Meet, Beat, and Pollute
Review of Accounting Studies, forthcoming
62 Pages Posted: 21 Apr 2021 Last revised: 19 May 2022
Date Written: May 18, 2022
We investigate two related questions about the trade-off between short-term pressures on managers to meet earnings targets and the long-term environmental benefits of reduced pollution. Do firms release more toxins by cutting back on pollution abatement costs to boost earnings in years they meet earnings benchmarks? If so, is that relation weaker for firms with higher environmental ratings? Using Environmental Protection Agency (EPA) data on toxic emissions, we find that U.S. firms pollute more when they meet or just beat consensus earnings per share (EPS) forecasts, suggesting that meeting expectations is a more important goal than reducing pollution. We find this relation is stronger, not weaker, for firms with higher environmental ratings: they increase pollution even more when meeting earnings benchmarks than firms with lower ratings. This suggests that highly rated firms build regulatory and reputational slack over time and use it when needed to soften the negative impact of increased pollution. We contribute to the real earnings management and environmental economics literatures by documenting a negative externality of financial reporting incentives on the environment and society. We also contribute to the corporate sustainability literature by showing that environmental, social, and governance (ESG) focus does not curb managerial short-termism.
Keywords: ESG; corporate sustainability; managerial short-termism; meeting earnings benchmarks; real earnings management; externality
JEL Classification: G10, M14, M41, Q50
Suggested Citation: Suggested Citation