Competence, Compensation and Accounting Manipulation

Category:

Competence, Compensation and Accounting Manipulation

The CFOs, CEOs, and other top executives of more than 3,000 public companies, accounting professors Anne Albrecht of Texas Christian University, Elaine Mauldin of the University of Missouri, and Nathan Newton of Florida State University discovered that executives’ backgrounds as partners or managers in audit firms can substantially increase the present likelihood of financial misstatements. 

Generally, auditors have many jobs to do such as finding important implications for regulators, corporate directors, and most crucially, external auditors charged with certifying the accuracy of client companies’ financial statements. However, auditors can do “two-edged sword” manipulation which is either to enhance or subvert financial reporting. The auditors know that the CFOs are doing a manipulation, but they ignore it and even they bond to hide it.

Based on Foster university, CEOs’ motivation to do manipulation is to make higher equity incentives to gain more power than counterparts at firms that practiced compliant accounting. Furthermore, firms that do manipulate experienced higher CFO turnover than non-manipulating, but some CFO do not want to do manipulating. Therefore, some CFOs lose their jobs under CEO pressure.

Based on data from David McCann, it shows that about 61% of the executives with this background were CFOs and about 9% were CEOs. About 10% of company financial reports contained misstatements that were corrected by subsequent restatements. In measuring executive pay, the researchers calculated expected compensation from many factors, including company size, complexity, financial performance, as well as the tenures and management-ability scores of executives. How big this difference affects the occurrence of manipulation in the financial report.

(source: https://corporatefinanceinstitute.com/resources/knowledge/accounting/managerial-accounting/)

The articles in 2019 state that managerial skills have a positive effect on earnings manipulation practices. The more experienced a manager is, the more understanding they’ll have about the company’s business conditions. Therefore, experienced managers can give management more opportunities to manipulate. 

Another study also found that accounting expertise among top corporate managers greatly increases the extent to which executive excess payments lead to financial reporting errors. When auditing background is not present in top management, companies with far above average executive salaries are only more likely to misstate than companies with relatively low pay. This is also supported by a study in 2020, which stated that in 2020 it was found that an increase in Executive Option Incentives increases the likelihood of financial reporting violations. Executive accounting competence increases the risk of material misstatement when combined with compensation-based incentives for reporting errors.

In conclusion, past auditing experience among top executives affects the likelihood of financial reporting errors. The likelihood of this misreporting increases greatly when the skill is met with excessive executive compensation, such that high-paying firms are far more likely than their low-paid counterparts to misstate. Therefore, competence and compensation are closely related to accounting manipulation.

 

 

REFERENCES :

McCann, D. (2018, October 25). The Dark Side of Accounting Expertise: A Knack for Hiding the Truth. Retrieved 2020, from https://www.cfo.com/leadership/2018/10/the-dark-side-of-accounting-expertise/

Herawaty, V., & Solihah, D. (2019). The Effect of CEO Tenure, Managerial Skills, and Earning Power on Earnings Manipulation with Corporate Governance as a Moderating Variable on Manufacturing Companies in Indonesia Stock Exchange. Academy of Accounting and Financial Studies Journal, 23(1). Retrieved 2020, from https://www.abacademies.org/articles/the-effect-of-ceo-tenure-managerial-skills-and-earning-power-on-earnings-manipulation-with-corporate-governance-as-a-moderating-va-8135.html

Chen, D., Wang, F., & Xing, C. (2020). Financial reporting fraud and CEO pay-performance incentives. Journal of Management Science and Engineering. doi:10.1016/j.jmse.2020.07.001

CFOs manipulate financials due to CEO pressure, not personal gain. (2010). Retrieved 2020, from https://foster.uw.edu/research-brief/cfos-manipulate-financials-due-to-ceo-pressure-not-personal-gain/