The valuation demand for accounting conservatism: evidence from firm-level climate risk measures
China Finance Review International
ISSN: 2044-1398
Article publication date: 13 September 2024
Issue publication date: 20 November 2024
Abstract
Purpose
Prior studies have found that managers adjust operational activities to tackle climate risk. However, the effects of climate risk on accounting practices are largely ignored in the literature. This paper investigates whether and how climate risk influences managers’ decision-making on the level of accounting conservatism and explains the results based on two competing channels: valuation demand and contracting demand.
Design/methodology/approach
Using firm level climate risk measures, we build a modified Basu (1997) model to conduct our econometric tests. In the baseline model, we use earnings before extraordinary items as the dependent variable, referred to as the earnings model. We control for different levels of fixed effect to identify the shocks of climate risk and mitigate potential concerns on endogeneity and bias in the model. A series of robustness tests provide supporting evidence for our baseline results and our explanation.
Findings
Using a sample of 35,832 firm-year observations on listed US firms over the period 2002 to 2019, we find that the perception of climate risk drives managers to choose the less conservative accounting policies. We conclude that the results are consistent with the valuation demand explanation but inconsistent with the contracting demand explanation.
Originality/value
The study provides additional evidence on how managers respond to climate risk by adjusting their corporate polices, specifically accounting policies. Our findings contradict the results of prior studies. We explain our results from a unique perspective. Overall, the study provides valuable insights for academics, investors, managers and policymakers.
Keywords
Acknowledgements
We are deeply indebted to two anonymous reviewers and Professor Wenfeng Wu (Editor-in-Chief) for their insightful comments and constructive suggestions. Their guidance has substantially improved the quality of the manuscript. We also appreciate comments from participants at the AFAANZ Conference 2023 and 32nd Asian-Pacific Conference on International Accounting Issues 2023. The paper gained the Best Paper Award at the 32nd Asian-Pacific Conference on International Accounting Issues 2023. All errors are our own.
Citation
Li, S., van Zijl, T. and Willett, R. (2024), "The valuation demand for accounting conservatism: evidence from firm-level climate risk measures", China Finance Review International, Vol. 14 No. 4, pp. 694-718. https://doi.org/10.1108/CFRI-03-2024-0117
Publisher
:Emerald Publishing Limited
Copyright © 2024, Emerald Publishing Limited