The Impact of CEO Career Concerns on Accruals Based and Real Earnings Management*

Abstract:     
This paper theoretically and empirically investigates the role of CEO career concerns on accruals based and real activities earnings management. We develop a model of earnings management, rooted in career concerns, that alternatively incorporates the features of the accrual accounting performance measurement system and the negative value-destroying effects of real activities earnings management choices. Given the reversing nature of accruals and the value destruction associated with certain discretionary expenses, our model leads to the surprising prediction that, absent explicit compensation contracts, managers who maximize lifetime compensation in a perfectly competitive labor market would have little incentive to engage in income-increasing accruals manipulation or real activities earnings management in the early stages of their careers. By contrast, managers in the later stages of their careers are "trapped" into managing earnings upward in order to influence their post-retirement labor market value even though the market correctly foresees this type of "signal jamming." Our empirical results support the hypotheses that younger managers engage in less accruals-based and real earnings management. For a subsample of firms that are likely to be under heightened pressure to manage earnings, we find that younger managers choose the "lesser of two evils" by managing accruals rather than undertaking real activities that ultimately have value-destroying consequences.

Number of Pages in PDF File: 47

Keywords: earnings management, career concerns, discretionary accruals, real activities earnings management

JEL Classification: M40, M41

working papers series