Air Pollution and Earnings Management

The development of firms in heavy-polluted industries causes a series of environmental problems. The disharmony between those firms’ operations and environmental protection is the main contradiction in Chinese environmental governance. Heavy-polluted firms normally lack the awareness to bear the associated costs of negative externalities, but as public awareness of environmental issues grows, firms attracting public attention are more likely to undergo strict scrutiny of government. Government reacting to public concerns imposes costs on heavy-polluted firms, particularly those with high earnings, by tightening project approval, strictly enforcing regulations and punishing polluted firms. This paper examines the impact of public attention to air pollution on corporate earnings management. I find that heavy-polluted firms manage their earnings in response to public attention to air pollution. The extent of firms’ downward earnings management increases with the rising public attention to air pollution. This paper not only provides an incentive for firms to adjust their earnings in the field of earnings management literature, but also verifies firms do react to these external pressures once there are potential costs.