CFOs and CEOs: Who Have the Most Influence on Earnings Management?

Abstract

This study examines the association between CFOs' equity incentives and earnings management. CEOs' equity incentives have been shown to be associated with accruals management, beating earnings benchmarks, and earnings restatements (Bergstresser and Philippon, 2006; Cheng and Warfield, 2005; McAnally et al. 2007; and Burns and Kedia, 2006). Given that CFOs' primary responsibility is financial reporting, we argue that for a given level of equity incentives the CFO's incentives should play a stronger role than those of the CEO. Consistent with this prediction, we find that the magnitude of discretionary accruals and the likelihood of beating benchmarks and earnings restatements are more sensitive to the CFOs' equity incentives than to those of the CEO. Our evidence supports the SEC's new disclosure requirement on CFO compensation.

Keywords: compensation, earnings management, equity incentives, CFO

JEL Classification: M52, J33, M41, M43, M44, G34, G29, G38