Big Bath Earnings Management Amid Evolving Climate Regulations

We investigate whether shocks to climate policy uncertainty (CPU) motivate emission-intensive firms to engage in big bath earnings management. Using a large sample of the US firms from 2001 to 2020 and utilizing a difference-in-differences research design, our findings indicate that emission-intensive firms exhibit higher income-decreasing discretionary accruals during heightened CPU shocks compared to other firms. These negative accruals reverse in the subsequent year, consistent with big bath accounting behavior. Furthermore, emission-intensive firms are more likely to engage in income-decreasing earnings management in the presence of positive stock returns and audits conducted by non-Big4 auditors. Additionally, the desire to engage in big bath accounting is more pronounced for emission-intensive firms experiencing a loss. Several sensitivity analyses and supplementary tests consistently corroborate the main findings. By understanding the reporting strategies employed by emission-intensive firms in response to climate policy shocks, investors can make more informed decisions about the risks and opportunities of their investment, and regulators can enhance transparency and accountability in financial reporting.