Environmental regulation and real earnings management—Evidence from the SO2 emissions trading system in China

This study investigates the effect of environmental regulations on the real earnings management and accrual earnings management of firms. Based on China's sulfur dioxide(SO2) emissions trading program, we adopt a difference-in-difference approach and find that the emissions trading program is negatively associated with real earnings management. The negative relation is stronger for firms with high information asymmetry and firms with poor corporate governance. Our findings suggest that market-based environmental regulations such as the cap-and-trade program can indeed incentivize firms to provide better earnings quality even in a weak institutional environment.