Internal Control over Financial Reporting and Corporate Environmental Performance

Abstract

We investigate the environmental implications of firms’ internal control over financial reporting. Our main result is that corporate environmental performance, measured using the amount of firms’ toxic production-related waste, is significantly poorer among firms with material weaknesses in internal control over financial reporting than firms without such weaknesses. Furthermore, we document a significant improvement in corporate environmental performance following the remediation of internal control deficiencies, substantiating a causal relation between internal control over financial report and corporate environmental performance. Additional analyses show that the adverse effect of internal control weakness is exacerbated for firms with greater earnings opacity or weaker external governance mechanisms. Overall, our findings provide insights into the determinants of corporate environmental performance, highlight the environmental and social benefits of effective internal control over financial reporting, and manifest the real and environmental impacts of accounting.

Keywords: Corporate Environmental Performance; Internal Control over Financial Reporting; Toxic Waste; Real Effects of Accounting

JEL Classification: M41, M48, Q53