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

56 Pages Posted: 29 Nov 2010

See all articles by Chong Wang

Chong Wang

Naval Postgraduate School - Graduate School of Business and Public Policy

Elizabeth A. Demers

University of Lausanne - Department of Accounting and Control

Multiple version iconThere are 3 versions of this paper

Date Written: November 28, 2010

Abstract

Our study investigates, using both theoretical and archival empirical methods, the role of CEO career concerns as a determinant of earnings management behavior. The significance of earnings management in market economies is well documented. Our investigations are motivated by the disconnect between recent survey evidence documenting that executives prioritize implicit contracting (i.e., labor market) concerns when making earnings management decisions (Graham et al (2005)) and the extant academic literature’s focus on explicit contracting explanations. We first 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. Our model leads to the surprising prediction that, absent explicit compensation contracts, managers do not engage in income-increasing earnings management early in their careers. By contrast, later career stage CEOs are "trapped" into managing earnings upward even though the market correctly foresees this classic type of "signal jamming". Consistent with this, we present robust new empirical evidence that CEO age is a statistically and economically significant determinant of real activities and accruals-based earnings management levels. After numerous robustness tests to discriminate between our hypothesis and alternative explanations for the significance of CEO age, we conclude that implicit career stage incentives are important determinants of corporate earnings management. Our findings are consistent with executives' self-insights regarding their behavior, while also suggesting that CEO age may be a significant correlated omitted variable in prior academic earnings management studies.

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

JEL Classification: M40, M41

Suggested Citation

Wang, Chong and Demers, Elizabeth A., The Impact of CEO Career Concerns on Accruals Based and Real Earnings Management (November 28, 2010). Finance and Corporate Governance Conference 2011 Paper. Available at SSRN: https://ssrn.com/abstract=1716535 or http://dx.doi.org/10.2139/ssrn.1716535

Chong Wang (Contact Author)

Naval Postgraduate School - Graduate School of Business and Public Policy ( email )

555 Dyer Road
Monterey, CA 93943
United States

Elizabeth A. Demers

University of Lausanne - Department of Accounting and Control ( email )

UNIL-Dorigny
Anthropole
Lausanne, 1015
Switzerland

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