Sustainability Commitment Versus Earnings Management Practices: Saudi Insights

Abstract

This paper aims to examine the impact of corporate sustainable management (CSM) on earnings management (EM) activities using annual data from 2018 to 2022 for 37 non-financial Saudi indexed firms. A multi-measure approach was utilized to proxy for EM (AEM and REM) and CSM (CSR sustainability reporting, CSR sustainability committee, CSR sustainability external audit, GRI report guidelines, ESG performance index). The empirical analysis employed pooled ordinary least squares (POLS) regression. The results suggest that CSM plays a significant role in reducing both AEM and REM practices, indicating that sustainability-oriented organizations mitigate EM activities. Furthermore, the study reveals a negative correlation between CSM and sales manipulation, overproduction, and cutting discretionary expenditures. This research supports the notion that companies prioritize sustainable management due to a focus on long-term strategies and transparency. This is the first work in the Middle East and Arab region, particularly in Saudi Arabia, investigating this association.

1. Introduction

Earnings management (EM) is commonly perceived as unethical conduct because it involves the exercise of managerial judgment in manipulating accounting figures, potentially leading to the misrepresentation of financial information communicated to stakeholders. Companies that engage in socially responsible initiatives demonstrate their commitment to the overall welfare of society, surpassing the profit-making goals. Enron serves as a prominent example where the company published annual corporate social responsibility (CSR) reports and actively endorsed environmental protection and philanthropic activities. However, it stands as a stark reminder that even when it adheres to CSR practices, it may still fall prey to significant ethical lapses and encounter direct consequences [1,2].

Recent studies have indicated that there is a direct correlation between sustainability initiatives and financial success [3,4,5,6,7,8]. According to research conducted by Harvard Business Review, companies that prioritize sustainability tend to outperform their competitors over the long-term. Global Reporting Initiatives (GRI) guidelines were utilized to measure the quality of sustainability disclosure in content analyses of corporate annual and stand-alone reports. Enron serves as a prime example of how a company’s commitment to CSR practices, demonstrated through the publication of annual CSR reports and engagement in environmental protection and philanthropic activities, did not protect it from significant ethical misconduct. This case emphasizes that despite a company’s adoption of CSR, it remains vulnerable to significant ethical lapses, as illustrated by Enron’s collapse [1].

Previously conducted empirical research has demonstrated that EM directly affects corporate reporting decisions [9]. EM occurs when managers use their own judgement in financial reporting and engage in transactions that manipulate financial statements [10]. Many scholars have found a strong and positive connection between CSR and EM practices [9,11,12,13,14].

According to the agency theory, businesses often use EM methods to surpass market projections, potentially leading to a conflict of interest where managerial goals take precedence over stakeholder interests [15,16,17]. EM involves manipulating financial data to achieve specific objectives, such as meeting targets or hiding unfavorable information. While earlier studies primarily focused on accruals-based earnings management (AEM), recent research highlights the importance of real earnings management (REM) in influencing sustainability performance [18]. However, a significant amount of research has been conducted in established capital markets, with limited focus on emerging markets. While different researchers have studied how managers could use ESG mechanisms to disguise opportunistic practices in emerging markets, this aspect remains largely unexplored in the Saudi context. Legitimacy theory proposes that a company’s success is strongly connected to its capacity to operate within societal norms, values, and expectations [19]. Essentially, businesses are viewed as legitimate entities when they contribute positively to society and operate in accordance with ethical, social, and environmental concerns. By engaging in responsible business practices and addressing stakeholders’ concerns, companies can enhance their legitimacy and sustain their long-term success. Expanding on the social norm theory, corporate sustainable management (CSM) is viewed as a method to establish credibility in the market and is seen as a type of risk management for businesses. Although it is commonly believed that companies with higher ESG ratings would prioritize transparency and ethical behavior, there are cases where managers use ESG strategies to deflect stakeholder scrutiny or conceal actions of earnings manipulation. This can lead to a correlation between earnings manipulation and ESG ratings [20].

This study aims to illuminate the intricate relationship between EM and CSM in the Saudi market. Ref. [21] studied the relationship between CSR and EM practices and provided evidence from Saudi Arabia. Our work represents a pioneering investigation into the relationship between AEM and REM, serving as two proxies of EM, and CSM in Saudi Arabia. This is the first study in the Middle East and Arab region, specifically in Saudi Arabia, to explore this association.

Drawing upon legitimacy theory and social norms, the Saudi Arabian environment offers a unique setting for exploring this connection, given its cultural distinctiveness and strong religious influence. The social norm theory posits that religion impacts individuals’ actions and choices by shaping shared values and beliefs [22]. As a result, managers in religious societies might employ external monitoring as a risk mitigation strategy and provide lower levels of ESG disclosure [23,24]. Saudi Arabia is known for its highly formal and structured social systems, which are tailored to uphold specific religious principles or interpretations, enforced by religious authorities. Furthermore, the Saudi Ministry of Commerce, guided by the vision of 2030, implements initiatives, projects, and strategic plans to achieve sustainable development and environmental preservation. The initiatives for sustainable development encompass social, economic, and environmental perspectives. These factors make Saudi Arabia a favorable country for studying the link between external monitoring and corporate social responsibility. Financial and non-financial data were gathered from the Thomson Reuters Eikon database for 37 firms indexed on the Tadawul All Share Index (TASI) for the period 2018 to 2022. The panel data were analyzed using POLS regression. The research findings demonstrate a clear and notable negative correlation between CSM and EM practices. These outcomes have substantial implications for managers, investors, and regulators alike.

The remainder of this work is organized as follows: Section 2 presents the literature review and hypotheses development, Section 3 develops the research methodology, Section 4 displays the main empirical outcomes, and Section 5 provides conclusions.

2. The Related Literature and Hypotheses Development

2.1. Earnings Management Activities

The financial scandals in the late 1990s and early 2000s highlighted that strong financial results do not always indicate true economic performance. Instead, these scandals revealed that management could manipulate financial metrics to create the illusion of better performance than the actual economic reality of the company. Enron, Tyco, WorldCom, and Xerox, prominent corporations known for their seemingly strong financial performance, were revealed to have manipulated their earnings to project a positive financial image. Empirical studies have confirmed the link between earnings manipulation and the display of strong financial performance. We explore the existing literature that examines how EM can be utilized to meet forecast targets, which ultimately leads to favorable financial performance as perceived by the market. The study by [25] illustrates how management employs discretionary accruals to prevent losses or declines in earnings. Moreover, refs. [26,27] have shown that managers use discretionary accruals to meet or exceed analysts’ expectations. Similarly, ref. [28] identified a strong correlation between discretionary accruals that boost income and the probability of steering clear of negative earnings surprises. Ref. [29] made an interesting observation that abnormal accruals contribute significantly to the asymmetry in forecast error distribution. This indicates that companies manipulate the accruals (AEM) to align with analyst expectations in current and future periods. Ref. [30] delves into the challenge of distinguishing between managerial decisions that represent a company’s economic status and those driven by opportunistic EM. The author discovered that certain managerial practices commonly adopted by expanding companies may be categorized as upward EM by annual accrual expectation models.

Given the importance of future performance for firms, owners, and shareholders, it is crucial to examine the implications of managing earnings on firm performance. The previous literature has examined the implications of managing earnings on actual and future firm performance [31]. It provided evidence on the consequences of utilizing operational variables. Indeed, engaging in practices related to REM can adversely affect a company’s cash flows. Making changes to operational aspects may reduce a company ability to be productive in the future, ultimately impacting its long-term economic performance. Hence, participating in EM is not merely seizing an opportunity but can also be in line with the objective of achieving short-term advantages. According to [32,33], managers prefer REM to AEM. They argue that REM has a direct impact on cash flow, making it equally important to AEM. Companies choose REM because it is easier to monitor by external auditors, government authorities, and regulatory bodies. Ref. [33] suggested that stakeholders are unable to differentiate between earnings adjusted by REM and REM. To address this, an empirical model related to REM was proposed to distinguish a firm’s normal business activities from abnormal ones. Ref. [16] noted that REM has become more prevalent in EM practices following the enforcement of the SOX act. Additionally, ref. [34] found that managers were more inclined to use REM during recapitalization processes. Furthermore, ref. [35] found that firms seeking mutual development were less engaged in REM compared to other firms.

2.2. Corporate Sustainability Management Practices

There is an increasing trend among corporations to allocate resources and develop strategies to promote sustainability and protect the environment. Several factors contribute to this shift, including the adoption of practices and the establishment of departmental structures that support corporate sustainability management. The latter is a strategic approach that seeks to generate long-term value for stakeholders by prioritizing ethical, social, environmental, cultural, and economic aspects in business operations.

In the modern world, CSM practices encompass ethical considerations and dilemmas. For instance, the core question of “what does sustainability mean?” prompts corporations to contemplate the ultimate objective of sustainability and raises concerns about standards, both internally and within their respective industries. It is essential to ask these fundamental questions as they greatly influence how we perceive challenges and develop effective solutions based on our understanding of what sustainability entails and what it does not. Corporate sustainability management is the intersection where businesses integrate sustainable practices. It involves overseeing and managing a corporation’s influence on the three essential aspects of profit, people, and the planet, ensuring their coexistence and prosperous development in the long run. Sustainability management is crucial for ensuring the corporation’s long-term viability by proactively addressing issues rather than simply reacting to them.

Corporations that prioritize CSM activities experience various market benefits, such as enhancing their long-term company value and positively influencing the capital market reaction to earnings disclosures. Additionally, these efforts can result in more efficient and profitable operations for the company [36]. Multiple research studies have shown that there is a strong link between sustainable practices and financial success. Ref. [37] have discovered that strategies like green finance, eco-friendly marketing, and operational environmental efficiency can provide companies with a substantial competitive advantage in their performance and financial outcomes. Hence, companies prioritizing sustainability tend to perform better in terms of long-term stock market performance and accounting measures compared to those that do not focus on sustainability.

2.3. Hypotheses Development

This study is based on two theoretical frameworks: external monitoring and internal corporate culture. The first framework suggests that management in environmentally responsible firms will face increased monitoring and compliance pressure due to heightened scrutiny from regulators, investors, society, and the media. These pressures may motivate environmentally conscious companies’ management to refrain from engaging in questionable financial reporting practices. The possible consequences, including damage to their reputation and increased legal risks, act as deterrents. Past research indicates that heightened supervision often leads to improved reported earnings accuracy or the decreased manipulation of earnings [38,39,40,41]. According to the theory of internal corporate culture, companies that adopt environmental initiatives promote a corporate culture defined by ethical principles and values centered on the common good. This, in turn, fosters a work environment where employees are happier, more productive, and more honest. Consequently, such corporate cultures encourage behaviors that are less motivated by self-interest, potentially reducing the tendency for profit manipulation in our specific context. This perspective is supported by research indicating a positive correlation between strong CSR practices and a healthy corporate culture [42,43,44,45]. Such a corporate culture, in turn, fosters corporate commitment and reduces self-interested behavior among employees [46,47].

Ref. [3] investigated how internal corporate governance mechanisms influence the connection between a company’s commitment to corporate environmental disclosure and its practices of EM in Jordan. Analyzing data from 100 listed firms between 2010 and 2014, the results indicate that although there is a negative association between corporate environmental disclosure and earnings manipulation, the impact of corporate governance practices on EM varies, as they could either decrease or increase earnings manipulation. In his research, ref. [36] identified a negative correlation between the initial issuance of a sustainability report, used as an indicator of sustainable management, and EM.

In general, it is evident that the findings regarding the influence of CSM on AEM are inconsistent. Therefore, delving deeper into exploring this connection in the Saudi context is imperative and the following hypothesis is proposed for this research study:

Hypothesis 1.

Sustainable management is negatively correlated with accruals-based earnings management.

Corporate sustainability performance plays an important role in restraining EM practices and in providing transparent and reliable financial reporting. Evidence from some investigations finds that sustainable firms are less likely to engage in EM practices [5]. Based on the triple bottom line approach to measure corporate sustainability performance, ref. [5] explored the association between corporate sustainability performance and EM in emerging East Asian economies. The author finds an inverse relationship between corporate sustainability performance and both accruals-based and real EM activities. Ref. [48] demonstrated that firms with strong sustainability management exhibit high levels of earnings transparency.

Previous research examining sustainable management has generally found that the reliability of accounting information is higher in companies that successfully implement sustainable management practices compared to those that do not. In particular, sustainable management, being a managerial activity, is closely related to a manager’s role in decision-making and overall management practices. Therefore, it is important to investigate the relationship between sustainable management and REM practices. Consequently, it is necessary to investigate the level of REM in companies that successfully implement sustainable management and address it within the framework of their internal code of ethics. In their study, ref. [49] investigate the link between CSR and EM in manufacturing firms operating in Pakistan, a developing economy. The researchers analyze two types of EM (AEM and REM). The study utilizes an annual dataset covering the period from 2009 to 2018, consisting of information from 160 firms. The findings of this research reveal a negative association between CSR and EM. However, it is important to note that the relationship between CSR and each measure of EM is found to be asymmetric. Ref. [50] discovered that executives are more inclined towards using REM rather than AEM when engaging in earnings manipulations. Their findings align with their expectations, indicating a negative correlation between AEM and CSR, but a positive correlation between REM and CSR.

Even though there have been various debates about the relationship between REM and sustainable management, there is a scarcity of relevant literature on this topic. Therefore, it is important to investigate the link between REM and CSM. Ref. [33] explores three categories of REM activities that could enhance overall income, namely sales manipulation (accelerating the timing of sales through increasing price discounts or more lenient credit terms), overproduction (reporting lower cost of goods sold through increasing production), and the reduction of discretionary expenditures (lessening discretionary expenses including advertising expense, research and development expenses, and selling, general, and administrative expenses to improve reported margins). Managers who manipulate earnings to appear more positive are likely to exhibit one or all the three mentioned activities. Thus, the following hypotheses are proposed:

Hypothesis 2.

REM shows a negative correlation with CSM.

Hypothesis 2a.

Sales manipulation practices show a negative correlation with CSM.

Hypothesis 2b.

Overproduction practices show a negative correlation with CSM.

Hypothesis 2c.

Lessening discretionary expenses practices shows a negative correlation with CSM.

3. Research Methodology

3.1. Sampling and Model Specifications

Our research obtained information from companies that are publicly traded on the Saudi Stock Exchange and included in the Tadawul All Share Index (TASI) between 2018 and 2022. The corporate governance regulation in KSA is issued by the board of the Capital Market Authority in 2017. Therefore, the investigation started post-2017 to not obtain biased results. We verified that the data satisfied the following criteria: (1) financial records were settled as of December 31, (2) financial information was available in the Thomson Reuters database, and (3) the companies belonged to a non-financial sector. As a result, we identified a sample of 37 indexed firms that reported ESG information. Both financial and non-financial data were sourced from Thomson Reuters databases (ASSET4 and Datastream). To test the impact of the CSM in Saudi indexed companies on the levels of EM practices, we develop the following regression:

$$\begin{gathered} {\mathrm{E}\mathrm{M}}_{\mathrm{i}\mathrm{t}}={\mathsf{\alpha }}_0+{\mathsf{\alpha }}_1{\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{R}\mathrm{E}\mathrm{P}\mathrm{O}\mathrm{R}\mathrm{T}\mathrm{I}\mathrm{N}\mathrm{G}}_{\mathrm{i}\mathrm{t}}+{\mathsf{\alpha }}_2{\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{C}\mathrm{O}\mathrm{M}\mathrm{M}\mathrm{I}\mathrm{T}\mathrm{T}\mathrm{E}\mathrm{E}}_{\mathrm{i}\mathrm{t}}+{\mathsf{\alpha }}_3{\mathrm{G}\mathrm{R}\mathrm{I}\mathrm{G}\mathrm{U}\mathrm{I}\mathrm{D}\mathrm{E}}_{\mathrm{i}\mathrm{t}}+{\mathsf{\alpha }}_4{\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{A}\mathrm{U}\mathrm{D}\mathrm{I}\mathrm{T}}_{\mathrm{i}\mathrm{t}}+{\mathsf{\alpha }}_5{\mathrm{E}\mathrm{S}\mathrm{G}}_{\mathrm{i}\mathrm{t}}+ \\ {\mathsf{\alpha }}_6{\mathrm{E}\mathrm{N}\mathrm{V}\mathrm{S}}_{\mathrm{i}\mathrm{t}}+{\mathsf{\alpha }}_7{\mathrm{S}\mathrm{O}\mathrm{C}\mathrm{I}\mathrm{A}\mathrm{L}\mathrm{S}}_{\mathrm{i}\mathrm{t}}+{\mathsf{\alpha }}_8{\mathrm{G}\mathrm{O}\mathrm{V}\mathrm{S}}_{\mathrm{i}\mathrm{t}}+\sum \mathrm{C}\mathrm{O}\mathrm{N}\mathrm{T}\mathrm{R}\mathrm{O}\mathrm{L}+\sum \mathrm{F}\mathrm{I}\mathrm{R}\mathrm{M}\mathrm{S}+\sum \mathrm{Y}\mathrm{E}\mathrm{A}\mathrm{R}\mathrm{S}+\sum \mathrm{I}\mathrm{N}\mathrm{D}\mathrm{U}\mathrm{S}\mathrm{T}\mathrm{R}\mathrm{I}\mathrm{E}\mathrm{S} \end{gathered}$$

where EM is either AEM or REM, SUSREPORTING is CSR sustainability reporting, SUSCOMMITTEE is the CSR sustainability committee, GRIGUIDE is the GRI report guidelines, SUSAUDIT is the CSR sustainability external audit, ESG is the index for environmental, social, and corporate governance performance, ENVS is the environmental performance score, SOCIALS is the social performance score, GOVS is the governance performance score. CONTROL includes the following: FSIZE is the firm size, DEBT is the firm debt level, ROA is the return on assets, MTBV is the market to book ratio, COVID is the coronavirus pandemic period, IFRS is IFRS adoption, WOMEN is women managers, BSIZE is the size of the board of directors, BMEETINGS is the number of board meetings, DUALITY is the CEO–chairman separation, BIG is the presence of a big4 audit firm, AUDITCOM is the presence of an audit committee, AUDITCOMINDEP is audit committee independence, and ROTATION is the auditor independence rotation.

3.2. Measuring AEM and REM Activities

We apply the model in [51] to calculate discretionary accruals (DAs). Discretionary accruals are determined as the absolute value of the variance between total accruals (TAs) and nondiscretionary accruals (NDAs). To calculate TAs, we refer to the net cash flow from operations disclosed in the cash flow statement and utilize the following ordinary least squares (OLS) regression (Model 1) to estimate the baseline accrual levels:

Model (1)

$$\frac{{\mathrm{A}\mathrm{c}\mathrm{c}\mathrm{r}\mathrm{u}\mathrm{a}\mathrm{l}\mathrm{s}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}={\mathrm{a}}_0+{\mathrm{a}}_1\frac{1}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathrm{a}}_2\frac{{\mathsf{\Delta }\mathrm{S}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathrm{a}}_3\frac{{\mathrm{P}\mathrm{P}\mathrm{E}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\epsilon }}_{\mathrm{t}}$$

where Accruals is total accruals. A is total assets. ΔS is the change in net sales. PPE is the amount of property, plant, and equipment.

To measure the extent of REM, we rely on the proxies developed by [16,33,52]. We estimate the normal level that represents ordinary CEO behavior associated with normal business operations. We develop models for the normal levels of cash flow from operations (Model 2), production costs (Model 3), research and development expenditures (Model 4), and selling, general, and administrative (SGA) expenditures (Model 5) as follows:

Model (2)

$$\frac{{\mathrm{C}\mathrm{F}\mathrm{O}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}={\mathsf{\alpha }}_0+{\mathsf{\alpha }}_1\frac{1}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\alpha }}_2\frac{\mathrm{S}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\alpha }}_3\frac{{\mathsf{\Delta }\mathrm{S}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\epsilon }}_{\mathrm{t}}^{\mathrm{C}\mathrm{F}\mathrm{O}}$$

Model (3)

$$\frac{{\mathrm{P}\mathrm{R}\mathrm{O}\mathrm{D}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}={\mathsf{\beta }}_0+{\mathsf{\beta }}_1\frac{1}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\beta }}_2{\mathrm{M}\mathrm{V}}_{\mathrm{t}}+{\mathsf{\beta }}_3{\mathrm{Q}}_{\mathrm{t}}+{\mathsf{\beta }}_4\frac{{\mathrm{S}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\beta }}_5\frac{{∆\mathrm{S}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\beta }}_6\frac{{∆\mathrm{S}}_{\mathrm{t}-1}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\epsilon }}_{\mathrm{t}}^{\mathrm{P}\mathrm{R}\mathrm{O}\mathrm{D}}$$

Model (4)

$$\frac{{\mathrm{R}\mathrm{D}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}={\mathrm{a}}_0+{\mathrm{a}}_1\frac{1}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathrm{a}}_2{\mathrm{M}\mathrm{V}}_{\mathrm{t}}+{\mathrm{a}}_3{\mathrm{Q}}_{\mathrm{t}}+{\mathrm{a}}_4\frac{{\mathrm{I}\mathrm{N}\mathrm{T}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathrm{a}}_5\frac{{\mathrm{R}\mathrm{D}}_{\mathrm{t}-1}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\epsilon }}_{\mathrm{t}}^{\mathrm{R}\mathrm{D}}$$

Model (5)

$$\frac{{\mathrm{S}\mathrm{G}\mathrm{A}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}={\mathsf{\gamma }}_0+{\mathsf{\gamma }}_1\frac{1}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\gamma }}_1{\mathrm{M}\mathrm{V}}_{\mathrm{t}}+{\mathsf{\gamma }}_2{\mathrm{Q}}_{\mathrm{t}}+{\mathsf{\gamma }}_3\frac{{\mathrm{I}\mathrm{N}\mathrm{T}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\gamma }}_4\frac{{∆\mathrm{S}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}+{\mathsf{\gamma }}_5\frac{{∆\mathrm{S}}_{\mathrm{t}}}{{\mathrm{A}}_{\mathrm{t}-1}}\times \mathrm{D}\mathrm{D}+{\mathsf{\epsilon }}_{\mathrm{t}}^{\mathrm{S}\mathrm{G}\mathrm{A}}$$

where CFO is cash flows from operations. A_t−1 is total assets at the beginning of year t. S is net sales. ΔS is the change in net sales. PROD is the sum of the cost of goods sold and change in inventory during the year. MV is natural log of market value. Q is Tobin’s Q. RD is research and development expense; we replace data on missing or negative research and development observations with zero to help increase the sample size. INT is internal funds. SGA is selling, general, and administrative expense. All continuous variables are winsorized at the 1st and 99th percentiles of their distribution to avoid the influence of outliers.

We determine the abnormal levels by comparing the actual values (CFO, PROD, RD, and SGA) with the normal values predicted by the mentioned models. A decrease in abnormal operating cash flows and discretionary expenditures would suggest an increase in income. To create a holistic measurement and fully account for the impact of REM, we combine the different mentioned proxies of REM practices into a single index. We then multiply the abnormal operating cash flows by (−1). So, higher values suggest that companies are reducing their operating cash flows to artificially inflate their earnings. Furthermore, we multiply the abnormal discretionary expenses (such as RD and SGA) by (−1). This also indicates that companies are reducing discretionary expenses to boost their reported earnings, as explained by [16,53,54].

3.3. Corporate Sustainability Management (CSM)

The CSM level, the independent variable, is measured using five proxies as follows: CSR sustainability reporting, CSR sustainability committee presence, GRI report guidelines, CSR sustainability external audit, and ESG performance index. We chose these five proxies for two main reasons. First, these variables represent different sustainable management practices that can measure the CSM level. Second, these variables enable robustness checks.

3.3.1. CSR Sustainability Reporting

This variable answers the question “does the company publish a separate sustainability report or publish a section in its annual report on sustainability?”. The data on this variable are provided by Thomson Reuters Asset4 database. We set SUSREPORTING to equal the value of 1 for every firm-year observation with the answer “yes”, and otherwise, the value of 0 is set. The answer “yes” signifies that the firm issued a sustainability report. Ref. [35] used the dummy variable issuance of a sustainability report to proxy for CSM.

3.3.2. CSR Sustainability Committee

This variable answers the question “does the company have a CSR committee or team?”. The data on this variable are provided by Thomson Reuters Asset4 database. We set SUSCOMMITTEE to equal the value of 1 for every firm-year observation with the answer “yes”, and otherwise, the value of 0 is set. Ref. [55] investigated whether having an independent sustainability committee helps companies meet the criteria of the Dow Jones Sustainability Index (DJSI) and be recognized as leading sustainable companies. The study specifically looks at the European firms indexed on Stoxx Europe 600 in 2015. The findings suggest that having a CSR committee consisting of independent directors with prior experience in socially responsible practices guides the board in successfully positioning the company for inclusion in the DJSI Europe. Furthermore, ref. [56] examined various characteristics of CSR committees that can improve CSR performance, develop CSR strategies, and minimize CSR controversies. In addition, the study compared companies with CSR committees to those without CRS committees in terms of the mentioned CSR aspects. The study utilized a sample of non-financial companies that are listed on the Financial Times Stock Exchange (FTSE) 100 from 2015 to 2017. The findings indicate that companies with board CSR committees tend to have superior CSR performance and CSR strategies, as well as fewer CSR controversies, compared to companies without CSR committees or those with CSR management committees. Furthermore, the study discovered that a CSR strategy was more effective when the CSR committee comprised a larger membership.

3.3.3. GRI Report Guidelines

This variable answers the question “is the company’s sustainability report published in accordance with the GRI guidelines?”. The data on this variable are provided by Thomson Reuters Asset4 database. We set GRIGUIDE to equal the value of 1 for every firm-year observation with the answer “yes”, and otherwise, the value of 0 is set. The GRI standards enable an organization to disclose information comprehensively, addressing all of its most notable impacts on the “3P”, planet, people, and profit, according to the triple bottom line. Ref. [57] examined the link between EM and sustainability disclosure. They employed data from a CSR reporting guideline database that adheres to GRI standards to develop their metric. The results offer valuable Indonesian perspectives on a notable association.

3.3.4. CSR Sustainability External Audit

This variable answers the question “does the company have an external auditor of its sustainability report?”. The data on this variable are provided by Thomson Reuters Asset4 database. We set SUSAUDIT to equal the value of 1 for every firm-year observation with the answer “yes”, and otherwise, the value of 0 is set.

3.3.5. ESG Performance Index

Environmental, social, and governance responsibility management in the ESG performance index were each considered as a measure of CSM. To compute the level of ESG disclosure, we utilize a combined ESG index derived from previous studies [58,59,60]. This index is created using the yearly environmental, social, and governance data from Thomson Reuters ASSET4. We follow [61,62] to weight each measure. The three pillars consist of 10 aspects derived from data that have been publicly reported: the environmental aspect (covering resource use, emissions, product/innovation), the social aspect (encompassing workforce, human rights, community, product responsibility), and the governance aspect (including management, shareholders, CSR strategy). The variable ESG denotes the average of the three scores, with each score being given equal weight, with ENVS representing the environmental performance score, SOCIALS representing the social performance score, and GOVS representing the governance performance score.

Below, Figure 1 presents the tested relationship as well as the different proxies used to measure both EM practices as dependent variables and the CSM as independent variables.

3.4. Control Variables

Several governance mechanisms are stipulated by the agency theory to defend shareholder interests and align principal–agent interests. Therefore, this study controls for a set of variables related to the firm characteristics, board of directors’ features, and auditing services characteristics. The effect of these variables on the EM level is extensively debated in academia. The motivation behind each variable is explained in the following paragraph. Please refer to Appendix A for the control variables’ measurement.

According to the hypotheses for EM highlighted by the positive accounting theory [63], we focus on two hypotheses. First, we select firm size (FSIZE) to account for the political costs’ hypothesis. Second, we select the debt ratio (DEBT) to account for the debt covenant hypothesis. This hypothesis predicts that the connection between the debt contracts and opportunistic actions of EM suggests a potential association between debt policy and EM. Existing research provides information about the impact of EM on present and subsequent firm performance [64,65]. In this study, we test whether firm’s performance has significant coefficient on EM practices and we use the return on assets (ROA). The next proxy is connected to accounting regulation. We account for the impact of both mandatory and voluntary IFRS adoption on the changes in the EM activities’ level. Under the convergence plan of the financial reporting framework in Saudi Arabia, IFRS accounting standards must be followed by all publicly accountable entities in KSA starting from 1 January 2017, and by all other entities starting from 1 January 2018. Following [66], this variable captures any disparity in EM between mandatory and voluntary adopters before the mandatory IFRS adoption date in KSA. Furthermore, we examine MTBV as there is a motivation to disclose earnings that grow with firms’ growth prospects [67,68]. We anticipate finding a positive relationship with MTBV. Previous research has established that males exhibit higher levels of overconfidence compared to females [69,70]. Hence, they are more prone to manage earnings. Ref. [71] observed a positive correlation between the inclusion of female directors and CSR levels. Furthermore, ref. [72] analyzed specific characteristics of boards of directors in relation to triple bottom line (TBL) sustainable performance. They found a significant positive coefficient on the female gender. Hence, this study predicts a negative coefficient on WOMEN. The size of the board may affect its functions, the level of EM, and therefore the financial firm performance. Several researchers found a non-linear relationship between board size and earnings manipulations [73,74]. Some other studies suggest that smaller boards can be more effective than larger boards; thus, they found a linear relationship between board size and EM level [75,76]. In relation to the size of the board of directors and sustainable management, research projects have shown that a larger number of directors can provide better guidance to management, reduce conflicts of interest, facilitate increased engagement with diverse stakeholders, and improve the disclosure level of financial, social, and environmental information [77,78,79]. Additionally, a larger board can contribute to greater diversity and resources that align with societal standards and values, thereby enhancing legitimacy [19,80,81]. Furthermore, a larger board is likely to have more experienced and skilled members who can effectively address various critical issues related to sustainable performance practices [74,82]. Then, the regression tests can be performed for the effect of CEO duality on EM (DUALITY). The CEO–chair would be expected to have greater firm knowledge than an external chair. A nonduality structure must be the default choice and the positions of the chairman and CEO should ideally be separated and held by different persons to avoid power concentration and CEO entrenchment. Empirically, it is proved that the likelihood that an EM practice will take place increases in firms with a dual CEO role [83,84,85]. We predict a positive sign on the DUALITY coefficient. Big audit firms may influence EM behavior [16,17,40,86]. The literature recognizes that the big auditors offer higher audit quality and provide better reliability to the audited firms than the non-big auditors. It is found that clients of the Big N auditors have lower absolute values of discretionary accruals since big audit firms are more conservative than non-big audit firms. Nevertheless, auditor scrutiny restrains managers’ aptitude to manage earnings using accruals [40]. Hence, the audited firms will choose REM [33]. In this line, ref. [17] found that the presence of a big audit firm is associated with greater REM. We predict a negative coefficient on big4 audit firms (BIG) when the dependent variable is AEM and a positive coefficient when the dependent variable is REM.

4. Empirical Analysis and Main Findings

4.1. Descriptive Analysis

Table 1. Summary statistics.

Variables	Mean	Std. Dev.	Percentiles
			25%	50%	75%
AEM	0.1954	0.1361	0.0620	0.0514	0.3742
AbnCFO	−0.0097	0.1107	−0.0262	0.0042	0.0381
AbnPROD	0.0352	0.6173	−0.4995	−0.1276	0.3795
AbnRD	0.0013	0.0149	−0.062	−0.0004	0.0058
AbnSGA	−0.0157	0.5271	−0.9114	−0.0057	0.7582
ESG	23.15	20.64	7.03	18.26	51.97
ENVS	18.20	17.53	0	14.93	47.06
SOCIALS	17.44	15.26	0	15.57	51.21
GOVS	39.57	27.10	6.94	21.82	70.37
FSIZE	17.78	6.03	2.16	13.61	20.58
DEBT	19.47	17.40	0	10.081	60
ROA	0.10	0.38	0	0.081	1

AEM is accruals-based earnings management, AbnCFO is abnormal CFO level, AbnPROD is abnormal production level, AbnRD is abnormal RD expense cutting level, AbnSGA is abnormal SGA expense cutting level, ESG is index for environmental, social, and corporate governance performance, ENVS is environmental performance score, SOCIALS is social performance score, GOVS is governance performance score, FSIZE is firm size, DEBT is firm debt level, ROA is return on assets, MTBV is market to book ratio, WOMEN is women managers, BSIZE is size of board of directors, BMEETINGS is number of board meetings, AUDITCOMINDEP is audit committee independence, ROTATION is auditor independence rotation.

presents summary statistics for continuous proxies. All the non-indicator variables are winsorized at the 1% and 99% levels to eliminate extreme observations. Please refer to Section 3 for further measurements and definitions.

The descriptive analysis reveals that the mean (standard deviation) value of AEM is 0.2823 (0.2615). This indicates that Saudi companies are committed to sustainability, manage the results upward, and apply income-increasing accounting policies. As explained in Section 3, the REM index combines the four proxies of the real activities. The abnormal levels of operating cash flows (AbnCFO), production costs (AbnPR), and discretionary expenditures (AbnDR and abnSGA) are the actual values of operating cash flows, production costs, and discretionary expenditures minus their normal levels based on the estimated result from the three models. Higher values of abnormal production costs (AbnPROD) indicate more REM by reporting a lower cost of goods sold to increase production. We multiply the residuals from the estimation models (2), (4), and (5) by (−1) such that higher values indicate a greater extent of REM by accelerating the timing of sales to increase price discounts or more lenient credit terms and by lessening discretionary expenses. The descriptive analysis suggests that the mean (median) from the REM index is 0.0038 (0.1046). The means of the four proxies abnCFO, abnPROD, abnRD, and abnSGA are not zero (−0.0023, 0.0102, 0.0001, and −0.0223, respectively). The mean value of the ESG performance index is about 23.15. This result shows an improvement of the ESG index among Saudi listed firms compared to the findings related to previous studies [60,87]. This enhancement is due to the efforts made by the government to promote sustainable growth in the kingdom through the 2030 vision. The descriptive analysis reveals that the mean (standard deviation) value of the ROA is 0.10 (0.38).

Table 2. Descriptive statistics for dichotomous variables.

	Obs (Value = 1)	%	Obs (Value = 0)	%
SUSREPORTING	110	59.46	75	40.54
SUSCOMMITTEE	85	45.95	100	54.05
GRIGUIDE	75	40.54	110	59.46
SUSAUDIT	60	32.43	125	67.57
COVID	74	40.00	111	60.00
IFRS	125	67.57	60	32.43
DUALITY	60	32.43	125	67.57
BIG	160	86.49	25	13.51
AUDITCOM	170	91.89	15	8.11

SUSREPORTING is CSR sustainability reporting, SUSCOMMITTEE is CSR sustainability committee, GRIGUIDE is GRI report guidelines, SUSAUDIT is CSR sustainability external audit, COVID is coronavirus pandemic period, IFRS is IFRS adoption, DUALITY is CEO–chairman separation, BIG is the presence of big4 audit firm, AUDITCOM is the presence of audit committee.

presents the frequencies of the dichotomous variables. First, the findings show that about 60% of the Saudi indexed companies committed to sustainability issue a separate sustainability report or publish a section in their annual reports on sustainable practices. Second, about 46% of the sampled companies have a CSR committee or team. Companies with CSR committees tend to have superior CSR performance and strategies, as well as fewer CSR controversies, compared to companies without CSR committees [56]. Third, 40% of the Saudi indexed companies committed to sustainability publish their sustainability report in accordance with the GRI guidelines. These companies present information in a manner that encompasses all their major effects on the planet, society, and financial performance. Fourth, 32% of the sampled companies hire an external auditor to review their sustainability report.

4.2. Earnings Management Estimations

Table 3. Estimation of the normal levels of total accruals, operating cash flow, cost of production, RD expenditures, and SGA expenditures.

Model 1: Accruals Accrualsit/At−1		Model 2: CFO CFOit/At−1		Model 3: PROD PRODit/At−1		Model 4: R&D RDit/At−1		Model 5: SG&A SGAit/At−1
Intercept	−0.0241 ***	Intercept	0.002 ***	Intercept	0.012 ***	Intercept	−0.004 ***	Intercept	0.039
1/At−1	−0.2379 **	1/At−1	0.080 ***	1/At−1	0.076 **	1/At−1	−0.067 **	1/At−1	1.127 ***
∆Sit/At−1	0.0211 ***	Sit/At−1	0.014 **	MVt	0.035 ***	MVt	−0.082 **	MVt	−0.000 ***
PPEit/At−1	−0.0905 **	∆Sit/At−1	−0.007 ***	Qt	0.080 ***	Qt	0.009	Qt	0.014 ***
				Sit/At−1	−0.002 ***	INTit/At−1	0.066 ***	INTit/At−1	0.652 ***
				∆Sit/At−1	0.001	RDit−1/At−1	0.972 ***	∆Sit/At−1	−0.017
				∆Sit−1/At−1	−0.000			(∆Sit/At−1) * DD	0.014
Adj R-Sq (%)	40	Adj R-Sq (%)	33	Adj R-Sq (%)	76	Adj R-Sq (%)	54	Adj R-Sq (%)	42

This table reports estimations from the normal levels of discretionary accruals, operating cash flow, production costs, and discretionary expenses. Accruals is total accruals, A is total assets, CFO is operating cash flow, PROD is production costs, RD is research and development expense, SGA is selling, general, and administrative expense, S is net sales, ΔS is variation in net sales, MV is market value, Q is Tobin’s Q, INT is internal funds, DD is an indicator variable equal to 1 when total sales decrease between t − 1 and t, and 0 otherwise. Asterisks ***, **, and * next to a coefficient indicate significance levels of 1%, 5%, and 10%.

displays the estimated residuals from models (1) to (5). All variables are winsorized at the 1st and 99th percentile levels to mitigate the impact of outliers. For variable definitions, please refer to Section 3 and Appendix A.

On average, all the mean coefficients are statistically significant and are in line with those reported in [31,33,88]. The adjusted R² values for the five models are 40 percent (accruals—Model 1), 33 percent (cash flow operations—Model 2), 76 percent (cost of goods sold—Model 3), 54 percent (RD expenditures—Model 4), and 42 percent (SGA expenditures—Model 5). These adjusted R² values indicate that these models have a reasonable to substantial degree of explanatory power.

4.3. Multicollinearity Analysis

Table 4. Multicollinearity analysis.

	Variables	1	2	3	4	5	6	7	8	9	10	11	12	13	14	15	16	17	18	19
1	AEM	1.000	0.002 **	0.002 *	−0.017 **	0.009	0.001 **	−0.023	−0.201 *	−0.282	−0.211 **	0.016 **	−0.072	0.015 *	0.031 **	−0.180	−0.029 *	−0.015 *	−0.112 *	0.026 **
2	REM		1.000	0.614 ***	0.629 **	0.720 **	0.618 **	−0.120 *	−0.223 **	−0.143 *	−0.175 **	0.127 ***	−0.054	0.072 *	0.052 **	−0.157	0.061 *	−0.108	0.021 *	0.190 ***
3	AbnCFO			1.000	0.781 **	0.651 **	0.635 **	−0.163 ***	−0.029	−0.150	−0.196	0.119 **	−0.023	0.051 **	0.017 *	−0.270	0.212	−0.290	0.015	0.162
4	AbnPROD				1.000	0.799 **	0.732 **	−0.027 *	−0.093	−0.022 *	−0.052	0.082 **	−0.015	0.072 *	0.023	−0.106	0.034 *	−0.154 *	0.032	0.134
5	AbnRD					1.000	0.605 ***	−0.080	−0.009	−0.064	−0.098	0.026 **	−0.064	0.052 **	0.077 *	−0.118	0.041	−0.103	0.007 **	0.115
6	AbnSGA						1.000	−0.016 *	−0.011	−0.092	−0.066	0.018 **	−0.088	0.019	0.091	−0.055	0.087 *	−0.086	0.026	0.019
7	ESG							1.000	0.823 ***	0.752 **	0.810 ***	0.193 ***	−0.021	0.083 **	0.018 **	0.042 ***	0.022 **	0.102 *	0.041	0.173 **
8	ENVS								1.000	0.901 *	0.836 **	0.085 *	−0.019	0.011 **	0.011	0.014 **	0.035	0.171	0.038 *	0.029 *
9	SOCIALS									1.000	0.750 **	0.177	0.003	0.097	0.097 **	0.026	0.016 *	0.083 *	0.019	0.116
10	GOVS										1.000	0.383 **	0.098	0.041 **	0054	0.077 *	0.009	0.091	0.046	0.132
11	FSIZE											1.000	0.198 **	0.034 ***	0.105	0.118 ***	0.253 **	0.170 *	0.088 **	0.062 *
12	DEBT												1.000	−0.028	−0.134	−0.265 **	0.113	0.172 *	0.001	0.101 *
13	ROA													1.000	0.014	0.019	0.011 *	0.035	0.044 *	0.026 *
14	MTBV														1.000	0.199	0.012	0.265 **	0.002	0.104
15	WOMEN															1.000	0.174	0.054	0.013	0.177
16	BSIZE																1.000	0.219 ***	0.081	0.144
17	BMEETINGS																	1.000	0.094	0.059
18	AUDITCOMINDEP																		1.000	0.198 ***
19	ROTATION																			1.000

AEM is accruals-based earnings management, REM is real earnings management, AbnCFO is abnormal CFO level, AbnPROD is abnormal production level, AbnRD is abnormal RD expense cutting level, AbnSGA is abnormal SGA expense cutting level, ESG is index for environmental, social, and corporate governance performance, ENVS is environmental performance score, SOCIALS is social performance score, GOVS is governance performance score, FSIZE if firm size, DEBT is firm debt level, ROA is return on assets, MTBV is market to book ratio, WOMEN is women managers, BSIZE is board of directors size, BMEETINGS is number of board meetings, AUDITCOMINDEP is audit committee independence, ROTATION is auditor independence rotation. Asterisks ***, **, and * next to a coefficient indicate significance levels of 1%, 5%, and 10%.

provides an overview of the correlation coefficients using a Pearson correlation coefficients matrix. After examining the correlation structure of the data, we noticed a significant correlation between REM, AbnCFO, AbnPROD AbnRD, and AbnSGA (correlation coefficients = 0.6 and 0.7) on one hand and between ESG, ENVS, SOCIALS, and GOVS on the other hand (correlation coefficients = 0.7, 0.8 and 0.9). These correlations are mechanistic, as the REM index involves managing three elements (CFO, PROD, RD, and SGA). Further, the ESG score is the sum of the main pillars (economic, social, environmental). Overall, the matrix shows that all other correlation coefficients are below 0.5 and above −0.5, indicating that the data panel is unbiased.

4.4. Hypotheses Validation and Results Discussion

The empirical analysis employed pooled ordinary least squares (POLS) regression. All continuous variables are winsorized at the 1st and 99th percentiles of their distribution to avoid the influence of outliers. Similar outcomes are achieved whether we winsorize at the 5th and 95th percentiles or at the 10th and 90th percentiles, or if we opt for median quantile regressions instead.

Regarding the impact of CSM and AEM activities,

Table 5. Empirical findings.

	Panel A	Panel B	Panel C	Panel D	Panel E	Panel F
	Y = AEM	Y = REM Index	Y = AbnCFO	Y = AbnPROD	Y = AbnRD	Y = AbnSGA
INTERCEPT	0.1827 ***	0.1241 ***	0.1902 ***	0.2918 **	0.1725 ***	0.2183 **
SUSREPORTING	−0.1921 ***	−0.1551 **	−0.1206 ***	−0.1461 *	−0.3011 **	−0.2061 **
SUSCOMMITTEE	−0.1054 *	−0.2980 **	−0.2273	−0.2950 **	−0.2143 **	−0.1502 *
GRIGUIDE	−0.2430 *	−0.1047 **	−0.1084 *	−0.0713 **	−0.0720 **	−0.1036 ***
SUSAUDIT	−0.1106 **	−0.2091 *	−0.1519	0.1008	−0.1256 **	−0.1945 *
ESG	−0.0031 **	−0.0748 **	−0.1155 *	−0.0562 **	−0.0914 *	−0.0824 ***
ENVS	−0.0128 *	−0.0191 **	−0.0782	−0.0490 **	−0.0235 *	−0.0214 **
SOCIALS	−0.0197	−0.0815 **	−0.0526 *	0.0312	−0.0821	−0.0411 *
GOVS	−0.0345 **	−0.0096	−0.0633 *	−0.0114 **	0.0166	−0.0019 **
FSIZE	0.0229 **	0.0157 *	0.0186 **	0.0285 *	0.0291 ***	0.0873
DEBT	−0.3402 **	−0.2710 *	0.1053	−0.2810 *	−0.2551 **	−0.1902 *
ROA	0.0014 *	0.0691 **	0.0752 *	0.0116	0.0822 **	0.0973 *
MTBV	0.0126 ***	0.0615 **	0.1254	0.1992 *	0.0710 **	0.0298 **
COVID	0.0231	0.0097	0.0083	0.0011	0.0065	0.0023
IFRS	−0.0001 **	0.0001 **	−0.0275	0.0068 **	0.0007 *	0.0016 *
WOMEN	−0.0526 **	−0.0187 **	−0.0120	−0.0972	−0.0835 *	−0.0129 *
BSIZE	−0.0927 *	−0.0736 *	0.0413	−0.0263 *	0.0198	0.0331
BMEETINGS	0.1534	0.1827	0.1058	0.2715	0.1513	0.2938
DUALITY	0.0182 *	0.0018 *	0.0192	0.0013	0.0283 *	0.0027
BIG	−0.0992 *	0.2981 *	0.3645	0.2834	0.1735 *	0.0281 *
AUDITCOM	−0.0431	−0.0912 *	0.0214	−0.0167	0.0529	0.0771
AUDITCOMINDEP	−0.0095 *	−0.0020	−0.0063	0.0038	0.0017	−0.0093
ROTATION	−0.1280	−0.1365 *	0.2402	−0.1302 *	0.1743	0.1961
DUMMIES	Included	Included	Included	Included	Included	Included

AEM is accruals-based earnings management, REM is real earnings management index, AbnCFO is abnormal CFO level, AbnPROD is abnormal production level, AbnRD is abnormal RD expense cutting level, AbnSGA is abnormal SGA expense cutting level, SUSREPORTING is CSR sustainability reporting, SUSCOMMITTEE is CSR sustainability committee, GRIGUIDE is GRI report guidelines, SUSAUDIT is CSR sustainability external audit, ESG is index for environmental, social, and corporate governance performance, ENVS is environmental performance score, SOCIALS is social performance score, GOVS is governance performance score, FSIZE is firm size, DEBT is firm debt level, ROA is return on assets, MTBV is market to book ratio, COVID is coronavirus pandemic period, IFRS is IFRS adoption, WOMEN is women managers, BSIZE is size of board of directors, BMEETINGS is number of board meetings, DUALITY is CEO–chairman separation, BIG is the presence of big4 audit firm, AUDITCOM is the presence of audit committee, AUDITCOMINDEP is audit committee independence, ROTATION is auditor independence rotation, DUMMIES are FIRMS, YEARS, INDUSTRIES. Asterisks ***, **, and * next to a coefficient indicate significance levels of 1%, 5%, and 10%.

, Panel A, shows a negative and significant coefficient on ${\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{R}\mathrm{E}\mathrm{P}\mathrm{O}\mathrm{R}\mathrm{T}\mathrm{I}\mathrm{N}\mathrm{G}}_{\mathrm{i}\mathrm{t}}$ (${\mathsf{\alpha }}_1=-0.1921)$, $\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{C}\mathrm{O}\mathrm{M}\mathrm{M}\mathrm{I}\mathrm{T}\mathrm{T}\mathrm{E}\mathrm{E}$ (${\mathsf{\alpha }}_2=-0.1054)$, $\mathrm{G}\mathrm{R}\mathrm{I}\mathrm{G}\mathrm{U}\mathrm{I}\mathrm{D}\mathrm{E} ({\mathsf{\alpha }}_3=-0.2430)$, $\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{A}\mathrm{U}\mathrm{D}\mathrm{I}\mathrm{T} ({\mathsf{\alpha }}_4=-0.1106)$, and $\mathrm{E}\mathrm{S}\mathrm{G} ({\mathsf{\alpha }}_5=-0.0031)$. These results indicate that sustainable oriented organizations, issuing sustainability reports, tend to lessen AEM activities. Furthermore, the results suggest that companies with CSR committees generally demonstrate higher performance in CSR and adopt more effective CSR strategies, while also being involved in fewer CSR controversies compared to companies without CSR committees. Additionally, CSR strategies are found to be most impactful when CSR committees have a larger membership. These findings align with the results by [5,49,50,81]. These executives are confident that by fulfilling sustainability goals, the firm’s value increases and shareholder equity loss decreases. Implementing a sustainable approach strengthens relationships with stakeholders, reduces asymmetric information, and minimizes conflicts of interest between principals and agents. In fact, sustainable practices are adopted to provide transparent and reliable financial reporting and consolidate owners’ trust as well as attract new investors, and lower asymmetric information. This inverse relationship between CSM and AEM activities can be due to the increased pressures in terms of monitoring, compliance with heightened scrutiny from regulators, investors, society, and the media, in environmentally, socially, and economically responsible firms. Since sustainable management is a managerial activity, these pressures may refrain the managers of these firms from engaging in questionable financial reporting practices.

As a robustness check, the study applied the Modified Jones Model of [39] to estimate discretionary accruals and measure AEM instead of the Jones Model. The untabulated results provide the same evidence.

REM is often motivated by the focus on short-term performance. Refs. [64,65] found that REM practices appear helpful in the current period, and it aids in reporting a good corporate picture. Managers that manage earnings upwards are likely to have one or all the three activities, namely, timing the sale of fixed assets to report gains, overproducing, and decreasing discretionary expenses. The result mentioned in Table 5, Panel B shows negative coefficients on ${\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{R}\mathrm{E}\mathrm{P}\mathrm{O}\mathrm{R}\mathrm{T}\mathrm{I}\mathrm{N}\mathrm{G}}_{\mathrm{i}\mathrm{t}}$ (${\mathsf{\alpha }}_1=-0.2091)$, SUSCOMMITTEE (${\mathsf{\alpha }}_2=-0.2980)$, $\mathrm{G}\mathrm{R}\mathrm{I}\mathrm{G}\mathrm{U}\mathrm{I}\mathrm{D}\mathrm{E} ({\mathsf{\alpha }}_3=-0.1047)$, $\mathrm{S}\mathrm{U}\mathrm{S}\mathrm{A}\mathrm{U}\mathrm{D}\mathrm{I}\mathrm{T} ({\mathsf{\alpha }}_4=-0.2091)$, and $\mathrm{E}\mathrm{S}\mathrm{G} ({\mathsf{\alpha }}_5=-0.0748)$. These findings indicate that CSM plays an important role in constraining REM practices. Our results align with those of [5,48], which can be explained by the fact that Saudi firms with strong sustainability management practices exhibit high levels of earnings transparency and lower levels of REM.

First, managers have the ability to speed up the sales by moving from the following year to the current year through methods such as raising price discounts or offering more flexible credit terms. The volume of sales increases with price discounts and lenient credit terms, e.g., lower interest rates offered by retailers and automobile manufacturers toward the end of the fiscal year increases sales in the current period. As the margins are positive, this additional sale helps to increase current period earnings. However, if the firm returns to the previous prices, the temporary increase in sale volume will disappear. Such sales’ manipulation will result in abnormally high sales level, higher production costs than what is normal given the sales level, and a lower cash flow per sale. To calculate the aggregate measure of REM, we multiplied the abnormal operating cash flows by (−1) (please refer to Section 3 for more details). As a result, higher values suggest that firms are reducing operating cash flows to artificially boost their earnings. Panel C shows negative and significant coefficients on SUSREPORTING, GRIGUIDE, and the ESG score. These findings indicate that sustainable management is negatively correlated with accelerating the timing of sales through increasing price discounts or more lenient credit terms.

Second, to increase earnings in current period, managers can produce more than necessary. Due to overproduction, firms may build up excess inventory to report a lower cost of goods sold since fixed overhead costs are spread over a larger number of units, lowering fixed costs per unit. The decline in the cost of goods sold helps firms to increase operating margins. Yet, firms still acquire other production and exhibit costs that are not recovered in the same period through sales. Therefore, cash flows from operations will be lower relative to the normal sales levels. The empirical results presented in Panel D show negative and significant coefficients on SUSREPORTING, SUSCOMMITTEE, GRIGUIDE, and the ESG score. This signifies that sustainable management practices are negatively correlated with reporting a lower cost of goods sold through increasing production.

Finally, to improve margins and boost current period earnings, managers may reduce discretionary expenses that comprise RD expenditures, advertising expenses, and selling, general, and administrative expenses (employee training, maintenance and travel, etc.). Such expenses are usually expensed in the same period that they are incurred. Henceforth, firms can lessen reported expenses when they do not engender immediate revenues and income. If the firm usually paid for these discretionary expenses in the form of cash, reducing these expenses will positively affect abnormal cash flows in the current period. To calculate the aggregate measure of REM, we multiplied the abnormal discretionary expenses (i.e., RD and SGA) by (−1) (please refer to Section 3). Therefore, higher values suggest that firms have reduced discretionary spending to boost reported earnings. Our result displayed in Panels E and F show negative and significant coefficients on SUSREPORTING, SUSCOMMITTEE, GRIGUIDE, SUSAUDIT, and the ESG score. This indicates that sustainable management is negatively correlated with lessening discretionary expenses including advertising expenses, RD expenses, and selling, general, and administrative expenses to improve reported earnings.

The coefficient on FSIZE is positive and significant in most panels. Large corporations tend to have more intricate operational processes and face a greater pressure to meet heightened investor demands. As a result, larger companies are more inclined to engage in EM, as they have a stronger motivation to do so according to the political costs’ hypothesis. The negative coefficient on DEBT is in conformity with the debt covenant hypothesis predicted by the positive accounting theory. Our result signifies that Saudi companies committed to sustainable management tend to reduce the debt ratio to increase current earnings. REM is frequently driven by the emphasis on short-term earnings upward. This can explain the positive and significant coefficient on the ROA. As predicted, firm growth (MTBV) is found to be positively linked to EM techniques. The WOMEN’s coefficient exhibits a negative correlation, which supports the idea that women do not engage in manipulating earnings. Women tend to behave more ethically than men and are generally less accepting of unethical behavior. This finding is aligned with the results found by [69,70]. Regarding the size of the board of directors and EM techniques, Panels A and B show a negative coefficient on BSIZE at the 10 percent level. Therefore, a larger number of directors in the board can provide better guidance to management, reduce conflicts of interest, and facilitate increased engagement with diverse stakeholders. This is due to the more experienced and skilled members who can effectively address various critical issues and to the greater diversity and resources that align with societal standards and values, thereby enhancing legitimacy.

5. Conclusions

The main goal of this study was to investigate how CSM influences the level of EM techniques (AEM and REM). This examination responds to the inquiries posed by [89,90] related to examining the correlation between EM and ESG sustainability disclosure within a social norms’ framework rather than ethical considerations. Using financial and non-financial data from 37 Saudi indexed firms spanning 2018 to 2022, the empirical outcomes revealed that Saudi sustainable firms with strong CSM are less likely to engage in AEM practices. Hence, CSM plays an important role in constraining EM using accruals, and in providing transparent and reliable financial reporting. Furthermore, the findings revealed that higher CSM is associated with reduced REM index levels in Saudi indexed firms. Additionally, the study identifies a negative relationship between CSM and the components of the REM index as follows: CSM–sales manipulation, CSM–overproduction, and CSM–cutting discretionary expenditures. We conclude that firms in a religious environment, such as KSA, do not tend to employ EM when they operate within a sustainable management system.

Managerial and policy implications: The results of this study hold significance for researchers, managers, and policymakers seeking insights into the impact of sustainable management on EM in religiously influenced businesses. This study provides a resource for executives and investment managers of indexed companies in Saudi Arabia and other Middle Eastern firms. It focuses on the importance of the board of directors in implementing sustainable policies and practices to help these companies be included in major sustainability indexes. Furthermore, this research provides valuable information for investors. By applying the principles of the generalized agency theory, which views managers as representatives of all stakeholders, this study will be beneficial for investors seeking a thorough evaluation of financial reporting quality to support their investment decisions. As investors are interested in enhancing sustainability, ESG scores are an essential tool to evaluate a company’s sustainability and ethical practices. The empirical findings offer valuable insights to policymakers aiming to improve sustainability by gaining a more profound comprehension of the operational methods within a business and management behaviors exhibited by Saudi companies. This research serves as a caution to policymakers that some efforts to enhance a company’s accountability could inadvertently impede other unethical behaviors. Managers are tasked with carrying out social or environmental initiatives to cater to both shareholders and non-shareholding stakeholders. However, they may utilize sustainable management as a guise.

Future investigations: The outcomes of this work propose new areas of exploration for both corporate governance and stakeholder perspectives. In addition to the three REM modalities highlighted by [33], future investigations can use different measures to proxy for REM activities as used by previous studies, such as the timing of asset sales [91] and the Just-In-Time production method [92].