Eco-Innovation and Earnings Management: Unveiling the Moderating Effects of Financial Constraints and Opacity in FTSE All-Share Firms

Paper: arXiv 2508.14935

Authors: Probowo Erawan Sastroredjo, Marcel Ausloos, Polina Khrennikova

Abstract

Our research investigates the relationship between eco-innovation and earnings management among 567 firms listed on the FTSE All-Share Index from 2014 to 2022. By examining how sustainability-driven innovation influences financial reporting practices, we explore the strategic motivations behind income smoothing in firms engaged in environmental initiatives. The findings reveal a positive association between eco-innovation and earnings management, suggesting that firms may leverage ecoinnovation not only for environmental signalling but also to project financial stability and meet stakeholder expectations. The analysis further uncovers that the propensity for earnings management is amplified in firms facing financial constraints, proxied by low Whited-Wu (WW) scores and weak sales performance, and in those characterised by high financial opacity. We employ a robust multi-method approach to address potential endogeneity and selection bias, including entropy balancing, propensity score matching (PSM), and the Heckman Test correction. Our research contributes to the literature by providing empirical evidence on the dual strategic role of ecoinnovation -balancing sustainability signalling with earnings management, under varying financial conditions. The findings offer actionable insights for regulators, investors, and policymakers navigating the intersection of corporate transparency, financial health, and environmental responsibility.

Complexity vs Empirical Score

• Math Complexity: 2.5/10
• Empirical Rigor: 8.5/10
• Quadrant: Street Traders — practical and empirical, lighter on theory

Why this score: This paper presents a rigorous empirical examination of the relationship between eco-innovation and earnings management using a comprehensive dataset of UK firms. It features strong statistical methodologies to address endogeneity (PSM, Heckman, entropy balancing) while relying primarily on empirical corporate finance techniques rather than dense mathematical derivations.

Research Flowchart

  flowchart TD
    A[Research Goal: Impact of Eco-Innovation on Earnings Management & Moderating Factors] --> B[Data Input: 567 FTSE All-Share Firms 2014-2022]
    B --> C[Core Analysis: Regression of Eco-Innovation on Earnings Management]
    C --> D[Endogeneity & Bias Mitigation: Entropy Balancing, PSM, Heckman Test]
    D --> E[Moderation Analysis: Financial Constraints WW Index/Sales & Opacity]
    E --> F[Key Outcome: Eco-Innovation drives Earnings Management, amplified by Constraints & Opacity]