Earning quality and climate risk: The case of European firms

Abstract

We investigate the effect of climate risk on two fundamental characteristics of earnings quality: faithful representation and relevance, of 184 European-listed companies over the period of 2010 to 2019. We find that climate risk has a negative impact on both the faithfulness and relevance of earnings, ultimately reducing overall earnings quality. Firms in countries with higher climate risk are more prone to engage in accrual-based earnings management and report less persistent, predictable, and relevant earnings. In addition, we investigate the moderating effect of corporate social responsibility and the Paris agreement on this relationship and find that the negative effect on earning quality is stronger for less socially responsible firms and in the period before the Paris agreement. Our results are robust to alternative measures of climate risk and earnings quality.