E vs. G: Environmental Policy and Earnings Management in China
E vs. G: Environmental Policy and Earnings Management in China
We examine how firms adjust their financial reporting behavior following the introduction of China's automatic air pollutant monitoring system, which increased transparency and regulatory scrutiny of environmental performance. Polluting firms respond by engaging more in earnings management, as reflected in larger discretionary accruals and reduced earnings informativeness relative to non-polluting firms. The response is strongest among firms with higher regulatory exposure---those that are larger, more profitable, located near monitoring stations, or operating in less market‑oriented regions---and is moderated by stronger customer-supplier relationships and lower market competition. We also show that polluting firms, particularly those that emit higher levels of pollutants, are more likely to engage in downward earnings management, consistent with pollution control and financial reporting manipulation functioning as substitute channels of regulatory avoidance. Our findings highlight important ESG trade-offs, demonstrating how environmental monitoring technologies can produce unintended governance consequences.