Companies with high greenhouse gas emissions more likely to manipulate finances

A new study investigating the relationship between greenhouse gas (GHG) emissions and financial reporting quality has found that high-polluting firms are more likely to lie about their earnings to offset climate-related costs.

The research, published in Journal of Applied Accounting Research, examined the financial risks associated with climate change regulations, such as the European Green Deal and the EU Emissions Trading System. It found that as companies face increased costs in transitioning to low-carbon operations, they may engage in earnings manipulation to present a stronger financial position.

A total of 476 European companies across 17 countries and various industries were analyzed between 2005 and 2018. The findings demonstrate the critical implications for corporate governance, regulatory policy, and climate change mitigation.

“High greenhouse gas emissions not only shine a light on polluting firms, but may also serve as a signal for identifying companies engaged in manipulating earnings management. This underscores the need for stronger oversight and transparency in financial reporting,” says Dr. Panagiotis Tzouvanas of the University of Portsmouth’s School Accounting, Economics and Finance

Key findings

• Firms with higher GHG emissions are more likely to engage in earnings management practices. These practices reduce financial reporting quality by misleading stakeholders about a firm’s actual performance and financial condition.
• Larger board sizes can moderate this relationship, leading to greater financial transparency.
• Despite stricter EU regulations on emissions, firms continue to engage in earnings management practices, suggesting a need for further regulatory scrutiny.

Dr. Tzouvanas explained, “High greenhouse gas emissions not only shine a light on polluting firms, but may also serve as a signal for identifying companies engaged in manipulating earnings management. This underscores the need for stronger oversight and transparency in financial reporting.”

The study also found that firms facing regulatory uncertainty regarding GHG emissions might use earnings management strategies to anticipate potential policy changes. With the EU’s ambitious goal to reduce emissions by 50% by 2030, researchers say companies must adapt their financial strategies while maintaining integrity in their reporting.

For investors, the findings suggest the need for greater vigilance when assessing financial reports from high-emission firms. Companies that manipulate earnings to offset climate-related costs may present misleading financial health, impacting investor decisions and long-term sustainability.

Policymakers can use these insights to refine regulations that not only address environmental goals but also improve financial transparency. The recently revised EU Energy Efficiency Directive (EU/2023/1791) is a step in this direction, reinforcing the need for stricter oversight on both emissions and corporate financial disclosures.

For investors, the findings suggest the need for greater vigilance when assessing financial reports from high-emission firms. Companies that manipulate earnings to offset climate-related costs may present misleading financial health, impacting investor decisions and long-term sustainability.

Policymakers can use these insights to refine regulations that not only address environmental goals but also improve financial transparency. The recently revised EU Energy Efficiency Directive (EU/2023/1791) is a step in this direction, reinforcing the need for stricter oversight on both emissions and corporate financial disclosures.

The study’s authors call for further research on a global scale to determine whether similar trends exist beyond Europe. They also suggest examining the role of additional corporate governance factors—such as board gender diversity and investor protection schemes—in mitigating the impact of GHG emissions on financial reporting quality.

This research provides the first evidence linking GHG emissions with earnings manipulation, despite strict EU regulations. It underscores the dual benefits of ambitious climate policies, reducing environmental harm and enhancing financial transparency.

“By holding firms accountable for both their emissions and financial reporting, regulators and investors can drive meaningful change toward a more sustainable and ethical corporate landscape,” added Dr. Tzouvanas.