Internal Governance and Real Earnings Management Flashcards
Definition of real earnings management by Cheng, Lee..
management actions that deviate from normal business practices, undertaken with the primary objective of meeting certain earnings thresholds
Why key subordinate executives usually care more about the long-term firm value than the CEO?
1) some of these executives desire to become the CEO in the future
2) executives have more to lose relative to their total wealth from corporate underperformance than the CEO. They are usually younger and have more remaining years of employment.
3) a manager’s outside opportunity wage depends on other managers’, including the CEO’s, actions and firm performance
The effectiveness of internal governance depends on … (2)
1) the decision horizon of key subordinate executives 2) the influence they have on the CEO
Main Finding of Cheng, Lee..
The extent of real earnings management decreases with subordinate executives’ horizon and relative compensation
Factors that affect the effect of internal governance (3)
1) key subordinate executives’ ability to influence the CEO’s decision hinges on their contribution to firm performance, and we argue that their contribution is greater when the firm’s operations are more complex
2) the impact of internal governance is stronger when operation complexity is higher
3) the effect of internal governance is stronger when the CEO is more effectively monitored and less powerful
4) the effect of internal governance is attenuated for firms in financial distress, for firms that routinely meet or beat earnings targets, and for firms with upcoming financing activities
5) internal governance is more effective in constraining real earnings management for firms in more homogenous and competitive industries -> CEOs presumably have greater career concerns -> manage earnings to report better financial performance
6) less effective in constraining real earnings management for firms with large forthcoming fixed-date option grants
