Winning an Award Could Set You Free: Earnings Management and the Balance of Power between CEOs and CFOs

Abstract

This paper investigates how the balance of power between chief executive officers (CEOs) and chief financial officers (CFOs) influences the use of earnings management. I employ nationwide awards that recognize CFO excellence as shocks to awardees’ job-market status and use a regression discontinuity design (RDD) to establish causal effects. I find that, compared to nominees who were close to winning the award, awardee CFOs experience a sharp increase in career opportunities, both outside and inside their own firms. Consistent with the view that shifts in bargaining power between the CEO and CFO can mitigate earnings management, I find that awardee firms have a significantly smaller magnitude of discretionary accruals than nominees in the first two years after the award. In addition, winning the award has a substantially negative effect on positive accruals, while the positive effect on negative accruals is less significant. Moreover, I find no evidence that the rise of CFO power triggers an increase in the use of real earnings management in awardee firms. Overall, my findings suggest that the balance of power between CEOs and CFOs plays an important role in the quality of financial reporting.