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Willingness to manipulate company earnings key to success in corporate accounting, study suggests

Why is earnings manipulation so endemic to the for-profit world? Some new research suggests the simplest of reasons -- namely that individuals who ascend to power and authority in corporate accounting are predisposed by their personality and values to manage earnings and, indeed, are hired and promoted precisely for that reason.

"To date, no empirical evidence about the relation between earnings management and employee selection has been brought to bear [possibly because] necessary employment files and documentation are either confidential or completely unavailable," begins a new study of the subject.

The paper, being presented at the annual meeting of the American Accounting Association (August 7-12 in Chicago), then proceeds to provide what the authors believe to be the strongest evidence yet for that very claim.

The study skirts the data-availability problem with experiments and surveys that put the matter to the people most likely to know – accounting and finance executives and executive-recruitment professionals.  It concludes that job candidates whose personality characteristics signal a predisposition to manage earnings are much more likely to be hired by companies that face common earnings-related pressures. Further job candidates whose personality characteristics signal an aversion to earnings management are likely to be screened out before even being considered by these companies.

When presented a choice between two candidates for a senior corporate accounting position who were similar in background and credentials, 87.5% of accounting and finance executives chose the candidate who was clearly more congenial to earnings management. Seasoned recruiting professionals rated that candidate’s fitness for the job at 81% and the fitness of the more ethically upright rival at only 35%.

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

Or, as the study puts it, the winning candidate "is characterized by a constellation of negative personality characteristics, which participants are apparently willing to accept in order to hire the job candidate who is predisposed to manage earnings."

To come to that conclusion, the professors conducted surveys of 56 accounting and finance executives and 41 executive-recruitment professionals. Executives, about 55% male, held titles indicating a high level of professional achievement, such as chief financial officer, chief accounting officer, and controller. Recruiters, about 64% male, had an average work experience of about 23 years and had been involved in an average of about 520 executive searches and 400 searches in accounting or finance.

Participants were asked to take the role of an executive of or recruiter for a publicly traded manufacturing company searching for a successor to the firm's recently retired senior accounting manager, who oversaw accounting operations and made important decisions with respect to financial reporting. The company's financial objectives, participants were informed, include 1) achieving profit goals, 2) maintaining smooth earnings, 3) avoiding earning volatility, and 4) maintaining low cost of capital, goals similar to those commonly enunciated by financial executives. Two finalists for the position have quite similar education and employment backgrounds but sharply contrasting values, including these:

  • Candidate A is "results-oriented" and willing to "rewrite the rules if necessary to achieve goals," while Candidate B is "process-oriented" and believes rules "should not be circumvented to achieve goals and should be changed only after significant deliberation."
  • Candidate A looks to the "norms of the organization…to determine what behavior is acceptable," while Candidate B "has rigid beliefs about what constitutes acceptable behavior and rarely deviates from those beliefs."
  • Candidate A "believes that leadership achievements require the ability to please those in positions of power," while Candidate B believes "leadership achievements are chiefly due to being in the right place at the right time."
  • Candidate A "can find justifications for actions after the fact," while Candidate B "prefers to avoid" doing so.

Asked which candidate the company would most likely hire, seven eighths of the executives selected Candidate A, who had been judged by a different group of accounting and finance professionals to be significantly more prone than Candidate B to engage in earnings management. And, when recruiting professionals were asked their degree of certainty that one or the other finalist would be a good fit for the company, they were, on average, 81% certain about  Candidate A and a mere 35% certain about Candidate B.

To explore the possibility that such judgments might reflect a sense that Candidate A was simply a better manager than Candidate B, the professors carried out another survey with different participants. This group was presented the same descriptions of the candidates that the executives and recruiters received and was asked to agree or disagree with six reasons why one might have been chosen over the other – 1) would provide more constructive feedback to staff; 2) would maintain staff morale better; 3) would be better at planning accounting department activities; 4) would work more efficiently; 5) would be more pleasant; 6) would be more likely to remove any roadblocks to profit goals. Of the six, Candidate A was judged superior only on the last, while Candidate B excelled in the first, second, fourth, and fifth.

In short, the losing job candidate was deemed superior on four of six management measures, with the preferred candidate judged better only at what amounted to willingness to manage earnings (even though the researchers took care not to state that outright).The point was further reinforced by still another survey in which participants were asked to rate the same two candidates' fitness to serve as senior financial officer of a non-profit foundation. With profit no longer in the picture, Candidate B was chosen hands down.

What can be done? The professors express doubt that regulation can make headway against a selection process as deeply ingrained as the study reveals this to be. Comments Prof. Jackson: "Hopefully, showing that people and their values are at the root of this problem will help. Companies commonly shine a spotlight on particular employees to demonstrate commitment to good corporate citizenship. Certainly the proven ethical integrity of a firm's financial leadership should be a powerful selling point to the investment community."

The paper, entitled "Earnings Management and Employee Selection," is among hundreds of scholarly presentations at the American Accounting Association meeting, which will draw some 3,500 scholars and practitioners to Chicago, from August 7th to 12th. The AAA is a worldwide organization devoted to excellence in accounting education, research, and practice. Journals published by the AAA and its specialty sections include The Accounting Review, Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Auditing: A Journal of Practice & Theory, and The Journal of the American Taxation Association.

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