CFOs’ Risk Preferences in Earnings Management: The Joint Effect of Risk-decreasing and Risk-increasing Incentives

Abstract

This study examines whether the equity incentives of the CFO are associated with earnings management. Prior research investigates delta and vega for the average of the top five executives on the firm’s financial misreporting. The top 5 executives variable most likely captures the culture of the firm as a whole rather than any one executive. We examine the CFO who is ultimately responsible for the quality of financial reporting. We find a negative effect of CFOs’ risk-decreasing incentives (delta) and a positive effect of CFOs’ risk-increasing incentives (vega) on our accrual-based earnings management proxies. Thus, we find the CFO responds to equity incentives differently from the average of the top five executives and that CFOs undertake or abstain from earnings management when it benefits their own wealth rather than shareholders’ interests.

Keywords: Equity Incentives, Executive Compensation, Risk-taking, Earnings Management, Accrual Earnings Management

JEL Classification: J33, G34, M41, M52