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Study: Earnings Management Key to Corporate Accounting Success

Aug 17th 2015
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Here's the quick version of a new study that links a propensity for earnings management and certain personality traits with the likelihood of getting a senior-level corporate accounting position: Nice people don't get the job.

“We couldn't help but be surprised by the overwhelming consensus in favor of a [job] candidate whom study participants considered inferior in just about every aspect of management except the ability to remove roadblocks to reporting a profit,” Scott Jackson, a professor in the University of South Carolina Darla Moore School of Business, who conducted the study with colleagues Ling Harris and Joel Owens, said in a prepared statement.

We know that you're shocked, simply shocked.

But, really, there's been speculation for about 30 years that those who are most likely to – how to put it? – cook the books in a for-profit public company have the greatest chance of moving up the corporate ladder.

In the study, Earnings Management and Employee Selection, which was presented during the annual meeting of the American Accounting Association earlier this month, the three professors say “economic Darwinism” will allow business practices, like earnings management, to survive because their benefits outweigh their costs.

“Business professionals understand the importance that investors and others ascribe to earnings, and a considerable amount of evidence indicates that managers find it tempting, if not essential, to manage earnings,” the report states.

What's more, the study found that recruiters weed out job candidates whose personalities indicate that earnings management isn't their style.

But how would they know who is more likely to be open to managing earnings? That's not blatantly obvious in personality profiles, according to the study. Rather, it's inferred from personality characteristics embedded in the profiles. And those traits include moral disengagement, Machiavellianism, narcissism, ethical orientation, and the ability to rationalize behavior, among other things.

These traits also signal other negative personality aspects about these managers: They are “significantly” less likable, perceived to be more likely to commit fraud and other bad things, less likely to stick to ethics when things get tough, and generally are worse managers, according to the study.

Still, there are powerful forces working against the Darth Vader in the C-suite. The Sarbanes-Oxley Act of 2002 requires CEOs and CFOs of public companies to certify that the financial statements are accurate, and it requires companies to have a code of ethics. And when “improprieties” are revealed, “there are adverse wealth-related consequences for executives,” the study states. That could move them to avoid candidates who indicate a tendency to manage earnings.

But the study calls into question just how effective the regulations are. The US Securities and Exchange Commission (SEC) certainly wages battle against such wrongdoing. But if managers are wired to manage the earnings, “no amount of regulation may significantly curtail earnings management under such circumstances.” Instead, changes in the hiring process may be more beneficial.

According to the study, former SEC Chairman Arthur Levitt hinted at that when he suggested “nothing less than a fundamental cultural change on the part of corporate management, as well as the whole financial community” to eliminate earnings management.

How did the professors reach their conclusions without access to personnel files? They asked financial executives and recruiters to evaluate two hypothetical job candidates: Candidate A's personality profile indicated a predisposition to manage earnings, while Candidate B's profile was the opposite.

One side note: For nonpublic company issues, Candidate B was favored over A and was viewed as “an equivalent or more capable/talented manager than Candidate A on all measured dimensions except for the one related to managing earnings to achieve accounting outcomes.”

The study is one of many to research earnings management. But prior studies targeted the triggers of earnings management, such as avoiding regulatory threats, negative earnings surprises and debt-covenant violations, and bolstering bonuses.

“We seek to answer a more fundamental question: Why are managers of public companies so responsive to commonly occurring earnings management stimuli?” the authors wrote. “We conclude that part of the answer involves the types of people who are selected by, and retained in, organizations.”