Reporting Concerns about Earnings Quality: An Examination of Corporate Managers

Abstract

Using an experiment with corporate financial managers (e.g., CFOs, controllers), we find that when red flags are present in the financial statements under their review, managers identify those red flags and, in turn, have greater concerns over earnings quality. In addition, when pressure to meet a financial target is high, managers are more concerned about earnings quality when red flags are present. We also document that when red flags are present, managers are more likely to report both internally to their CEO and, if their concerns are not resolved internally, externally to their auditor. Pressure to meet a financial target directly influenced the decision to report internally, but not externally. Additional analyses contemplate the countervailing personal costs associated with reporting or not reporting earnings quality concerns. We demonstrate the important role short-term costs play in external reporting decisions. Finally, we provide initial evidence that corporate managers with a longer tenure at their position (public accounting background) are less (more) likely to report externally.