Managers: Their Effects on Accruals and Firm Policies
Arthur Andersen Professor of Accounting
Tippie College of Business
University of Iowa
Iowa City, IA
Tippie College of Business
University of Iowa
Iowa City, IA
January 29, 2009
Preliminary Do Not Quote Without Permission
* Corresponding author.
We thank Forbes and Kevin J. Murphy for generously providing their data. We thank John
Geweke and in particular Paul Hribar for many helpful discussions. Errors are the authors’
Managers: Their Effects on Accruals and Firm Policies
This study focuses on top managers’ effects on accounting accruals by asking whether individual
managers can in part explain accounting accruals. We further investigate these manager effects
on accruals by asking whether and how managers affect accruals through their decisions on firm
policies. Extending the basic research design of Bertrand and Schoar (2003), we show that
managers exert a significant individual-specific influence over accruals and are important
determinants of accruals. We estimate manager fixed effects for their firm policy choices and
show that a manager’s economic policy decisions affect the firm’s accounting accruals. Finally,
we separate and investigate CEO and CFO effects on accruals. We find that CFOs have the same
influence as CEOs on accounting accruals, but the magnitude of the accruals is smaller for CFOs
for CEOs, i.e. CFOs tend to push accruals to zero, suggesting that CFOs tend to report more
“solid” earnings than CEOs.
Managers: Their Effects on Accruals and Firm Policies
In this study, we focus on the top managers’ effects on accruals. The primary objective of
this paper is to ask whether individual managers, as opposed to firm, industry, or market factors,
can in part explain accounting accruals. We further investigate these manager fixed effects by
asking what proportion of the accounting accruals are associated with their firm policy decisions
and what proportion is associated with the manager’s accounting choices. Finally, we separate
and compare the effects that CEOs and CFOs imposed on accounting accruals.
Do individual managers matter for firm’s accounting accruals? Despite extensive
empirical research on accounting accruals, little consideration has been given to the effects of
individual managers. Exsiting accounting literature typically relies on firm-level, industry-level
and market-level characteristics to explain accruals, e.g., Klein (2002), Leuz, Nanda and
Wysocki (2003), Hribar and Nichols (2007). To our knowledge, only a few recent studies
provide evidence on manager effects for accruals. Hribar and Yang (2007) show that
overconfident managers are more likely to issue overly optimistic forecasts and use income
increasing accruals subsequently; Matsunaga and Yeung (2008) find that ex-CFOs utilize more
income-decreasing accruals and provide more precise earnings guidance to analysts; and Francis,
Huang, Rajgopal and Zang (2008) document a negative relation between CEO press coverage
and earnings quality proxied by accrual-based measures.
A prevailing view in the financial press and among managers themselves is that top
managers are crucial determinants of corporate practices including financial disclosure. In an
influential survey paper, Graham, Harvey and Rajgopal (2005) show that managers’ career
concerns and external reputation are important drivers of financial reporting practices. Consistent
with this view, a large body of academic research in other fields such as organizational theory,
finance and economics has devoted considerable effort in isolating the contribution of
management to firms’ corporate decisions and performance. For example, Finkelstein and
Hambrick (1996) argue that managerial ego, biases, and experiences affect firm behavior
because of the ambiguity and complexity that characterize the task of top managers. Rotemberg
and Saloner (2000) and Van den Steen (2005) explicitly model the vision of the CEO as an
important determinant of firm policy. Chatterjee and Hambrick (2006) find that CEOs’
narcissism level affect firms’ organizational outcomes. Liu and Yermack (2007) show the
interesting relationship between a CEO’s home purchases and firm performance, while
Bennedsen, Perez-Gonzalez and Wolfenzon (2007) find that CEOs and their family deaths are
correlated with firm performance.
Recent research in financial economics, Bertrand and Schoar (2003), find that individual
managers have a significant impact on the firm’s investment, financing and operating decisions
and firm’s performance. This leads logically to our interest to examine management’s effect on a
firm’s accruals. By adopting the basic research design of Bertrand and Schoar (2003), we first
test whether a given manager influences accounting accruals at different firms. Specifically, we
construct a manager-firm matched panel data set, where we track individual top managers across
different firms over time. We quantify how much of the observed variation in firms’ accounting
accruals can be attributed to manager fixed effects, controlling for observable and unobservable
differences across firms. Our results show that these managers exert a significant individual-
specific influence over accruals and are empirically important determinants of accruals. Adding
the manager fixed effects to the models of accruals that already account for observable and
unobservable firm characteristics results in increases in the adjusted R2 and all the F-tests reject
the null hypothesis of no significant joint effects of managers.
Given we document individual managers’ significant role in accruals, we next ask how
managers affect accruals. As Lafond (2008) points out, there are two important channels through
which managers could affect accounting accruals. Since managers are the key decision-makers
presiding over firm’s investment, financing, and operating policies, Bertrand and Schoar (2003),
one channel through which managers potentially affect accounting accruals is through their
decisions on these firm policies. For example, managers’ decisions to invest internally or engage
in mergers and acquisitions have implications for accruals. A second channel through which
managers affect accounting accruals, obviously, is accounting choices. Managers’ accrual
estimates, choice of measurement methods, and discretion in recognizing economic transactions
affect accruals. We use Bertrand and Schoar’s (2003) design to focus on how manager affect
accounting accruals through their firm policy decisions. We estimate manager fixed effects on
different firm policies and ask whether and how managers’ decisions on these firm polices affect
accounting accruals. Our results show that managers’ decisions on certain firm policies are
associated with their effects on accruals. For example, managers who do not use the firm’s
market valuation as a benchmark for their investment decisions tend to have more income-
decreasing accruals; managers who spend more on R&D and advertising do not have a lot of
income-increasing accruals. In addition, we find that managers have significant additional effects
on accruals after controlling for their effects on firm policies. This confirms that firm policy
decisions are not the only channel through which managers affect accruals; managers affect
accruals significantly through other channels which include accounting choices.
Finally, since we have specific effects for different management positions, we are able to
study separately the effects of CEOs and CFOs. Previous studies which examine top managers’
effects on firm policies often focus on CEOs. Although CEOs are responsible for major policy
choices and firm strategies, CFOs may also be important when it comes to issues such as
accounting choices. It is, therefore, worthwhile to compare the role of CEOs and CFOs in
affecting accounting accruals. We find that CFOs have the same influence as CEOs on
accounting accruals, suggesting that future research should consider the role of CFOs when
examining issues related to accruals. In addition, the magnitude of the accruals is smaller for
CFOs than for CEOs, i.e. CFOs tend to push accruals to zero, suggesting that CFOs tend to
report more “solid” earnings than CEOs.
Our study contributes to the accounting literature addressing accruals. We do this by
extending Bertrand and Schoar (2003)’s design to the study of accounting accruals. Other
accounting researchers have also begun to use this design. Bamber, Jiang and Wang (2008) and
Yang (2009) show that manager effects play an important role in firms’ earnings guidance
characteristics; Dyreng, Hanlon, and Maydew (2008) investigate managerial fixed-effects with
respect to tax avoidance behavior; Ge, Matsumoto and Zhang (2008) examine the effect of CFOs
on firms’ financial reporting choices. Similar to our study, Ge et al. (2008) consider accounting
accruals. Their focus is abnormal accruals measured by the modified Jones model. We consider
six accruals measures, total accruals, abnormal accruals from modified Jones model, abnormal
accruals from forward-looking Jones model, both signed and unsigned. While Ge et al. (2008)
use a cross-sectional modifies Jones model for a sample period from 1992 to 2006, we use
different time-series accrual models for a sample period from 1969 to 2006. Ge et al. (2008)
consider the CFOs and control for CEOs. We consider the CEOs, CFOs, and other key
executives, and compare and contrast the effects of the CEOs and CFOs. Ge et al. (2008)
correlate CFOs’ effects to personal background. We use managers’ decisions on firm policies to
isolate managers’ effects on accruals through these decisions and their effects on accruals above
and beyond these decisions.
The paper is organized as follows. Section 2 provides a brief discussion of Bertrand and
Schoar (2003) applied to accounting accruals. Section 3 presents the data sources, describes the
construction of the data set and defines major variables of interest. Section 4 quantifies the
importance of manager fixed effects for different accrual measures and section 5 discusses
manager decisions on firm policies and how these decisions affect accruals. Section 6 compares
fixed effects of CEOs and CFOs. Section 7 summarizes.
2. Empirical methodology
To ask how much of the variance in firm’s accounting accruals can be attributed to
manager-specific effects, we estimate the models below, following Bertrand and Schoar (2003).
stands for the accrual variable for each firm in each year,
are year fixed effects,
are firm fixed effects,
represents a vector of time-varying firm level controls, and ? is an
are our main variables of interest, representing the
incremental fixed effects of individual managers on accrual variables.
are fixed effects for
the group of managers who are CEOs in the last position we observe them,
are fixed effects
for the group of managers who are CFOs in the last position we observe them, and
fixed effects for the group of managers who are neither CEOs nor CFOs in the last position we
observe them. This allows us to separately study the effect of CEOs, CFOs, and other top
executives on firm accounting accruals. When estimating these equations, we account for serial
correlation by allowing for clustering of the error term at the firm level.
We estimate equation (1) as the benchmark model, which includes only the firm fixed
effect, year fixed effect, and time-varying firm level controls. This allows us to test the
explanatory power of these year and firm-level characteristics. Equation (2) and (3)
consecutively add the CEO fixed effect and the fixed effects for all three groups of executives
(CEOs, CFOs and other top positions). These two models allow us to test whether individual
manager fixed effects play a significant role in explaining accounting accruals after controlling
for the year fixed effect, firm fixed effect and the relevant time-varying firm characteristics.
If a manager has a unique impact on a firm’s accounting accruals, we will observe
significant manager fixed effects explaining accruals after controlling for relevant firm-level
characteristics. It is evident from equation (2) and (3) that the estimation of the manager fixed
effects is not possible for managers who never leave a given firm during the sample period. If a
firm has no managerial turnover during the sample period, the firm’s fixed effect cannot be
separated from the manager’s fixed effect because these two effects are perfectly collinear.
Therefore, separating manager fixed effects from firm fixed effects is only possible when the
firm has at least one manager who switched firms. In our sample construction, we restrict our
attention to the subset of firms for which at least one top manager can be observed in at least one
other firm and this allow us to estimate the firm fixed effect and manager fixed effect separately.
The estimate of the fixed effect for each individual manager enables us to examine not only the
existence but also the magnitude of individual managers’ effects on firms’ accounting accruals.
3. Sample and data
3.1 Sample construction
To estimate manager fixed effects, we adopt Bertrand and Schoar’s (2003) basic design
to construct a manager-firm matched panel data set that allows us to track the same top managers
across different firms over time.
We use the Forbes 800 files, from 1969 to 1991,1 and Execucomp database, from 1992 to
2006. The Forbes data provide information on the CEOs of the 800 largest U. S. firms.
Execucomp allows us to track the top five highest paid executives in the S&P 1500. We require
that one individual manager has to switch firms once in our sample period. We also impose the
requirement that the managers have to be in each firm for at least three years. This three-year
requirement ensures that managers have enough time to “make their mark” on a given company.
For each firm satisfying these requirements, we keep years where this firm has other managers as
well. The resulting sample contains 954 firms and 811 individual managers who can be followed
in at least two different firms. The average length of stay of a manager in a given firm is a little
over 6 years and the average number of different firms for each manager is 2.06. 2 Firms from the
financial service industry (SIC code 6000-6999) and utility industry (SIC code 4900-4949) are
excluded from the analysis. Finally, we match each firm-year with accounting data reported in
the Compustat database and acquisition data reported in the SDC database.
3.2 Sample description
Table 1 presents means, medians and standard deviations for firm characteristics
variables and the firm policy variables of interest.3 Details for the definition and construction of
1 We thank Kevin J. Murphy and Forbes for generously providing us with their data.
2 Only 32 managers are observed in strictly more than two different firms and the maximum number of firms is 4.
3 These variables are from Bertrand and Schoar (2003).
the variables reported in the table are available in the appendix. All variables are winsorized at
1% tail to mitigate the outlier problem. The first three columns report descriptive statistics for
our manager-firm matched sample. For comparison, we also report the same statistics for all
firms in Forbes files and Execucomp data over the period 1969 to 2006 (the population from
which we choose our sample) in the last three columns.
The average firm in our sample has a higher level of total assets, sales and market value
than the average firm in the Forbes and Execucomp data. This is the same as in Bertrand and
Schoar (2003) and tells us that the selection criteria lead us to choose firms larger than the
population average. The reason being managers from larger firms are more likely to move to
another firm within the Forbes 800 and S&P1500 firms, and managers from smaller firms are
more likely to move to private firms or positions in large firms that are below the top five highest
paid positions. Therefore, managers from smaller firms cannot be tracked in our data sources and
are excluded from our sample. Our focus on larger firms may bias our results, but it is very
likely to bias against finding important manager individual effects. In smaller firms, managers
might have more influence because they have more personal involvement in the firm’s daily
activities. In fact, Finkelstein and Hambrick (1996) show that managerial discretion – and hence
any manager-specific effect – declines with company size.
Besides being larger than the average firm in the population, the average firm in our
sample engages in more acquisition activities and has slightly higher leverage and lower interest
coverage, but is very similar to the average population firm with respect to all other