Welcome to the gray zone: shades of honesty and earnings management

Abstract

We examine the influence of face-based judgments of CFO/CEO honesty on earnings management for the largest publicly traded companies in America. After controlling for incentives and opportunities to manage earnings, CFOs and CEOs perceived to be less honest engage in higher levels of both accruals and real earnings management. The beneficial impact of perceived honesty on earnings quality is most pronounced when both the CFO and the CEO are perceived to be honest. Findings are consistent with our conjecture that both the CFO and CEO independently contribute to a firm’s reporting environment and Kahneman’s (2003) findings that many aspects of person perception can be considered to be “intuitive”.

Valuation Insight: Lower perceived honesty based on face-based judgments of CFOs and CEOs is found to be associated with higher levels of accruals and real earnings management. Thus, higher perceived honesty is associated with higher earnings quality which positively affects firm value.