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Review of Accounting Studies

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01.03.2015

The effect of CEO inside debt holdings on financial reporting quality

verfasst von: Guanming He

Erschienen in: Review of Accounting Studies | Ausgabe 1/2015

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Abstract

This study investigates the effect of CEO inside debt holdings on financial reporting quality. I find that higher CEO inside debt holdings are associated with lower abnormal accruals, higher accruals quality, a lower likelihood of an earnings misstatement, and a lower incidence of earnings benchmark beating, suggesting that CEO inside debt promotes high financial reporting quality. Additional analyses reveal that (1) CEO inside debt holdings reduce firm-specific stock price crash risk, and that (2) auditors are less likely to report a material internal control weakness for firms that have large CEO inside debt.

Vorheriger Artikel The predictive qualities of earnings volatility and earnings uncertainty

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See Ball and Shivakumar (2005), Francis and Martin (2010), Jayaraman and Shivakumar (2013), Roychowdhury (2010), and Bushman et al. (2011), for instance, for the details on how accounting conservatism could curb risky and value-destroying investment activities of a firm.

The difference in the number of firm-year observations for the final sample is due to the data requirements in constructing different financial reporting quality proxies for the regression analyses. For instance, to construct an abnormal accruals variable using the modified Jones model, observations in a two-digit SIC-code industry that has less than 20 firms for a year are excluded. In constructing an earnings benchmark beating variable, observations with no analyst earnings forecasts for a fiscal year are eliminated. In addition, the number of unique firms in my sample could exceed 1,500 because the classification on S&P 1,500 firms changes over years in the sample period.

It is difficult to determine the deferred compensation investment choices of individual CEOs in a systematic manner because the disclosure requirements are ambiguous (Wei and Yermack 2011). So following Cassell et al. (2012), I assume that CEOs do not invest their deferred compensation in the common stocks. In untabulated sensitivity tests, I alternatively assume that all CEOs are required to invest 100 % of their deferred compensation in common stocks. Accordingly, I adjust the relative leverage ratio by shifting the aggregate amount of deferred compensation from CEO debt holdings to CEO equity holdings. Use of this alternate variable specification does not change any inference in the paper.

I obtain qualitatively the same results if I use firm leverage which is defined as the sum of long-term debt and debt in current liabilities divided by the sum of market value of stockholders’ equity and fair market value of outstanding stock options.

I do not describe the detailed procedure of estimating the CEO relative incentive ratio, as I follow exactly the same procedure as that of Wei and Yermack (2011).

Another proxy for financial reporting quality is the indicator for whether the SEC publishes an Accounting and Auditing Enforcement Release (AAER) that identifies accounting fraud or misrepresentation that occurs for a firm over a fiscal year. Unfortunately, there are less than 50 AAER firm-year observations in my sample, which prevents me from drawing valid statistical inferences from the multivariate results. Thus I do not use AAERs as the proxy for financial reporting quality.

See Dechow et al. (2010) for detailed literature review on earnings target beating.

According to Stock et al. (2002), when there are two instruments in the first-stage regression, the F-statistic for the instruments needs to be above 11.59 to reject the null hypothesis that the instruments are weak.

The results qualitatively hold if I measure the stock price crash risk by the negative skewness of firm-specific weekly stock returns over a fiscal year (Kim et al. 2011a, b).

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Titel: The effect of CEO inside debt holdings on financial reporting quality
verfasst von: Guanming He
Publikationsdatum: 01.03.2015
Verlag: Springer US
Erschienen in: Review of Accounting Studies / Ausgabe 1/2015
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI: https://doi.org/10.1007/s11142-014-9305-8

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