International Evidence on the Relationship Between ESG Decoupling and Earnings Quality

ABSTRACT This study examines the association between environmental, social, and governance (ESG) decoupling and earnings quality (EQ) using an international sample of firms over the period 2005–2024. ESG decoupling refers to the misalignment between firms' ESG disclosure and ESG performance. The results show that ESG decoupling is negatively associated with EQ, suggesting that greater divergence between what firms communicate about ESG and what they substantively achieve is linked to lower‐quality financial reporting. This finding is consistent with legitimacy theory, which distinguishes between symbolic and substantive organisational behaviour. Further analysis shows that the negative association is stronger in countries with weaker governance quality, indicating that the institutional environment shapes the extent to which ESG misalignment is associated with reporting quality. Additional tests distinguishing between the direction of misalignment reveal that greenwashing is negatively associated with EQ, whereas brownwashing is not significantly associated with EQ. Overall, the findings extend the literature by showing that ESG decoupling is relevant to both the credibility of sustainability reporting and financial reporting quality, and that this association varies across governance settings.