Skip to main content
SpringerLink
Log in

Chalk it up to experience: CEO general ability and earnings management

  • Original Research
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

We provide evidence that firms managed by CEOs with high general ability, or broad experience in their background, are more likely to utilize discretionary accruals to manage earnings than CEOs with focused experience. Cross-sectional variation suggests that the mechanism underlying the increased use of discretionary accruals is generalist CEOs’ increased willingness to bear the risk inherent in managing earnings given their enhanced tolerance for failure stemming from outside career options. Importantly, the practice is more pronounced for CEOs of firms with suspect earnings. To better control for unobservable variation between generalists and specialists, we use a propensity score-match sample and entropy balancing to adjust the sample to balance differences between firms with generalists and firms with specialists and firm fixed effects. The evidence suggests that the diversity of CEOs’ experience influences incentives to manage earnings. The increased trend to hire generalist CEOs may be coupled with an unintended increase in the use of discretionary accruals, largely stemming from the outside employment options of these executives.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. The results in the paper are robust to firm-level clustering.

  2. Our primary control for tenure is the length of service of a CEO at her/his current institution. Another concern may be that results are driven by tenure across all institutions that the CEO has worked at. In unreported results, we find that including this measure has no material impact on the findings.

  3. Some literature suggests that firms do not use writedowns as a way to strategically manage earnings by using discretionary accruals (e.g., Rees et al. 1996). We find evidence of this. Specifically, the coefficient on the level term for writedowns is negative and significant, suggesting that firms do not use writedowns to strategically manage earnings, on average. The interaction suggests that generalists are statistically more likely to utilize writedowns in this way, consistent with the notion that these CEOs are more willing to take risk in managing earnings.

  4. The control variable for managerial ability in the paper is based on raw values. In unreported results, we also find that the results are robust if we use ranked values of managerial ability.

References

  • Ali A, Zhang W (2015) CEO tenure and earnings management. J Account Econ 59:60–79

    Article  Google Scholar 

  • Bird RC, Knopf JD (2015) The impact of local knowledge on banking. J Financ Serv Res 48:1–20

    Article  Google Scholar 

  • Bishara ND, Martin KJ, Thomas RS (2015) An empirical analysis of noncompetition clauses and other restrictive postemployment covenants. Vanderbilt Law Rev 68:1

    Google Scholar 

  • Burgstahler D, Dichev I (1997) Earnings management to avoid earnings decreases and losses. J Account Econ 24(1):99–126

    Article  Google Scholar 

  • Chen X, Cheng Q, Wang X (2015) Does increased board independence reduce earnings management? Evidence from recent regulatory reforms. Rev Account Stud 20(2):899–933

    Article  Google Scholar 

  • Cho H, Choi GY (2023) Managerial ability and revenue-expense matching: accrual estimation versus real business decision. Asia-Pac J Account Econ 30(4):1120–1135

    Google Scholar 

  • Choi TH, Pae J (2011) Business ethics and financial reporting quality: evidence from Korea. J Bus Ethics 103(3):403–427

    Article  Google Scholar 

  • Custódio C, Ferreira M, Matos P (2013) Generalists versus specialists: Lifetime work experience and chief executive officer pay. J Financ Econ 108:471–492

    Article  Google Scholar 

  • Custódio C, Ferreira M, Matos P (2017) Do general managerial skills spur innovation? Manag Sci 65:459–954

    Article  Google Scholar 

  • Dechow PM, Dichev ID (2002) The quality of accruals and earnings: the role of accrual estimation errors. Account Rev 77(s-1):35–59

    Article  Google Scholar 

  • Demerjian PR, Lev B, McVay SE (2012) Quantifying managerial ability: a new measure and validity tests. Manag Sci 58:1229–1248

    Article  Google Scholar 

  • Demerjian PR, Lev B, Lewis MF, McVay SE (2013) Managerial ability and earnings quality. Account Rev 88:463–498

    Article  Google Scholar 

  • Francis J, Huang AH, Rajgopal S, Zang AY (2008) CEO reputation and earnings quality. Contemp Account Res 25:109–147

    Article  Google Scholar 

  • Garmaise MJ (2011) Toes that truly bind: noncompetition Agreements, executive compensation, and firm investment. J Law Econ Organ 27:376–425

    Article  Google Scholar 

  • Hainmueller J (2012) Entropy balancing for causal effects: a multivariate reweighting method to produce balanced samples in observational studies. Polit Anal 20(1):25–46

    Article  Google Scholar 

  • Hazarika S, Karpoff JM, Nahata R (2012) Internal corporate governance, CEO turnover, and earnings management. J Financ Econ 104:44–69

    Article  Google Scholar 

  • Hribar P, Nichols D (2007) The use of unsigned earnings quality measures in tests of earnings management. J Account Res 44:1017–1053

    Article  Google Scholar 

  • Hribar P, Yang H (2016) CEO overconfidence and management forecasting. Contemp Account Res 33:204–227

    Article  Google Scholar 

  • Jones JJ (1991) Earnings management during import relief investigations. J Account Res 29:193–228

    Article  MathSciNet  Google Scholar 

  • Kabir M, Rashid H (2023) Do generalist CEOs engage in more tax avoidance than specialist CEOs? Account Bus Res 2023:1–27

    Article  Google Scholar 

  • Kim R (2022) Do more able managers provide better non-GAAP earnings? Account Finance. Ahead of Print. https://doi.org/10.1111/acfi.12941

  • Liu M, Tian S, Zhang Y (2023) CEO marital status and corporate tax planning behavior? Rev Quant Financ Acc 61(4):1207–1242

    Article  Google Scholar 

  • Marquez-Illescas G, Zebedee A, Zhou L (2019) Hear me write: does CEO narcissism affect disclosure? J Bus Ethics 159:401–417

    Article  Google Scholar 

  • McNichols MF (2002) Discussion of the quality of accruals and earnings: the role of accrual estimation errors. Account Rev 77(s-1):61–69

    Article  Google Scholar 

  • Milbourn TT (2003) CEO reputation and stock-based compensation. J Financ Econ 68:233–262

    Article  Google Scholar 

  • Murphy KJ, Zabojnik J (2007) Managerial capital and the market for CEOs. SSRN 984376

  • Olsen KJ, Stekelberg J (2016) CEO narcissism and corporate tax sheltering. J Am Tax Assoc 38:1–22

    Article  Google Scholar 

  • Rijsenbilt A, Commandeur H (2012) Narcissus enters the courtroom: CEO narcissism and fraud. J Bus Ethics 117:413–429

    Article  Google Scholar 

  • Roychowdhury S (2006) Earnings management through real activities manipulation. J Account Econ 42(3):335–370

    Article  Google Scholar 

  • Shen Y (2021) CEO characteristics: a review of influential publications and a research agenda. Account Finance 61(1):361–385

    Article  Google Scholar 

  • Sun J, Liu G, Lan G (2011) Does female directorship on independent audit committees constrain earnings management? J Bus Ethics 99(3):369–382

    Article  Google Scholar 

  • Xu X (2023) Generalist CEOs, management risk and internal control weaknesses. J Bus Finance Account. https://doi.org/10.1111/jbfa.12691

  • Zang A (2012) Evidence on the trade-off between real activities manipulation and accrual-based earnings management. Account Rev 87(2):675–703

    Article  Google Scholar 

Download references

Acknowledgements

We appreciate feedback from Busra Agcayazi (Discussant), participants at the 2021 Southwest Finance Association Annual Meeting, seminar participants at Washington State University, and anonymous reviewers. We are grateful to Cláudia Custódio, Miguel Ferreira, and Pedro Matos for making the general ability index data available and sharing with us the updated sample. We are grateful to Robert Bird and John Knopf for sharing with us their state-level data on the strength of enforceability of non-competition agreements.

Funding

No funding was received to assist with the preparation of this manuscript.

Author information

Authors and Affiliations

  1. College of Business, Bryant University, 1150 Douglas Pike, Smithfield, RI, 02917, USA

    Leila Zbib

  2. Lucas College and Graduate School of Business, San Jose State University, San Jose, CA, 95112, USA

    Kourosh Amirkhani

  3. Carson College of Business, Washington State University, Pullman, WA, 99164, USA

    Douglas Fairhurst

Authors
  1. Leila Zbib
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Kourosh Amirkhani
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Douglas Fairhurst
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Leila Zbib.

Ethics declarations

Competing interests

The authors have no competing interests to declare that are relevant to the content of this article.

Additional information

Publisher's Note

Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.

Appendix: Variable descriptions

Appendix: Variable descriptions

Variable

Description

Big N

Indicator variable equal to one if the audit firm belongs to the Big N audit firms (Compustat BIGN)

Bonus Compensation

Log of one plus total CEO bonus compensation (Execucomp BONUS)

Leverage

Total liabilities adjusted to the book value of assets (Compustat [DLC + DLTT]/AT))

CEO Age

CEO age (Execucomp)

CEO Tenure

Number of years as CEO in the current firm (Execucomp)

First 3 Years

Indicator variable equal to one if it is the CEO’s first three years in his or her current position, and zero otherwise (Boardex)

GAI Generalist

First factor of applying principal components analysis to five proxies of general managerial ability: past number of positions, number of industries, number of firms, indicator variable for CEO experience, indicator variable for conglomerate experience (Custódio et al. (2013))

Indicator variable equal to one if the CEO’s general ability index is above the yearly median, and zero otherwise (Custódio et al. (2013))

Goodwill

An indicator variable equal to one if the impairment of goodwill expense is nonzero, and zero otherwise (Compustat GDWIP)

Last Year

An indicator variable equal to one it is the CEO’s last year in his or her current position (Boardex)

Loss

Indicator variable equal to one if the net income is negative, and zero otherwise

MAI

Portion of variation in sales attributable to the managerial fixed effects (Demerjian et al. (2012))

Market to Book

Market value of assets divided by the book value of assets (Compustat [DLC + DLTT + PRCC_F*CSHO + PSTKL]/AT)

Non-Compete Enforcement

Log of one plus the non-compete enforcement index in a firm’s headquarters state (see Garmaise (2009))

Restructuring

An indicator variable equal to one if the restructuring costs pretax is nonzero, and zero otherwise (Compustat RCP)

R&D

Research and development expense divided by the sales (Compustat XRD/SALE). XRD is set to zero if missing

Sales Growth

Book value of sales in year t over book value of sales in year t−1, minus one

Size

Log of the market value of equity (Compustat [PRCC_F*CSHO])

Suspect Tobins’Q

An indicator variable equal to one if the level of earnings deflated by lagged total assets or change in earnings per share is between zero and 0.05, and zero otherwise (Compustat)

Market value of equity plus the total assets minus the book value of common equity divided by the total assets (Compustat [PRCC_F*CSHO + TA-CEQ]/TA)

Writedowns

An indicator variable equal to one if the Writedowns cost is nonzero, and zero otherwise (Compustat WDP)

WriteOffs

An indicator variable equal to one if any one of the three corporate events, i.e. Goodwill, Restructuring, and Writedowns, is nonzero, and zero otherwise

Rights and permissions

Springer Nature or its licensor (e.g. a society or other partner) holds exclusive rights to this article under a publishing agreement with the author(s) or other rightsholder(s); author self-archiving of the accepted manuscript version of this article is solely governed by the terms of such publishing agreement and applicable law.

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Zbib, L., Amirkhani, K. & Fairhurst, D. Chalk it up to experience: CEO general ability and earnings management. Rev Quant Finan Acc 62, 1007–1036 (2024). https://doi.org/10.1007/s11156-023-01228-2

Download citation

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-023-01228-2

Keywords

JEL Classification

Search

Navigation