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Published in: Journal of Business Ethics 1/2022

23-02-2021 | Original Paper

Contaminated Heart: Does Air Pollution Harm Business Ethics? Evidence from Earnings Manipulation

Authors: Charles H. Cho, Zhongwei Huang, Siyi Liu, Daoguang Yang

Published in: Journal of Business Ethics | Issue 1/2022

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Abstract

We investigate whether air pollution harms business ethics from the perspective of earnings manipulation, which exerts a real effect on the economy and social welfare. Using a large sample and a comprehensive air quality index in China, we find that firms located in cities with more severe air pollution exhibit higher levels of discretionary accruals and are more likely to restate their financial statements, consistent with exposure to air pollution leading to more earnings manipulation. We further provide causal evidence using propensity score matching and a discontinuity regression design (RDD) exploiting the Qinling Mountain–Huai River Heating Policy Line, which exogenously leads to more air pollution to cities located immediately north of the Line but not those in the south. Our findings are robust to controlling for weather conditions and alternative samples and measures of air pollution and earnings manipulation. Overall, this study unveils how the ecological environment shapes business ethics.
Appendix
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Footnotes
1
We use “earnings manipulation” and “earnings management” interchangeably in this paper.
 
2
The combination of overall severe air pollution with substantial variation in air pollution levels across regions in China provides a powerful setting to test our prediction. See Sect. 3.1 for more details.
 
3
See, for instance, Dechow et al. (2010) and Bishop et al. (2017) for comprehensive reviews of the earnings management literature.
 
4
Although poor performance is implicated as a determinant of earnings management in many prior studies, some research suggests that firms with good performance may also engage in earnings management. For instance, Healy (1985) finds that managers engage in downward earnings management when their bonuses have reached the maximum due to good firm performance. While Harris and Bromiley (2007) find that bonuses have no impact on firms’ financial misrepresentation, their results suggest that the probability of restatements is increasing in firm performance. We believe this alternative nonetheless works against us finding significant results. We thank an anonymous reviewer for leading us to this discussion.
 
5
Our inference remains the same if we follow Kothari et al. (2005) or Dechow and Dichev (2002) to estimate discretionary accruals, or if we follow Chen et al. (2018b) and include explanatory variables of the modified Jones model as control variables in Eq. (2) that we use for the hypothesis testing.
 
6
See Table 1 Panel B for the industry classification scheme.
 
7
We focus on the case of restatements that correct the overstated financial position or performance (Ahluwalia et al. 2018) and are not tax driven. Expanding to all restatements does not alter our inference.
 
8
All Chinese firms have a fiscal year that runs from January 1 to December 31. Our results remain similar when we measure AP from January 1 to the date of financial statements issuance, as shown in Table 9.
 
9
The results do not change when we exclude observations for which the parent company’s total assets are less than 60%, 70%, 80%, and 90% of those of the consolidated company. For brevity, we do not tabulate these results, but they can be made available upon request.
 
10
Due to the lack of data, we are not able to test for financial restatement of parent companies.
 
11
The polluting industries include: B-Mining, C1-Textile, Clothing & Fur, C3-Papermaking & Printing, C4-Petroleum, Chemistry & Plastic, C6-Metal & Nonmetal, C8-Medicine & Biologics, D-Utilities.
 
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Metadata
Title
Contaminated Heart: Does Air Pollution Harm Business Ethics? Evidence from Earnings Manipulation
Authors
Charles H. Cho
Zhongwei Huang
Siyi Liu
Daoguang Yang
Publication date
23-02-2021
Publisher
Springer Netherlands
Published in
Journal of Business Ethics / Issue 1/2022
Print ISSN: 0167-4544
Electronic ISSN: 1573-0697
DOI
https://doi.org/10.1007/s10551-021-04762-y

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