Abstract

Using ESG (Environmental, Social, and Governance) data from the Korea Institute of Corporate Governance and Sustainability (KCGS) from 2018 to 2022, this study investigates the relationship between an increase in ESG ratings and earnings management. We also examine whether audit efforts have a moderating effect on that relationship. For the purpose, we measure earnings management by discretionary accruals and use increases in audit hours, audit fees, and audit fees per hour as proxies for auditors’ efforts, which prior studies have reported to have an effect on reducing discretionary accruals. The empirical results of this study are as follows. First, there is a significantly positive relationship between an increase in ESG ratings and earnings management. This result does not change no matter whether we use a continuous variable or a dummy variable for the ESG rating increase. This result suggests that companies seeking to enhance their ESG ratings might be more inclined towards earnings management, implying a preference for ‘greenwashing’ activities over a commitment to long－term sustainability. Furthermore, when analyzing by the components of ESG, we find that the result is attributable to environmental management (E), social responsibility management (S), and corporate governance (G) alike. Second, the positive relationship between the increase in ESG ratings and earnings management weakens as the auditors’ audit hours increase, or as audit fees and fees per hour increase. These findings suggest that an increase in auditors’ efforts or compensation acts as a moderating effect, mitigating the negative relationship between the increase in ESG ratings and audit quality. In summary, this study highlights the significance of finding that an increase in ESG ratings is positively related to earnings management and that this positive relationship weakens when the auditors’ efforts increase. Moreover, the findings of this study offer useful implications for regulatory authorities and policymakers interested in ESG disclosure.

Keywords

• increase in ESG ratings
• earnings quality
• audit quality
• audit effort
• moderating effect

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