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

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.