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The Influence of CFO and CEO Narcissism on Financilal Reporting
Presented by
Dr Nick Seybert
Assistant Professor University of Maryland
# 2014/15-10
The views and opinions expressed in this working paper are those of the author(s) and not necessarily those of the School of Accountancy, Singapore Management University.
THE INFLUENCE OF CFO AND CEO NARCISSISM ON FINANCIAL
REPORTING
Charles Ham Robert H. Smith School of Business
University of Maryland, College Park [email protected]
Mark Lang
Kenan-Flagler Business School University of North Carolina at Chapel Hill
Nicholas Seybert* Robert H. Smith School of Business
University of Maryland, College Park [email protected]
Sean Wang
Kenan-Flagler Business School University of North Carolina at Chapel Hill
October 14, 2014
***VERY PRELIMINARY – PLEASE DO NOT CITE OR DISTRIBUTE WITHOUT PERMISSION***
*Corresponding author.
THE INFLUENCE OF CFO AND CEO NARCISSISM ON FINANCIAL
REPORTING
Abstract
We utilize the size of CFO and CEO signatures as a proxy for narcissism to
determine the influence of the executive’s personality on financial reporting
characteristics and outcomes. Our experimental validation study first demonstrates that
narcissism predicts misreporting behavior among students, and that student signature size
predicts misreporting through its positive association with narcissism. Our archival tests
subsequently examine notarized CFO and CEO signatures drawn from the same
document and reveal that CFO narcissism predicts accruals and real earnings
management as well as lower conditional accounting conservatism, weaker internal
controls, and a higher probability of accounting restatements and shareholder lawsuits.
CEO narcissism is not associated with any of these financial reporting characteristics or
outcomes. Taken together, the results suggest that signature size is valid proxy for
narcissism, and that CFO narcissism can lead to poor reporting quality.
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THE INFLUENCE OF CFO AND CEO NARCISSISM ON FINANCIAL
REPORTING
1. Introduction
“I ought to be CFO of the year. I’ve seen it in CFO Magazine. I want it to be me.
Do you realize what a great job I’ve done at this company?” Andrew Fastow, former
CFO of Enron, made these statements shortly before the exposure of the massive fraud
that he helped orchestrate (Eichenwald 2005). Eichenwald’s interviews with Fastow’s
colleagues portray him as a narcissist that would do anything for his own self-interest at
the expense of the welfare of those around him. His knowledge of accounting and finance
was described as substandard but his self-perception of those abilities was dramatically
inflated. Psychology research suggests such behavior is typical of narcissists, with a
variety of studies demonstrating that symptoms of narcissism include excessive focus on
oneself, inflated sense of self-worth, domination of decision processes, failure to take
feedback from others, and need for constant recognition and fame (Wink 1991, Oliver
and Robbins 1994, Rhodewalt and Morf 1995, Lakey, Rose, Campbell and Goodie 2008,
Goncalo, Flynn and Kim 2010, Nevicka, Tan Velden, De Hoogh and Van Viannen 2011,
Tamborski, Brown and Chowning 2012).
In this paper, we draw from psychology theory on individual narcissism to ask
what behaviors would be expected from a CFO who is narcissistic. Because the CFO’s
domain is financial and accounting decisions, we expect their need for recognition,
domination of decisions, inflated self-perception, and need for recognition to take a toll
on the accounting and financial reporting functions of the company. For example, a
narcissistic CFO could ignore concerns from subordinates that there may be a problem
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with internal controls because they erroneously believe that they know more about the
control system than they actually do. A narcissistic CFO could also be more willing to
engage in earnings management activities to achieve their own selfish goals. Finally, a
narcissistic CFO could spend time obsessing over their own self-importance or image at
the expense of time allocated to ensuring that the financial reports are free of
misstatements. All of these shortcomings could result in a variety of negative outcomes,
such as accounting restatements, internal control weaknesses, and lawsuits. And yet, few
papers have examined CFO personality traits or their effects on financial reporting
outcomes.
We utilize the Ham, Seybert and Wang (2014) signature size measure of
narcissism (the area-per-letter of the executive’s signature), which they validated in a
laboratory setting, to examine how CFO and CEO narcissism impacts a number of
accounting choices and outcomes. We find that more narcissistic CFOs engage in more
accruals and real earnings management, and present accounting numbers that are less
conditionally conservative. They also appear to exercise less oversight of internal
controls, as they are more likely to preside over ineffective internal controls and suffer
from a higher number of material weaknesses. Finally, they are more likely to have their
annual financial reports restated in the future and suffer a class action lawsuit as a result.
On the contrary, we find that CEO narcissism does not predict accruals or real earnings
management, internal control effectiveness or material weaknesses. CEO narcissism is
also not associated with accounting restatements or the probability of a class action
lawsuit.
2
Prior research documents that managers strategically intervene in the financial
reporting process to meet salient benchmarks (Burgstahler and Dichev 1997; Degeorge,
Patel, and Zeckhauser 1999). Generally, incentives to manage earnings have been related
to management compensation contracts (Healy 1985; Dechow and Sloan 1991), debt
covenant contracts (Defond and Jiambalvo 1994), and capital market penalties and
rewards to reported earnings (Teoh, Welch and Wong 1998; Dechow and Skinner 2002).
Given that earnings are the sum of accounting accruals and cash flows, executives
have two major options in altering earnings to meet their desired benchmarks. In the first
case, managers can manipulate accruals by exploiting the flexibility of accounting rules
to create biased estimates of certain revenue or expense accounts. For example, a
manager could manipulate accruals upwards by understating provisions for bad debt or
anticipated warranty expenses. Because these accrual manipulations are cosmetic, they do
not affect cash flows and ultimately reverse in future periods, with the net effect being
higher current period earnings in exchange for lower future earnings. In the second case,
managers can engage in real earnings management by making strategic decisions that
directly affect cash flows. Examples of real earnings management include an abnormal
reduction in discretionary expenses (e.g. R&D or advertising). These reductions increase
cash flows and profitability in the current period, but will also stifle growth in future
periods, resulting in decreased cash flows in subsequent periods.
While accrual manipulations do not directly impact cash flows, they can also be
costly. Aggressive accounting actions that violate GAAP can increase the probability of a
qualified opinion from auditors, financial penalties from the SEC, restatement of prior
announced earnings and class action lawsuits (Skinner 1997). The magnitude of these
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financial penalties can have substantial effects on a firm’s market valuation. Palmrose,
Richardson and Scholz (2004) document an average abnormal return of -9% over a two-
day announcement window for firms that restate their financial statements. Gande and
Lewis (2009) measure the economic effects of shareholder-initiated class action lawsuits
around the filing date and find a -9.79% abnormal return over a two week window.
Given that our results show that narcissistic CFOs are more likely to commit earnings
management via both accrual and real manipulations, CFO narcissism should increase the
likelihood that the firm’s shareholders will experience negative future outcomes in the
form of either lower cash flows in future earnings announcements, or large negative stock
price crashes from restatements and lawsuits.
Our paper contributes to the growing literature on the role of executive
personality traits in the financial reporting context. While this paper is the first to
investigate how CFO personality impacts the financial statements, there are a number of
papers that investigate the effects of CEO personality traits on firm operating and
financial reporting decisions. Prior research finds that CEO narcissism predicts increased
aggressiveness in mergers and acquisitions (Aktas, De Bodt, Bollaert and Roll 2012),
firm performance volatility (Chatterjee and Hambrick 2007), corporate tax avoidance
(Olsen and Stekelberg 2014), and overinvestment, lack of innovation, and poor
performance (Ham, Seybert and Wang 2014). Studies also document that overconfident
CEOs use less conservative accounting policies (Ahmed and Duellman 2013), they are
more likely to issue earnings guidance, their guidance is both more optimistic and precise
(Libby and Rennekamp 2012; Hribar and Yang 2013), and they are more likely to engage
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in earnings management that results in SEC enforcement actions (Schrand and Zechman
2012).
In contrast to the burgeoning literature on CEO personality traits, Malmendier and
Zheng (2014) is the only paper of which we are aware that utilizes a specific CFO
psychological trait. They find that CFO overconfidence predicts financing decisions such
as debt and equity issuance while CEO overconfidence predicts operating decisions such
as investment and acquisitions. This is consistent with our results in that CFO psychology
predicts decisions in the financial domain while CEO psychology does not. We expand
upon their paper by showing that another CFO personality trait, narcissism, impacts
additional important decisions that CFOs make – those involving accounting and
financial reporting choices.
Our paper also contributes to the ongoing debates concerning the relative impact
of CFOs and CEOs on financial reporting choices. Ge, Matsumoto, and Zhang (2011)
report that the style or cognitive mindset of the CFO has a significant impact on a firm’s
accounting choices. Jiang, Petroni and Wang (2009), Oberholzer-Gee and Wulf (2012)
and Liu (2013) show that CFO equity incentives are particularly important in predicting
earnings management, although Feng, Ge, Luo and Shevlin (2011) indicate that CFOs
appear to be pressured into accounting manipulation by CEOs. While prior research has
arrived at conflicting results concerning the competing effects of CFO and CEO equity
incentives, our results suggest the competing effects of CFO and CEO personality traits is
more clear – CFO narcissism is a much stronger predictor of financial accounting
problems.
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Our results suggest a cautionary note for investors, corporate boards, auditors, and
regulators. While prior research indicates that these parties should heavily monitor the
operating decisions of a narcissistic CEO, our results indicate that they should also
monitor the financial accounting and reporting decisions of a narcissistic CFO. Auditors
may benefit from spending more effort on engagements with a narcissistic CFO,
corporate boards may benefit from strengthening audit committee oversight, and
shareholders may benefit from healthy skepticism and additional financial analysis of the
company’s reports. The remainder of the paper is organized as follows: Section 2
describes an experimental validation of our narcissism measure and misreporting
behavior, Section 3 reports the empirical methodology, Section 4 reports results, and
Section 5 concludes.
2. Laboratory Validation of Signature Measure and Misreporting Behavior
2.1 Experimental Design and Participants
We utilize an experimental economics laboratory study to determine whether our
area-per-letter measure of signature size is correlated with scores on the NPI-40
narcissism personality scale and whether these measures are jointly linked to
misreporting behavior. Sixty-three participants were recruited in two junior-level
accounting courses at a U.S. News top-twenty-five ranked business school in return for
an expected payment of $5 and a roughly one in sixty chance to win a $200 pair of Beats
by Dre headphones.1 Participants received a four-page document that included a consent
form, a brief economic experiment, and a follow-up personality survey. They printed and
1 One participant failed to write or sign their name on the consent form and another participant signed their name using Chinese characters. These participants were excluded from the analysis due to insufficient data. Participants’ signed names were verified when they came to pick up their payments for the study.
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signed their name on the consent form, providing the signature that forms the basis of our
area-per-letter narcissism measure. Participants then proceeded to the study description,
which informed them that there was a $5 payment jointly allocated to them and one other
person. They learned that their default allocation was $2.50, and thus that the default
allocation to the other person was also $2.50. Each participant was randomly and
anonymously paired with one other participant, and had to decide whether to report their
true default monetary allocation of $2.50 or to over/underreport this amount. The
allocation they chose to report to the other participant was the amount they retained, and
the other participant received the remainder of the $5. Participants were also informed
that different participants may have received different default allocations that were
greater or less than $2.50, and therefore that their paired participant would not know the
true value of their default allocation. Each member of the pair performed the same task,
resulting in a maximum payment of $10 and minimum payment of $0 for each
participant.2 Following the monetary reporting decision, participants complete the NPI-
40 questionnaire, which measures their clinical level of narcissism, and return the packet
to the administrator.
The experimental design captures several important features of the real-world
reporting environment that a CFO and investor would face. Only the CFO knows the true
underlying nature of the firm’s performance, but they can inflate the reported
performance to increase their own welfare at the expense of the investor’s welfare. In our
study, only the participant knows their true default monetary allocation, but they can
2 The maximum (minimum) payment of $10 ($0) is received if the participant allocates $5 ($0) to him or herself and the paired participant allocates $0 ($5) to him or herself.
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inflate the reported allocation to increase their own welfare at the expense of the other
participant’s welfare.
2.2 Experimental Results
Consistent with prior psychology and business research (Zweigenhaft 1977; Ham,
Seybert and Wang 2014) a research assistant used a ruler to draw a rectangle around each
signature, with each side touching the most extreme endpoint of the signature. The
square-area of the rectangle was measured and standardized by the number of letters in
the signature. Using this measure, the score on the NPI-40, and the result of the
experimental task, we conduct a mediation analysis of the effect of area-per-letter (APL)
on narcissism and the allocation reported. Figure 1 displays the mean monetary allocation
and the NPI-40 narcissism score by quartile of APL. As the figure indicates, both the
reported allocation and the narcissism score increase monotonically across quartiles of
APL, suggesting that there is a meaningful relationship between these three variables.
Figure 2 displays the results of the mediation analysis. The Baron and Kenny
(1986) mediation analysis tests whether one variable’s effect on another variable operates
through an intervening variable. The test originally included four steps. Whether a true
mediation necessitates meeting all four steps has been under a great deal of debate in
recent years, but this is not relevant to our study since all four steps are met. Step one,
which appears at the top of the figure, is to determine whether signature size predicts the
reported monetary allocation, which reveals a positive and significant relationship (β =
0.36, p = 0.035). Step two is to determine whether signature size predicts narcissism,
which reveals a positive and significant relationship (β = 2.23, p = 0.014). Step three is to
determine whether narcissism predicts the reported monetary allocation, which again
8
reveals a positive and significant relationship (β = 0.05, p = 0.026). Finally, step four is to
examine whether substantially the entire effect of signature size on reported monetary
allocation operates through narcissism. This test requires that both signature size and
narcissism be included in a regression predicting reported monetary allocation. If
signature size operates entirely through narcissism, then signature size should become
statistically insignificant in predicting reported allocation in the presence of the
narcissism variable. This requirement is met as signature size no longer loads at strict
significance (β = 0.27, p = 0.124).
Taken together, the results of our experimental study reveal that signature size
does indeed predict narcissism as well as misreporting, and that the effect of signature
size on misreporting appears to be primarily attributable to its relationship with
narcissism. We believe this provides a high level of confidence in the archival measure of
narcissism that we utilize in the remainder of the paper.
3. Archival Study of CFO Narcissism and Misreporting Behavior
3.1 Data and Sample Selection
In response to the financial frauds that took place in the early 2000s, on June 27,
2002 the SEC issued an order requiring the senior executives of certain publicly traded
firms to certify the accuracy of their firms’ financial statements. Specifically, the order
required written statements, under oath, from the CEO and CFO of 947 publicly traded
companies with revenues greater than $1.2 billion. We hand-collected all of the available
statements with notarized executive signatures from the SEC’s website.3 The sample
initially includes 1,885 statements that correspond to 939 firms, 945 CEOs, and 940
3 The data source can be found at the following location: http://www.sec.gov/spotlight/officerstatements.htm
9
CFOs.4 We are able to match and obtain relevant compensation data from Execucomp for
571 CFOs and 820 CEOs. Because we standardize the signature by the number of letters
signed, two research assistants had to agree on the letters in the signature. If agreement
could not be reached, the signature was omitted. The legibility requirements restrict the
sample to 405 CFOs and 535 CEOs. Finally, we require Compustat data to calculate the
outcome and control variables in our central tests, which results in a final sample of 340
CFOs and 500 CEOs.
3.2 Empirical Specification
We conduct five sets of tests involving accruals earnings management, real
earnings management, accounting conservatism, internal controls, and
restatements/lawsuits. All models include two-digit SIC fixed effects and are dual
clustered by firm and year. We first test whether CFO and CEO narcissism predict
absolute discretionary accruals, accruals quality, and real activities manipulation. The
general specification for these models is as follows:
𝐸𝐸𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 = 𝛽𝛽1𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽2𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽3𝐵𝐵𝐵𝐵𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽4𝐹𝐹𝑆𝑆𝑆𝑆𝐹𝐹𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖+ 𝛽𝛽5𝐿𝐿𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽6𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽7𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆ℎ𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽8𝑆𝑆𝑆𝑆𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖+ 𝛽𝛽9𝐸𝐸𝐸𝐸𝑆𝑆𝐸𝐸𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽10𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽11𝐸𝐸𝐸𝐸𝑆𝑆𝑆𝑆𝑆𝑆𝐸𝐸𝐸𝐸𝐿𝐿𝐹𝐹𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 + 𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
𝐸𝐸𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 represents the earnings management variable of interest associated with executive i
and firm j in year t. 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is the area-per-letter signature metric for each
executive which captures the level of individual narcissism. 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is the natural log of
total assets, 𝐵𝐵𝐵𝐵𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 is the ratio of book value of equity to market value of equity,
4 While the SEC required written statements from 947 companies, only 939 submitted the statements. The remaining companies were acquired before the statement deadline, thus terminating the obligation to submit the statement. The number of CEOs and CFOs is greater than the number of companies because certain firms maintain co-CEOs or co-CFOs.
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𝐹𝐹𝑆𝑆𝑆𝑆𝐹𝐹𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is the number of years elapsed since the firm first appeared on CRSP,
𝐿𝐿𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is the ratio of total liabilities to total equity, 𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 is an indicator variable
equal to one if the firm incurred a loss on income before extraordinary items in the prior
year and zero otherwise, 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆ℎ𝑖𝑖𝑖𝑖𝑖𝑖 is the percentage change in revenue over the
prior year, 𝑆𝑆𝑆𝑆𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is an indicator variable equal to one if the executive is female and
zero otherwise, 𝐸𝐸𝐸𝐸𝑆𝑆𝐸𝐸𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is the executive’s age in the current year, 𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is the
number of years the executive has been in the position, and 𝐸𝐸𝐸𝐸𝑆𝑆𝑆𝑆𝑆𝑆𝐸𝐸𝐸𝐸𝐿𝐿𝐹𝐹𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 is the natural
log of the ratio of Black-Scholes valued option grants plus restricted stock grants to total
compensation in the current year.
We use five different proxies for earnings management in our tests. The first is
AbsAccruals, defined as the absolute value of abnormal discretionary accruals from the
modified Jones model developed by Dechow, Sloan and Sweeney (1995). The second is
AccrualsQuality, defined as the abnormal change in working capital developed by
Dechow and Dichev (2002), as modified by McNichols (2002). Higher values of these
accruals measures indicate higher levels of earnings management. The final three
variables are proxies for real earnings management as developed by Roychowdhury
(2006). These include AbDisExp, abnormal discretionary expenses, AbCFO, abnormal
cash flows from operations, and AbProdCost, the abnormal production costs incurred.
Lower values of the discretionary expense and cash flow measures indicate higher levels
of earnings management, while a higher value of the production cost measure indicates a
higher level of earnings management.
We next test whether CFO and CEO narcissism predict conditional accounting
conservatism. We use two different models for this set of tests. The first is the conditional
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conservatism measure from Basu (1997), which is based on the differential sensitivity of
earnings to negative versus positive annual abnormal returns:
𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖/𝑃𝑃𝑖𝑖𝑖𝑖𝑖𝑖−1 = 𝛽𝛽1𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽2𝑅𝑅𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽3𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽4𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝑅𝑅𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
+ 𝛽𝛽5𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽6𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝑅𝑅𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
+ 𝛽𝛽7𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝑅𝑅𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝐸𝐸𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝐿𝐿 + 𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖/𝑃𝑃𝑖𝑖𝑖𝑖𝑖𝑖−1 represents current year earnings before extraordinary items scaled by lagged
market value of equity. 𝑅𝑅𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is the cumulative equal-weighted market adjusted return
for the firm beginning in month -8 and ending in month +3 around the fiscal year end.
𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 is an indicator variable equal to one if cumulative abnormal return is negative and
zero otherwise. The key effect of interest in this regression is normally 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝑅𝑅𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖,
which represents the interaction between the magnitude of returns and the sign of the
returns. A positive coefficient would indicate that earnings are more responsive to
negative news and thus are more conditionally conservative. We add the term
𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝑅𝑅𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 (and its lower order interactions) because our central
question is whether conditional conservatism changes with narcissism. A positive
coefficient on this term would indicate that executives with larger signatures exhibit
greater conditional conservatism. We also include a number of control variables and all
of their two- and three-way interactions (suppressed in the results for ease of
presentation), which are: 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, the natural log of market value of equity, as well as
𝐵𝐵𝐵𝐵𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖, 𝐿𝐿𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, 𝑆𝑆𝑆𝑆𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, 𝐸𝐸𝐸𝐸𝑆𝑆𝐸𝐸𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, and 𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 which are as previously
defined.
12
The second conditional conservatism model is drawn from Ball and Shivakumar
(2005) which does not rely on market returns. Instead, it tests the differential sensitivity
of total current accruals to negative versus positive cash flows from operations:
𝐹𝐹𝐸𝐸𝐸𝐸𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 = 𝛽𝛽1𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽2𝐸𝐸𝐹𝐹𝐶𝐶𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽3𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽4𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐸𝐸𝐹𝐹𝐶𝐶𝑖𝑖𝑖𝑖𝑖𝑖
+ 𝛽𝛽5𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽6𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐸𝐸𝐹𝐹𝐶𝐶𝑖𝑖𝑖𝑖𝑖𝑖
+ 𝛽𝛽7𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐸𝐸𝐹𝐹𝐶𝐶𝑖𝑖𝑖𝑖𝑖𝑖 + 𝐸𝐸𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝐿𝐿 + 𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
𝐹𝐹𝐸𝐸𝐸𝐸𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 is defined as income before extraordinary items minus cash flow from
operations scaled by lagged total assets. 𝐸𝐸𝐹𝐹𝐶𝐶𝑖𝑖𝑖𝑖𝑖𝑖 is the cash flow from operations. 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 is
an indicator variable equal to one if cash from operations is negative and zero otherwise.
We focus on the term 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐷𝐷𝑖𝑖𝑖𝑖𝑖𝑖 ∗ 𝐸𝐸𝐹𝐹𝐶𝐶𝑖𝑖𝑖𝑖𝑖𝑖 because our central question is
whether conditional conservatism changes with narcissism. A positive coefficient on this
term would indicate that executives with larger signatures exhibit greater conditional
conservatism in terms of sensitivity of accruals to negative cash flows. We also include a
number of control variables and all of their two- and three-way interactions (suppressed
in the results for ease of presentation), which are: 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, the natural log of total assets,
as well as 𝐵𝐵𝐵𝐵𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖, 𝐿𝐿𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, 𝑆𝑆𝑆𝑆𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, 𝐸𝐸𝐸𝐸𝑆𝑆𝐸𝐸𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖, and 𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 which are as
previously defined.
We next test whether CFO and CEO narcissism predict a weaker oversight of
internal controls. We use ordinal logit and binary logit models to test the probability of
effective internal controls and the number of internal control weaknesses, respectively.
The specifications are as follows:
13
𝐸𝐸𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 = 𝛽𝛽1𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽2𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽3𝐵𝐵𝐵𝐵𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽4𝐹𝐹𝑆𝑆𝑆𝑆𝐹𝐹𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖+ 𝛽𝛽5𝐿𝐿𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽6𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽7𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆ℎ𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽8𝐹𝐹𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆�𝑆𝑆𝑆𝑆𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖+ 𝛽𝛽9𝑆𝑆𝑆𝑆𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽10𝐸𝐸𝐸𝐸𝑆𝑆𝐸𝐸𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽11𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽12𝐸𝐸𝐸𝐸𝑆𝑆𝑆𝑆𝑆𝑆𝐸𝐸𝐸𝐸𝐿𝐿𝐹𝐹𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖+ 𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
𝐸𝐸𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 is defined as the number of material weaknesses in the ordinal logit
specification, and as an indicator variable equal to one if the internal controls are
effective and zero otherwise in the binary logit specification. All control variables are as
previously defined, though we also include 𝐹𝐹𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝐹𝐹𝑆𝑆𝑆𝑆𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖, the level of current year audit
fees scaled by total assets, to control for the complexity of the firm’s accounting and
accounting systems.
The final tests examine financial reporting outcomes. We test whether CFO and
CEO narcissism predict an increased probability of accounting restatements and
subsequent class-action lawsuits using binary logit models. The specifications are as
follows:
𝑅𝑅𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 = 𝛽𝛽1𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽2𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽3𝐵𝐵𝐵𝐵𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽4𝐹𝐹𝑆𝑆𝑆𝑆𝐹𝐹𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖+ 𝛽𝛽5𝐿𝐿𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽6𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽7𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆ℎ𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽8𝐹𝐹𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝐹𝐹�𝑆𝑆𝐿𝐿+ 𝛽𝛽9𝑆𝑆𝑆𝑆𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽10𝐸𝐸𝐸𝐸𝑆𝑆𝐸𝐸𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽11𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽12𝐸𝐸𝐸𝐸𝑆𝑆𝑆𝑆𝑆𝑆𝐸𝐸𝐸𝐸𝐿𝐿𝐹𝐹𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖+ 𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
𝑅𝑅𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is defined as a binary variable equal to one if there was a restatement relating
to the current year accounting report and zero otherwise. All other variables are as
previously defined. We also examine the probability of a class action lawsuit following
the restatement, using a similar specification:
𝐿𝐿𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 = 𝛽𝛽1𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽2𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽3𝐵𝐵𝐵𝐵𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽4𝐹𝐹𝑆𝑆𝑆𝑆𝐹𝐹𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖+ 𝛽𝛽5𝐿𝐿𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽6𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝐿𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽7𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆ℎ𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽8𝐹𝐹𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝐹𝐹𝑆𝑆𝑆𝑆𝐿𝐿+ 𝛽𝛽9𝑆𝑆𝑆𝑆𝑆𝑆𝐺𝐺𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽10𝐸𝐸𝐸𝐸𝑆𝑆𝐸𝐸𝐹𝐹𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽11𝐵𝐵𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 + 𝛽𝛽12𝐸𝐸𝐸𝐸𝑆𝑆𝑆𝑆𝑆𝑆𝐸𝐸𝐸𝐸𝐿𝐿𝐹𝐹𝐸𝐸𝑖𝑖𝑖𝑖𝑖𝑖+ 𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖
14
𝐿𝐿𝑆𝑆𝑆𝑆𝐿𝐿𝑆𝑆𝑆𝑆𝑆𝑆𝑖𝑖𝑖𝑖𝑖𝑖 is defined as a binary variable equal to one if there was a class-action lawsuit
following the restatement and zero otherwise. All other variables are as previously
defined.
4. Results
4.1 Descriptive Statistics
Table 1 reports summary statistics for our primary dependent and independent
variables. The firms in our sample are generally financially healthy and mature. The
average firm age is thirty-eight years, the average book-to-market ratio is 0.49, and nine
percent of firms incurred a loss during the prior year. Average year-over-year sales
growth is 7%. With regard to executive characteristics, the average age is fifty-five years,
3% of the executives are female, and the average time spent in the position is seven years.
On average, 24% of the executive’s compensation is comprised of equity compensation.
Table 2, Panels A and B report univariate Pearson correlations for the CFO and
CEO samples, respectively. CFO signature size is positively correlated with abnormal
discretionary accruals, negatively correlated with abnormal discretionary expenses, and
positively correlated with abnormal production costs (all indicating higher levels of
earnings management). CFO signature size is also positively correlated with accounting
restatements and subsequent class-action lawsuits. CEO signature size is negatively
correlated with accruals quality (indicating a lower level of earnings management), but
negatively (positively) correlated with abnormal discretionary expenses and production
costs (indicating a higher level of earnings management). CEO signature size is also
negatively correlated with the number of internal control weaknesses and accounting
restatements. In summary, at the univariate level, CFO signature size predicts greater
15
accounting and real earnings management as well as negative reporting related outcomes,
while CEO signature size predicts greater real earnings management but generally
exhibits opposing effects for the accounting earnings management and reporting
outcomes.
4.2 Empirical Results
4.2.1. Accruals EM. Table 3 reports the results of the tests of executive narcissism
and accruals earnings management. The first specification examines absolute
discretionary accruals and the second specification examines accruals quality. The first
two columns test the effects of CFO narcissism. SignatureSize loads positively in the
abnormal discretionary accruals model (𝛽𝛽1 = 0.009, p < 0.05) and the accruals quality
model (𝛽𝛽1 = 0.001, p < 0.05), both of which indicate a higher level of earnings
management. The second two columns test the effects of CEO narcissism. SignatureSize
does not load significantly in the abnormal discretionary accruals model (𝛽𝛽1 = -0.002, p >
0.10) or the accruals quality model (𝛽𝛽1 = -0.000, p > 0.10), although both coefficients are
negative and thus indicate a lower level of earnings management. Taken together, the
results suggest that narcissistic CFOs exercise discretion in managing the firm’s accruals,
while narcissistic CEOs do not exercise similar discretion in managing the firm’s
accruals.
4.2.2. Real EM. Table 4 reports the results of the real earnings management
regressions. The first three columns test the effects of CFO narcissism. SignatureSize
loads negatively in the abnormal discretionary expense model (𝛽𝛽1 = -0.060, p < 0.05) and
positively in the abnormal production costs model (𝛽𝛽1 = 0.081, p < 0.01), both of which
indicate a higher level of real earnings management. While the coefficient in the
16
abnormal cash flows model is negative and therefore also indicative of higher real
earnings management, it is not significant. The second three columns test the effects of
CEO narcissism. SignatureSize does not load significantly in the abnormal discretionary
expense model (𝛽𝛽1 = 0.004, p > 0.10), the abnormal cash flow model (𝛽𝛽1 = -0.005, p >
0.10), or the abnormal production costs model (𝛽𝛽1 = 0.001, p > 0.10). These results
indicate that while CEO signature size was significantly related to two of these three
proxies at the univariate level, the relationships become insignificant once control
variables are included. Taken together, narcissistic CFOs seem to exercise control over
the domain of real earnings management, understating discretionary expenses and
overstating production costs, while narcissistic CEOs again do not exercise similar
discretion.
4.2.3. Conditional Conservatism. Table 5 reports the results of the conditional
accounting conservatism regressions. The first two columns test the effects of CFO
narcissism. SignatureSize*D*Ret loads negatively in the Basu earnings-returns test (𝛽𝛽7 =
-0.048, p < 0.05), indicating that earnings are less sensitive to negative returns news as
narcissism increases. SignatureSize*D*CFO also loads negatively in the Ball and
Shivakumar accruals-cash flow test (𝛽𝛽7 = -2.702, p < 0.10), indicating that accruals are
less sensitive to negative cash flow news as narcissism increases. The second two
columns test the effects of CEO narcissism. Neither of the three-way interactions loads
significantly in the conservatism tests. Taken together, narcissistic CFOs seem to
incorporate less conditional conservatism into their accounting reports, resulting in
earnings and accruals that are less sensitive to bad news, while CEO narcissism has no
effect on conservatism.
17
4.2.4. Internal Control Weaknesses. Table 6 reports the results of the internal
controls tests. The first two columns test the effects of CFO narcissism. SignatureSize is
positively associated with the number of material weaknesses reported (𝛽𝛽1 = 0.948, p <
0.05) and negatively associated with the probability of internal controls being assessed as
effective (𝛽𝛽1 = -0.943, p < 0.05). The second two columns test the effects of CEO
narcissism. SignatureSize is not significantly associated with the number of material
weaknesses reported (𝛽𝛽1 = 0.186, p > 0.10) or with the probability of internal controls
being assessed as effective (𝛽𝛽1 = -0.166, p > 0.10). Taken together, the results suggest
that narcissistic CFOs preside over less effective internal controls that are subject to a
greater number of material weaknesses. Whether this is intentional or due to a lack of
care and oversight is not clear and is open for future empirical investigation. Narcissistic
CEOs unsurprisingly have little effect on the quality of internal controls.
4.2.5. Restatements and Lawsuits. Table 7 reports the results of the accounting
restatement and subsequent class-action lawsuit tests. The first two columns examine
CFO narcissism. SignatureSize is positively associated with the probability of an
accounting restatement (𝛽𝛽1 = 0.689, p < 0.01) and with the probability of a class-action
lawsuit following the restatement (𝛽𝛽1 = 1.101, p < 0.05). The second two columns
examine CEO narcissism. SignatureSize is not significantly associated with the
probability of an accounting restatement (𝛽𝛽1 = -0.476, p > 0.10) or with the probability of
a class-action lawsuit following the restatement (𝛽𝛽1 = -1.067, p > 0.10). It is worth noting
that both of these coefficients indicate lower probabilities of negative reporting outcomes,
especially as the lawsuit coefficient is nearly significant (p = 0.107). Taken together, the
firms of narcissistic CFOs suffer from an increased probability of restatements and
18
lawsuits, while CEO narcissism does not appear to create such problems. Again, this
should not be surprising given that the results of our prior tests indicate that CEO
narcissism also does not affect accruals earnings management, real earnings management,
or internal controls quality.
5. Conclusion
Prior literature has documented that managers have a variety of incentives (e.g.
capital market incentives, compensation incentives) to meet performance thresholds.
Given these incentives, several studies have examined the means that firms utilize to
reach these thresholds and what causes managers to exploit the use of these tactics. Of
particular interest is the manager’s use of earnings management tactics to reach earnings
targets. We use a novel measure of the personality trait narcissism, signature size, to
examine the relation between executive narcissism and financial reporting quality and
outcomes.
We begin by conducting an experimental study to validate our archival measure
of narcissism and to confirm its anticipated relation with misreporting. The results
indicate that signature size is positively related to both narcissism and misreporting.
Further, the mediation analysis suggests that the channel by which signature size is
related to misreporting is primarily via the individual’s level of narcissism. We then
utilize a sample of notarized CEO and CFO signatures to examine the relation between
executive narcissism and financial reporting quality and outcomes. The results indicate
that CFO narcissism is associated with greater accruals and real earnings management,
and lower conditional accounting conservatism. CFO narcissism is also associated with
weaker internal control quality and an increased likelihood of restatements and
19
shareholder lawsuits. CEO narcissism is not associated with any of these characteristics
or outcomes.
Our study is subject to certain limitations. First, we are unable to directly observe
the executive’s level of narcissism, but instead utilize the executive’s signature size to
proxy for this personality trait. However, our experimental study validates the use of this
archival measure. Further, we attempt to control for variation in signature size that is not
due to the level of narcissism via the executive’s age and gender. Second, our sample is
limited to the firms required by the SEC to provide the corporate officer statements
described in Section 3.1. While this limits our sample size, the sample includes very large
and influential firms, thus increasing the implications of the results. Further, this data
source allows us to collect notarized executive signatures, thus alleviating concerns of the
signature’s authenticity.
20
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25
Figure 1
Mean Monetary Allocation Reported and NPI-40 Narcissism Score by Quartile of
Signature Size
-0.6-0.5-0.4-0.3-0.2-0.1
00.10.20.30.40.5
1 2 3 4
Stan
dard
ized
Mea
n
Signature Size (Area-Per-Letter) Quartile
Relationship Between Signature Size, Narcissism, and Reported Monetary
Allocation
Narcissism (NPI-40) Score
Reported Monetary Allocation
26
Figure 2
Mediation Analysis of Signature Size, NPI-40 Narcissism Score, and Monetary
Allocation Reported
Signature Size
Monetary Allocation Reported
β = 0.36 p = 0.035
Signature Size
Monetary Allocation Reported
β = 0.27 p = 0.124
Narcissism (NPI-40)
β = 2.23 p = 0.014
β = 0.05 p = 0.026
Step 1
Step 3 Step 2
Step 4
27
Table 1
Descriptive Statistics
This table presents summary statistics for our variables of interest for the pooled sample of CFOs and CEOs.
Mean Std. Dev. p25 p75 AbsAccruals 0.04 0.04 0.01 0.05 AccrualQuality -0.00 0.04 -0.02 0.02 AbDisExp -0.01 0.15 -0.09 0.05 AbCFO 0.03 0.08 -0.01 0.07 AbProdCost -0.02 0.16 -0.09 0.06 NumWeaknesses 0.03 0.31 0.00 0.00 EffControls 0.99 0.12 1.00 1.00 Restatement 0.09 0.28 0.00 0.00 Lawsuit 0.12 0.33 0.00 0.00 SignatureSize 0.80 0.47 0.49 0.98 Size 8.84 1.44 7.77 9.81 B/M 0.49 0.33 0.29 0.63 FirmAge 38.38 21.09 26.00 49.00 Loss 0.09 0.29 0.00 0.00 Leverage 3.82 3.82 2.06 4.20 SalesGrowth 0.07 0.19 0.00 0.13 AuditFees 0.00 0.00 0.00 0.00 Gender 0.03 0.18 0.00 0.00 ExecAge 54.95 6.86 50.00 59.00 Tenure 7.48 4.37 4.00 10.00 EquityComp 0.24 0.21 0.00 0.43
28
Table 2
Pearson Correlations
Panel A: CFO Sample
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
1 AbsAccruals
2 AccrualQuality -.08
3 AbDisExp -.05 -.03
4 AbCFO .01 -.19 -.09
5 AbProdCost .03 .03 -.77 -.46
6 NumWeaknesses -.02 -.00 -.02 -.04 .04
7 EffControls .02 -.00 .03 .03 -.04 -.82
8 Restatement -.01 .02 -.15 .02 .13 .15 -.20
9 Lawsuit .01 -.02 -.18 .03 .12 .11 -.07 .53
10 SignatureSize .06 .00 -.16 -.01 .17 .02 -.03 .10 .07
11 Size -.11 .01 -.08 .00 .07 .03 -.02 -.00 .07 .07
12 B/M -.05 -.00 -.12 -.23 .26 .02 -.03 .07 -.02 .03 .03
13 FirmAge -.11 .01 -.16 -.01 .07 -.02 .02 .01 -.01 .10 .11 -.07
14 Leverage -.12 -.01 .03 -.12 .07 .04 -.04 .04 .09 .01 .39 .12 -.02
15 Loss .15 -.05 -.01 -.15 .08 .00 -.02 .05 .01 .01 -.08 .09 -.06 .06
16 SalesGrowth .03 -.08 .02 -.10 .10 .00 -.01 .00 .02 -.01 -.07 -.16 -.01 -.08 -.13
17 AuditFees .13 -.06 .10 .03 -.12 .05 -.06 -.03 -.07 -.09 -.52 -.24 .00 .23 .06 .03
18 Gender -.02 -.02 -.07 -.06 .07 .06 -.03 -.00 .05 -.06 .07 -.04 -.02 -.03 -.01 -.03 .01
19 ExecAge -.01 -.03 -.09 -.08 .09 .06 -.06 .14 .11 .19 .20 .07 .12 .04 .00 -.03 .04 -.13
20 Tenure -.02 -.02 .06 -.02 -.05 .00 -.03 .07 .02 -.00 .13 .07 .07 -.09 -.02 -.06 .04 -.09 .50
21 EquityComp -.01 .03 .08 .03 -.10 .00 .01 -.00 .09 .02 -.02 -.11 -.06 .07 -.01 .06 -.18 .07 -.28 -.40 This table presents pearson correlations between our variables of interest for CFOs. Bolded coefficients are significant at p < 0.10.
29
Panel B: CEO Sample
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
1 AbsAccruals
2 AccrualQuality -.03
3 AbDisExp -.02 -.03
4 AbCFO .07 -.21 .03
5 AbProdCost -.05 .02 -.72 -.43
6 NumWeaknesses -.01 .04 -.01 -.08 .04
7 EffControls -.01 -.05 .03 .09 -.06 -.68
8 Restatement .06 -.04 -.05 .04 .07 .10 -.16
9 Lawsuit .04 -.06 .01 .09 .01 .07 -.09 .68
10 SignatureSize -.03 -.04 -.07 .01 .05 -.04 .03 -.04 -.02
11 Size -.14 -.01 -.13 .02 .09 .01 -.00 .02 .11 .05
12 B/M -.08 .06 -.18 -.29 .31 .03 -.05 .03 -.07 -.01 .02
13 FirmAge -.12 .02 -.13 -.04 .08 .01 -.02 -.07 -.05 .03 .21 -.03
14 Leverage -.12 -.00 -.02 -.19 .14 .01 -.04 .02 .03 .01 .44 .15 -.04
15 Loss .09 -.03 -.04 -.16 .10 .01 -.03 .04 .00 .02 -.07 .10 -.04 -.04
16 SalesGrowth .06 -.07 .17 .02 -.01 -.02 .01 .02 .06 -.00 -.16 -.16 -.09 -.12 -.12
17 AuditFees .05 .01 .09 -.11 -.06 .10 -.16 .01 -.04 -.03 -.52 -.14 .09 .05 .08 .01
18 Gender -.01 .00 .23 -.02 -.23 .00 -.02 .02 .23 -.03 .00 -.05 .00 .00 .01 -.00 .13
19 ExecAge -.05 .01 -.03 -.07 .08 .06 -.03 -.02 -.02 .04 .09 .10 .04 -.02 -.02 -.05 .05 -.10
20 Tenure -.07 .00 -.03 .03 -.03 .06 -.06 -.00 -.05 -.04 .26 .09 .21 .05 -.06 -.10 .06 .00 .40
21 EquityComp .02 -.01 .02 .10 -.06 -.01 .05 .07 .15 .02 .05 -.14 -.12 .06 .00 .03 -.20 .02 -.20 -.36 This table presents pearson correlations between our variables of interest for CEOs. Bolded coefficients are significant at p < 0.10.
30
Table 3
Abnormal Discretionary Accruals and Accrual Quality
CFO Narcissism CEO Narcissism Absolute
Discretionary Accruals
Accruals Quality
Absolute Discretionary
Accruals Accruals Quality
SignatureSize 0.009** 0.001** -0.002 -0.000 (0.004) (0.001) (0.002) (0.002) Size -0.002* 0.001 -0.001* -0.001 (0.001) (0.001) (0.001) (0.001) B/M -0.002 -0.005 -0.011** 0.003 (0.007) (0.004) (0.005) (0.004) FirmAge -0.000 -0.000 -0.000** 0.000 (0.000) (0.000) (0.000) (0.000) Leverage -0.001** -0.000 -0.001 0.000 (0.001) (0.000) (0.000) (0.001) Loss 0.012*** -0.005 0.011** -0.006* (0.004) (0.005) (0.004) (0.004) SalesGrowth 0.006 -0.019** 0.005 -0.017* (0.008) (0.009) (0.007) (0.009) Gender -0.002 -0.008** -0.007 -0.003 (0.005) (0.003) (0.005) (0.007) ExecAge -0.001** -0.000 -0.000 0.000 (0.000) (0.000) (0.000) (0.000) Tenure 0.000 -0.000* -0.000 -0.000 (0.000) (0.000) (0.000) (0.000) EquityComp -0.007 -0.001 -0.004 0.003 (0.008) (0.003) (0.006) (0.005) Industry Fixed Effects ✓ ✓ ✓ ✓ N 1,674 1,671 2,825 2,829 Adjusted R-square 0.12 0.01 0.10 0.04
This table presents the results of OLS regressions testing the effects of CFO and CEO narcissism (signature size) on accruals earnings management, where abnormal discretionary accruals are based on the Dechow et al. (1995) modified Jones model and accruals quality is based on McNichols (2002). All models include two-digit SIC fixed effects and are dual clustered by firm and year. Coefficients marked with a ***, **, or * are significant at the p < 0.01, 0.05, or 0.10 level, respectively.
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Table 4
Real Earnings Management
CFO Narcissism CEO Narcissism Abnormal
Discretionary Expenses
Abnormal
CFO
Abnormal Production
Costs
Abnormal Discretionary
Expenses
Abnormal
CFO
Abnormal Production
Costs SignatureSize -0.060** -0.012 0.081*** 0.004 -0.005 0.001 (0.024) (0.011) (0.030) (0.018) (0.007) (0.017) Size -0.019** 0.004 0.011 -0.033*** 0.005 0.023** (0.009) (0.004) (0.009) (0.009) (0.004) (0.009) B/M -0.051*** -0.025*** 0.095*** -0.075*** -0.046*** 0.130*** (0.017) (0.009) (0.022) (0.020) (0.008) (0.023) FirmAge -0.001* -0.000 0.001* -0.000 -0.000** 0.001** (0.001) (0.000) (0.001) (0.000) (0.000) (0.000) Leverage 0.003* -0.001 -0.003 -0.002 -0.002 0.001 (0.002) (0.001) (0.002) (0.002) (0.001) (0.002) Loss -0.011 -0.040*** 0.047*** -0.009 -0.036*** 0.046*** (0.013) (0.011) (0.013) (0.015) (0.007) (0.013) SalesGrowth 0.034 -0.048*** 0.092** 0.115*** -0.008 0.030 (0.031) (0.016) (0.041) (0.038) (0.011) (0.033) Gender -0.014 -0.019* 0.033 0.387*** -0.048** -0.319*** (0.044) (0.011) (0.043) (0.093) (0.021) (0.107) ExecAge -0.003 -0.002** 0.004 0.000 -0.001 0.002 (0.003) (0.001) (0.003) (0.002) (0.001) (0.002) Tenure 0.007* 0.002** -0.008* 0.002 0.002** -0.005* (0.004) (0.001) (0.004) (0.003) (0.001) (0.003) EquityComp -0.056** 0.021 0.013 0.005 0.024** -0.038 (0.028) (0.013) (0.025) (0.027) (0.011) (0.029) Industry Fixed Effects ✓ ✓ ✓ ✓ ✓ ✓ N 1,250 1,249 1,246 2,204 2,203 2,190 Adjusted R-square 0.32 0.23 0.30 0.30 0.24 0.28
This table presents the result of OLS regressions testing the effects of CFO and CEO narcissism (signature size) on real earnings management, where abnormal discretionary expenses, cash flows, and production costs are based on Roychowdhury (2006). All models include two-digit SIC fixed effects and are dual clustered by firm and year. Coefficients marked with a ***, **, or * are significant at the p < 0.01, 0.05, or 0.10 level, respectively.
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Table 5
Conditional Accounting Conservatism
CFO Narcissism CEO Narcissism Earnings-Returns
Sensitivity
Accruals-Cash Flow Sensitivity
Earnings-Returns
Sensitivity
Accruals-Cash Flow Sensitivity
SignatureSize 0.004 0.004 0.003 0.002 (0.007) (0.014) (0.006) (0.005) D 0.066 0.171 -0.009 -0.017 (0.074) (0.110) (0.043) (0.101) Ret 0.412** 0.023 (0.186) (0.108) D*Ret -0.395** 0.048 (0.188) (0.118) SignatureSize*D -0.012 -0.071** 0.011 0.002 (0.009) (0.033) (0.007) (0.027) SignatureSize*Ret 0.009 0.004 (0.017) (0.027) SignatureSize*D*Ret -0.048** 0.013 (0.023) (0.028) CFO -0.303 -0.629*** (0.267) (0.218) D*CFO 4.709* -1.340 (2.859) (2.360) SignatureSize*CFO -0.004 -0.006 (0.112) (0.049) SignatureSize*D*CFO -2.702* -0.438 (1.454) (1.590) Industry Fixed Effects ✓ ✓ ✓ ✓ N 1,677 1,929 2,836 3,183 Adjusted R-square 0.14 0.41 0.20 0.42
This table presents the results of OLS regressions testing the effects of CFO and CEO narcissism (signature size) on conditional accounting conservatism, where earnings-returns sensitivity is based on Basu (1997) and accruals-cash flow sensitivity is based on Ball and Shivakumar (2005). All models include a number of controls as described in the methods section and all two- and three-way interactions with those controls, which are suppressed for ease of presentation. All models include two-digit SIC fixed effects and are dual clustered by firm and year. Coefficients marked with a ***, **, or * are significant at the p < 0.01, 0.05, or 0.10 level, respectively.
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Table 6
Internal Control Efficacy and Material Weaknesses
CFO Narcissism CEO Narcissism
Number of
Weaknesses Effective Controls
Number of Weaknesses
Effective Controls
SignatureSize 0.948** -0.943** 0.186 -0.166 (0.456) (0.449) (0.434) (0.451) Size 0.439 -0.470* 0.439 -0.436 (0.299) (0.267) (0.313) (0.300) B/M 1.338* -1.390* 0.699 -0.770 (0.698) (0.722) (0.619) (0.533) FirmAge -0.010 0.011 -0.006 0.008 (0.012) (0.011) (0.011) (0.010) Loss 0.069 -0.074 0.033 -0.034 (0.070) (0.070) (0.049) (0.046) Leverage 0.829 -0.903 -0.333 0.026 (0.884) (0.855) (1.083) (0.847) SalesGrowth 2.248** -2.293** 0.679 -0.672 (0.926) (0.971) (1.314) (1.457) AuditFees 0.003*** -0.003*** 0.003*** -0.003*** (0.001) (0.001) (0.001) (0.001) Gender 0.691 -0.628 -0.327 0.333 (0.697) (0.602) (1.369) (1.387) ExecAge 0.074 -0.067 -0.030 0.036 (0.061) (0.058) (0.067) (0.062) Tenure 0.018 -0.025 0.045 -0.034 (0.101) (0.100) (0.134) (0.131) EquityComp 1.915 -1.911 -0.222 0.524 (1.253) (1.237) (0.902) (0.834) Industry Fixed Effects ✓ ✓ ✓ ✓ N 1,523 1,523 2,101 2,101 Pseudo R-square 0.24 0.29 0.28 0.34
This table presents the results of ordinal and binary logit models testing the effects of CFO and CEO narcissism (signature size) on number of material weaknesses reported and the probability of internal controls being assessed as effective. All models include two-digit SIC fixed effects and are dual clustered by firm and year. Coefficients marked with a ***, **, or * are significant at the p < 0.01, 0.05, or 0.10 level, respectively.
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Table 7
Restatements and Class Action Lawsuits
CFO Narcissism CEO Narcissism Restatement Lawsuit Restatement Lawsuit SignatureSize 0.689*** 1.101** -0.476 -1.067 (0.204) (0.545) (0.445) (0.661) Size -0.188 -0.096 0.062 0.527* (0.179) (0.502) (0.157) (0.270) B/M 0.200 -3.237 0.492 -1.380 (0.411) (2.133) (0.386) (1.001) FirmAge -0.003 -0.011 -0.018** -0.020 (0.007) (0.014) (0.007) (0.015) Loss 0.047 0.215** 0.037 -0.045 (0.045) (0.109) (0.054) (0.062) Leverage 0.502 0.213 0.371* 0.097 (0.411) (0.797) (0.215) (0.488) SalesGrowth 0.081 -3.044 0.429 1.646*** (0.746) (2.809) (0.583) (0.624) AuditFees -0.000 -0.001 0.000* 0.001 (0.001) (0.002) (0.000) (0.000) Gender -0.351 2.005** -0.092 0.318 (0.443) (0.931) (1.159) (1.094) ExecAge 0.060 0.347** 0.005 -0.007 (0.038) (0.139) (0.025) (0.045) Tenure 0.012 -0.187 -0.068** -0.131 (0.046) (0.138) (0.034) (0.085) EquityComp 0.311 4.194*** 0.859** 3.121*** (0.869) (1.114) (0.407) (0.861) Industry Fixed Effects ✓ ✓ ✓ ✓ N 1,523 1,523 2,101 2,101 Pseudo R-squared 0.14 0.55 0.14 0.38
This table presents the results of binary logit models testing the effects of CFO and CEO narcissism (signature size) on the probability of an accounting restatement and class-action lawsuit following the restatement. All models include two-digit SIC fixed effects and are dual clustered by firm and year. Coefficients marked with a ***, **, or * are significant at the p < 0.01, 0.05, or 0.10 level, respectively.
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