Final DBA Dissertation Defense - Melissa A. Nelson
ABSTRACT
Water pollution and water scarcity combine to create a formidable business risk. Yet many corporations based in the United States (U.S.) do not disclose water risks. In partnership with the Big 4 accounting firms, the World Economic Forum (2020) produced a report outlining metrics to enable companies to measure and disclose substantive information about their water impacts. This dissertation addresses the question: What are the effects of water risk disclosure on earnings management? Publicly traded, U.S. companies that responded to CDP’s annual water security survey from 2010-2022 are investigated to answer this question.
Drawing on information, voluntary disclosure, and signaling theories, as well as ethical considerations, the current study predicts and finds firms that voluntarily disclose water risk enjoy less earnings management than firms that do not disclose. Better performing firms publicize signals envied by firms with lower water risk disclosure. This suggests that water reporting supplements existing information in financial reports and leads to reduced information asymmetry between managers and stakeholders, hence decreasing management’s propensity to manipulate earnings. Also proposed is that corporate ethical culture influences a firm’s adoption of water-related disclosure. Demands by stakeholders for greater transparency and accountability help to make a company’s reported information more complete and meaningful and socially responsible firms are likely to respond, leading to enhanced overall reporting quality.
The present study further investigates the moderating effects of three influences: the degree of top management commitment, strength of corporate governance, and procurement of external assurance. Higher degrees of top management commitment or the “tone at the top” set by the upper echelon is posited and found to enhance the negative association between water risk disclosure and earnings management behaviors. The strength of corporate governance is also hypothesized and found to magnify the negative effect between the water risk disclosure quality and earnings management. With strong monitors in place, managers’ discretion is minimized, thereby reducing manipulations. Lastly, external assurance is predicted and found to enhance the negative relationship between water risk disclosure quality and earnings management. Credible disclosures, assured through a third party, verify the validity of a company’s reported information, both financial and nonfinancial. The study’s predictions are supported by the main analysis, and prove robust to a series of tests.
The importance of understanding how water risk disclosure affects financial reporting quality has implications for users of corporate information, such as auditors, investors, and policymakers. This paper extends information, voluntary disclosure, and signaling theories in an application of corporate water disclosure. Overall, this research has implications to support increased incentives for corporations to voluntarily disclose water risk and mitigation efforts.
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