Does Environmental,  Social and Governance  Performance Score Mitigate Earnings Management Practices ? Evidence from  the US Commercial Banks.

Abstract Environmental, social and governance (ESG) performance has attracted debates of regulatory bodies and the academic community. Previous studies highlighted the relationship between corporate social responsibility (CSR) disclosure index and earnings management (EM) for non-financial firms. In this paper, we examine the relationship between the ESG performance and EM practices for a sample of US commercial banks over the period 2010–2019. We use two proxies for earnings management: abnormal loan loss provisions (ALLP) and EM to avoid losses (SPOS). Consistent with the transparent financial reporting hypothesis, we find that banks reporting higher ESG performance are less likely engaged in income-increasing practice through (ALLP). However, no evidence supports that ESG score mitigates EM through loss avoidance. Furthermore, we disaggregate the ESG score into its main three components: environmental, social, and governance. Our findings show that the governance pillar effectively mitigates earnings management (EM) practice under its two proxies. Furthermore, the social pillar also seems to be an efficient constraint of banks’ EM through income increasing abnormal loan loss provisions and loss avoidance activity. However, no supporting evidence of a mitigating role for the environmental pillar is provided. Taken together, our results show that, except the environmental pillar, ESG performance score acts as an efficient mitigating tool for EM practices. Our findings provide a better understanding of banks earnings management practices. Our findings are helpful for managers, regulators, and banks’ stakeholders.