The dark side of CEO social capital: Evidence from real earnings management and future operating performance

Posted: 9 Mar 2021

See all articles by Paul A. Griffin

Paul A. Griffin

University of California, Davis - Graduate School of Management

Hyun A. Hong

University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management

Yun Liu

Claremont Colleges - Keck Graduate Institute

Ji Woo Ryou

West Virginia University

Date Written: March 3, 2021

Abstract

We examine the role of CEO social capital as an important driver of the widespread practice of real earnings management (REM). Using the number of social connections to outside executives and directors to measure CEO social capital, we first find that well-connected CEOs associate with higher levels and volatilities of REM. The positive relation between REM and CEO network size is stronger when the CEO connects with more informed and influential persons, and when a more severe misalignment of interests can occur. Second, we find a contagion of REM among well-connected CEOs in an industry. Third, the level of REM induced by a large CEO social network associates negatively with future operating performance. This result is consistent with social capital circulating REM-related information ex-ante and increasing the power and influence for the CEO to deviate from optimal operating policies ex-post. Social capital shields the well-connected executive in the takeover and labor markets despite possible suboptimal future operating performance. While the prior literature finds that CEO social capital reduces accrual earnings management, our findings suggest a dark side of CEO social capital: it induces excessive levels and volatilities of REM costly to the firm in the long-run while imposing relatively low personal risk on the top executive.

Keywords: Network size, CEO social capital, Real earnings management. Future operating performance

JEL Classification: G30, L14, M41

Suggested Citation

Griffin, Paul A. and Hong, Hyun A. and Liu, Yun and Ryou, Ji Woo, The dark side of CEO social capital: Evidence from real earnings management and future operating performance (March 3, 2021). Journal of Corporate Finance, forthcoming. https://doi.org/10.1016/j.jcorpfin.2021.101920, Available at SSRN: https://ssrn.com/abstract=3796631

Paul A. Griffin (Contact Author)

University of California, Davis - Graduate School of Management ( email )

3102 Gallahger Hall
Davis, CA 95616
United States
(530) 752-7372 (Phone)
(425) 799-4143 (Fax)

HOME PAGE: http://www.gsm.ucdavis.edu/griffin/

Hyun A. Hong

University of California, Riverside (UCR) - A. Gary Anderson Graduate School of Management ( email )

Riverside, CA 92521
United States

Yun Liu

Claremont Colleges - Keck Graduate Institute ( email )

535 Watson Drive
Claremont, CA 91711
United States

Ji Woo Ryou

West Virginia University ( email )

PO Box 6025
Morgantown, WV 26506
United States

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