Does Managerial Risk Aversion Affect Earnings Management? Evidence from CEO Political Ideology

Abstract

We investigate whether managerial risk aversion, as measured by CEO political ideology, affects corporate decisions to undertake earnings management. Using a sample of 10,799 firm-year observations for S&P 1500 firms during the period from 1996 to 2008, we document that Republican CEOs, who tend to have a conservative ideology and be risk-averse, engage in less accrual-based earnings management but more real earnings management than Democratic CEOs. The impacts of managerial risk aversion on earnings management are incremental to the impacts of managerial incentive-based compensation and certain managerial attributes. Our main findings are robust to various sensitivity checks and to controls for potential endogeneity concerns. Importantly, we show that management control mechanisms (i.e., family ownership and CEO political ideology misalignment with subordinate executives in top management teams) can further constrain CEOs’ opportunistic earnings management behaviors. Taken together, our findings suggest that CEOs with strong political ideology have discretion to translate their personal risk attitude into earnings management decisions.