs between achieving the net zero target and the financial implications on firms due to these regulatory changes. Originality/value The findings are informative to firms’ insiders, investors and regulators in relation to the potential risks that arise due to managers’ discretionary choice in using REM as a strategy to achieve both the net zero target preparations and the desired earnings outlook. More importantly, the findings provide insights to investors and analysts in helping them to assess the true value of firms. In particular, many countries are now racing to achieve a net zero target, which may cause economic trade-offs between achieving the net zero target and the financial implications on firms due to these regulatory changes.