The Impact of Executive Ethnic Diversity on Real Earnings Management

Abstract

SYNOPSIS This study examines the impact of the ethnic diversity of executives on real earnings management (REM) by using 21,217 firm-year observations for 2,209 U.S. public firms between 1993 and 2020. Social identity theory and top management team research suggest executive diversity enhances mutual monitoring and subordinate executives’ independence from the CEO, thus incentivizing subordinate executives to curb CEOs’ opportunistic financial reporting. The empirical results indicate a negative relation between executive ethnic diversity and REM. This result holds after controlling for various characteristics of executives and firms, as well as for potential endogeneity by using instrumental variable regressions and entropy balancing technique. Cross-sectional tests show that the effect is stronger when each executive has a greater influence on the firm’s operating decisions and when the firm has better internal corporate governance. Collectively, our evidence suggests that executive ethnic diversity strengthens the internal governance of U.S. public firms. JEL Classifications: M41; M48.