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The Impact of CEO career concerns on accruals based and real earnings management

Author: Demers, Elizabeth ; Wang, ChongINSEAD Area: Accounting and Control Series: Working Paper ; 2010/13/AC Publisher: Fontainebleau : INSEAD, 2010.Language: EnglishDescription: 46 p.Type of document: INSEAD Working Paper Online Access: Click here Abstract: This paper theoretically and empirically investigates the role of CEO career concerns on accruals-based and real activities earnings management. We 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 choices. Our model leads to the surprising prediction that, in the absence of explicit compensation contracts, managers who maximize lifetime compensation in a perfectly competitive labour market would have little incentive to engage in incomeincreasing accruals manipulation or real activities earnings management in the early stages of their careers. By contrast, mature executives are into managing earnings upward in order to influence their post-retirement labour market value even though the market correctly foresees this type of “signal jamming”. Our empirical results support the hypotheses that younger managers engage in less accruals-based and real earnings management than older CEOs, even after controlling for explicit compensation and wealth-based incentives, as well as other factors that have been shown to be associated with earnings management. We also find evidence that younger managers choose the “lesser of two evils” by managing accruals rather than opting for value-destroying real activities earnings management choices.
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This paper theoretically and empirically investigates the role of CEO career concerns on accruals-based and real activities earnings management. We 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 choices. Our model leads to the surprising prediction that, in the absence of explicit compensation contracts, managers who maximize lifetime compensation in a perfectly competitive labour market would have little incentive to engage in incomeincreasing accruals manipulation or real activities earnings management in the early stages of their careers. By contrast, mature executives are into managing earnings upward in order to influence their post-retirement labour market value even though the market correctly foresees this type of “signal jamming”. Our empirical results support the hypotheses that younger managers engage in less accruals-based and real earnings management than older CEOs, even after controlling for explicit compensation and wealth-based incentives, as well as other factors that have been shown to be associated with earnings management. We also find evidence that younger managers choose the “lesser of two evils” by managing accruals rather than opting for value-destroying real activities earnings management choices.

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