Eco-Innovation and Earnings Management: Unveiling the Moderating Effects of Financial Constraints and Opacity in FTSE All-Share Firms

TL;DR

This study examines how eco-innovation influences earnings management in FTSE All-Share firms, revealing that environmental initiatives are linked to strategic financial reporting, especially in financially constrained and opaque firms.

Contribution

It provides empirical evidence on the dual role of eco-innovation in sustainability signaling and earnings management, considering financial constraints and opacity as moderating factors.

Findings

Eco-innovation is positively associated with earnings management.

Financial constraints and opacity amplify earnings management in eco-innovative firms.

The study employs robust methods like PSM and Heckman correction to address bias.

Abstract

Our research investigates the relationship between eco-innovation and earnings management among 567 firms listed on the FTSE All-Share Index from 2014 to 2022. By examining how sustainability-driven innovation influences financial reporting practices, we explore the strategic motivations behind income smoothing in firms engaged in environmental initiatives. The findings reveal a positive association between eco-innovation and earnings management, suggesting that firms may leverage ecoinnovation not only for environmental signalling but also to project financial stability and meet stakeholder expectations. The analysis further uncovers that the propensity for earnings management is amplified in firms facing financial constraints, proxied by low Whited-Wu (WW) scores and weak sales performance, and in those characterised by high financial opacity. We employ a robust multi-method approach to address potential endogeneity and selection bias, including entropy balancing, propensity score matching (PSM), and the Heckman Test correction. Our research contributes to the literature by providing empirical evidence on the dual strategic role of ecoinnovation -balancing sustainability signalling with earnings management, under varying financial conditions. The findings offer actionable insights for regulators, investors, and policymakers navigating the intersection of corporate transparency, financial health, and environmental responsibility.