Through the Fog: Climate Risk, Financial Constraints, and Financial Reporting Quality *

Abstract

This study explores how firm-level exposure to climate change influences corporate financial reporting quality, focusing on earnings management as a key indicator. We find that firms facing greater climaterelated risks are more likely to engage in earnings manipulation. This tendency is especially pronounced among financially constrained firms, which may resort to presenting a more favorable financial profile through misreporting, ultimately increasing their stock risk. Our analysis also reveals that this effect is stronger in firms operating in less competitive industries and those receiving limited attention from financial analysts. Moreover, we find that the impact of climate risk on earnings management has diminished in the years following the Paris Agreement, suggesting the growing influence of global climate policy in shaping corporate behavior. Our findings survive a battery of tests, including employing alternative measures of climate risk and financial constraints and addressing endogeneity concerns.

Keywords: Climate change, Financial reporting quality, Earnings management, Financial constraints G30, G34, M41 Climate change, Financial reporting quality, Earnings management, Financial constraints G30, G34, M41

JEL Classification: G30, G34, M41