CEO characteristics and Real Earnings Management

Abstract

Real earnings management (REM) behaviour can be influenced by external factors, including agency cost, political costs, and compensation motivations. Consequently, prior research investigated REM with respect to these aspects. While previous research has explored REM behaviour within these contexts, there has been a lack of attention paid to how a CEO's characteristics might play a role in these intricate situations. This thesis addresses this gap by demonstrating how a CEO’s traits interact with these external factors to shape REM practices, and the three papers are interconnected by this viewpoint. This method not only addresses gaps in the current body of literature but also underscores the significance of examining the decision-making processes of managers regarding REM by taking into account both internal CEO characteristics and external factors. Therefore, the first study investigates how narcissistic CEOs influence REM taking into account how this dynamic may change under Corporate Social Responsibility (CSR). Namely, this study set out how the interaction between CSR and CEO narcissism influences REM behaviour. To answer this question, a sample of firms listed on the S&P 500 Index from 2008 to 2020 was used. In accordance with previous studies, the first paper reveals a negative relationship between CSR and REM and a positive relationship between CEO narcissism and REM. Interestingly, the interaction term reveals that CSR improves earnings quality by reducing this positive association between CEO narcissism and REM. This is a consequence of the reduced information asymmetry and increased involvement of stakeholders that these CSRs bring, as well as the ability of CSR to redirect the interpersonal strategies of the CEO narcissism system, leading narcissistic CEOs to engage more in CSR and less in REM in order to improve the firm's image and achieve a sense of pride and dominance. The second paper examined whether the relationship between government contract and REM is conditional upon the ability of managers. While prior studies have examined political cost through government contracts as a factor determining earnings management (EM) behaviour in politically sensitive firms, this study demonstrates that managerial characteristics interact to determine EM behaviour. A sample of 162,756 firm-year observations of US companies in COMPUSTAT from 1980 to 2020 was examined. This study found that due to the monitoring that comes with government contracts, contractors engage in REM as a less detectable EM method. However, REM activity is reduced if the contractor firm is led by highly able managers. The third paper investigated whether the relationship between industry tournament incentives and REM is influenced by the ability of managers. The inconsistent results of previous studies that have examined the relationship between industry tournament incentives and REM have served as motivation for this study. The findings indicate that firms are more likely to engage in REM as a consequence of CEO industry tournament incentives. However, the level of involvement in REM reduces when the company is managed by high-ability managers. This finding suggests that managerial characteristics influence EM behaviour, highlighting the importance of employing high-ability managers to mitigate any potentially unethical consequences. This finding was achieved by studying a sample of 26,255 firm-year observations covering all US firms in COMPUSTAT from the years 1992–2020. The findings are robust, involving a number of sensitivity tests. This research empirically contributes to the EM literature by indicating that the influence of external factors (CSR, political connection, and industry tournament incentives) is subject to the CEO's characteristics.