Sustainability as a Selective Safeguard: ESG, Earnings Management Types, and Financial Distress in an Emerging Market

ABSTRACT This study examines whether environmental, social, and governance (ESG) performance is associated with lower financial distress arising from earnings management in an emerging market and whether this association differs for accrual‐based earnings management (AEM) versus real earnings management (REM). While prior research generally treats ESG as a uniformly effective governance mechanism, it largely overlooks differences in strategies adopted by managers for earnings management and the conditions under which ESG can constrain such actions. Addressing this gap, this study conceptualizes ESG as a selective governance safeguard whose effectiveness depends on the nature of earnings management. Drawing on agency, stakeholder, and signalling theories, we argue that ESG may attenuate the negative risk arising from accounting‐based opacity but not from real operational manipulation. Using a panel of 569 Indian nonfinancial firms from 2019 to 2023 and fixed effects regressions, we examine the interplay between AEM, REM, and financial distress proxied by the emerging‐market Altman Z ‐score. The results show that ESG attenuates the negative association between AEM and financial health but does not moderate the relationship between REM and financial health. Results are robust to winsorization and GMM estimations. These findings identify a key boundary condition in ESG's governance role, suggesting that ESG is not a comprehensive safeguard against all forms of managerial opportunism.