CFO accounting education on the choice of earnings management

• Published date: 01 October 2023
• Author: Ling Tuo,Ruixue Du,Zhenfeng Liu
• Date: 01 October 2023
• DOI: http://doi.org/10.1002/jcaf.22629

Received:  November  Accepted:  March 

DOI: ./jcaf.

RESEARCH ARTICLE

CFO accounting education on the choice of earnings

management

Ling Tuo1Ruixue Du2Zhenfeng Liu3

School of Accountancy, Old Dominion

University, Norfolk, Virginia, USA

Menlo College, Atherton, California,

USA

Accounting Finance and International

Business, University of Michigan – Flint,

Flint, Michigan, USA

Correspondence

Ling Tuo, School of Accountancy,Old

Dominion University, Norfolk,VA, USA.

Email: ltuo@odu.edu

Abstract

This paper investigates whether CFO’s educational backgroundcould influence

his/her firm’s level of earnings management because CFO plays a direct role

in overseeing financial reporting. Based on agency theory and upper echelons

theory, we discuss whether a CFO with/without an accounting degree could

incentivize him/her to choose one over another among the three types of earn-

ings management. Using a US sample between  and , we empirically

find that CFOs with an accounting degree are associated with a higher degree

of accrual earnings management and a higher degree of real earnings manage-

ment through overproduction while CFOs without any accounting degree are

associated with a higher degree of classification shifting. Our results hold robust

when we implement a difference-in-difference test on the executive turnover

from a CFO without any accounting degree to a CFO with an accounting degree.

Finally, we find that CFOs with CPA certification behave more ethically in all

three types of earnings management. Our study enriches the management demo-

graphic factor influence literature, unveils the roleof CFO in choices of earnings

management, supports ethics requirements in business education, and provides

implications to executive hiring as well to audit practices.

KEYWORDS

CFO’s education, financial reporting, accrual earnings management, real earnings manage-

ment, classification shifting

1 INTRODUCTION

In April , after  month into the pandemic shutdown,

SEC chairman Jay Clayton expressed the concerns over

the significant implications of financial reporting caused

by COVID-, with revenue recognition among one of the

most affected areas (Teotia, ). In the United States,

about % of all detected financial frauds were related

to revenue recognition (Alali & Wang, ). Improper

revenue recognition serves as one of the main earnings

management techniques. Prior research has focused on

factors affecting a firm’s earnings management choices

both on the firm level (Huang et al., ; Liu et al., ;

El Diri et al., ) and on the executive level (Healy,;

Krishnan & Parsons, ; Harris et al., ; Zalata &

Abdelfattah, ). However,little attention has been given

to the CFOs’ education background. Sarbanes-Oxley Act of

 requires both CEO and CFO to certify their periodic

reports while prior studies pay more attention to the effect

of CEO on the quality of financial reporting (Bergstresser

& Philippon, ;Ali&Zhang,).

This study investigates the impact of CFOs’ accounting

related education and certification on their choices of earn-

ings management types. Specifically, we examine whether

J Corp Account Finance. ;:–. ©  Wiley Periodicals LLC. 9wileyonlinelibrary.com/journal/jcaf

10 TUO  .

CFOs with an accounting education background behave

more ethically in financial reporting compared with CFOs

without any accounting education background. Upper

echelons theory suggests that managers’ demographic fac-

tors may be used to capture their cognitivevalues, and have

impact on corporate strategies and outcomes (Hambrick

& Mason, ). We focus on CFOs’ accounting education

background because overseeing financial reporting is one

of CFOs’ primary responsibilities and they can exercisedis-

cretion over financial reporting (Jiang et al., ) and it is

important to learn whether trainings in accounting skills

and business ethics at early ages distinguish them from col-

leagues with different trainings when deciding the choice

of earnings management.

Moreover, we are interested in how different education

backgrounds influence CFOs’ choices among accrual-

based earnings management, real activity earnings man-

agement, and classification shifting, which are the three

main forms of earnings management that companies

engage to achieve their financial goals. Historically,

researchers focused mainly on accrual-based earnings

management (Healy, ; Jones, ; Dechow et al.,

; Kothari et al., ). However, recent studies show

that firms also largely engage in real earnings man-

agement,where the management alters real activities,

such as boosting sales by accelerating revenue recogni-

tion (Gunny, ; Roychowdhury, ). Besides these

two methods, companies also engage in classification

shifting to inflate their continuing income (McVay, ;

Malikov et al., ). Prior research suggests that man-

agers trade off among accrual earnings management, real

earnings management, and classification shifting based on

the constraints of different earnings manipulation meth-

ods (Zang, ; Abernathy et al., ). This introduces

tension in our study whether the CFO’s accounting ver-

sus non-accounting education background leads to skill

and judgment differentials and thus has an impact on the

choices of earnings management types, especially when

earnings management is widespread (Bertomeu et al.,

).

We manually collect the educational background data

of S&P  CFOs between  and . Using alterna-

tive measures of various types of earnings management,

we find first, that CFOs with an accounting degree are

associated with a higher degree of accrual earnings man-

agement and a higher degree of real earnings management

through overproduction compared with CFOs without any

accounting degree. This suggests formal accounting edu-

In this paper,we follow Roychowdhury () and refer to real earnings

management activities as the actions that management takes that devi-

ate from normal business practices with the primary objective of meeting

certain earnings thresholds.

cation offers CFOs with necessary accounting knowledge

and skills to use discretionary accruals more aggressively

within the flexibility of accounting standards and calculate

product costs more accurately to implement overproduc-

tion. Second, consistent with prior studies which suggest

that real earnings management is mainly constrained by

internal and external monitoring, we do not find a sig-

nificant relation between CFOs’ educational background

and the degree of real earnings management through

lowering discretionary expenditures and accelerating rev-

enues recognition. This suggests budget reduction in R&D,

advertising, and SG&A expenditures are commonly imple-

mented in the real business world regardless of CFOs’indi-

vidual educational background. Finally, non-accounting

majored CFOs are associated with a higher degree of shift-

ing operating expenses to special items to manipulate their

core earnings upward, while accounting majored CFOs

may not prefer classification shifting.

Moreover, we find that the effect of education on earn-

ings management weakens when CFOs become older.

Our main results hold when we test the effect of change

from nonaccounting majored CFOs to accounting majored

CFOs on the three types of earnings management. Addi-

tionally, we find mixed results for CFOs with a business

degree in their earnings management practice while CFOs

with CPA certification are associated with a lower degree

of all the three types of earnings management.

This paper contributes to the current literature of

accounting and business research in several ways. First,

we enrich the management demographic factor influ-

ence literature by identifying a new executive-level factor,

educational background, related to a firm’s earnings man-

agement choice. Second, to the best of our knowledge,

this paper is the first empirical study that comprehensively

investigates CFO’s choice among accrual based, classifi-

cation shifting, and real activities earnings management,

while most prior research focuses on the CEO’s effect

on firms’ strategies of earnings management (Bergstresser

& Philippon, ;Ali&Zhang,). Our paper sug-

gests that CFO individual characteristics have the direct

effect on firms’ financial reporting strategies and provides

additional evidence for the CFO certification required by

Sarbanes-Oxley Act. Third, collaborating with the com-

plete updates of the international ethics code by Interna-

tional Ethics Standards Board for Accountants (IESBA)

in , our findings call for more ethics trainings and

ethics awareness in accounting and business education.

Our result that CFOs with CPA certification aremore eth-

ical in financial reporting also supports recently increased

requirements of ethic credits in the CPAexam and contin-

uing professional education (AICPA, ;CalCPA,).

Finally,through empirically unveiling that executive’sedu-

cation results in decision-making differentials, our study