Recidivism is a fundamental idea in law enforcement. Past bad behavior, sometimes even in unrelated fields, tends to predict an individual’s proclivity to cross the line in the future. Might the same insight hold for irresponsible ESG behavior of a firm? Will a company’s record of violations related to worker welfare, product safety or environmental damage predict reporting shenanigans?
To evaluate this conjecture in the corporate context, my co-authors (Shuqing Lo and Simi Kedia) and I combined ESG data from several sources for 4,621 unique firms spanning the years 1994 to 2011.
As hypothesized, we found that a firm’s prior noncompliance record on ESG activities is statistically associated with the likelihood of subsequent financial misreporting measured as (i) a material earnings restatement; (ii) the issue of a subsequent Accounting and Auditing Enforcement Release (AAER) by the SEC; or (iii) the violation of disclosure laws or GAAP (Generally Accepted Accounting Principles) alleged via a securities class action lawsuit.
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