This study examines the association between financial expert CEOs and earnings management (EM) around initial public offerings. We identify financial expert CEOs as those having past experience in either banking or investment firms, large auditing firms, or finance-related roles. We find strong evidence that newly listed firms with financial expert CEOs are less likely to engage in either accrual-based or real EM in the offering year than those with non-financial expert CEOs. In particular, our results are robust after controlling for the potential selection issue that occurs due to non-random matching of CEOs to firms. In addition, we employ alternative measures of financial expertise, including past experience in a CFO position, financial experience variety, and professional qualifications. We document that CEOs who used to work as CFOs and those who gained varied financial experience are less likely to manage earnings through both accruals and real activities. Moreover, CEOs who have a professional qualification in finance and/or accounting are also associated with lower accrual-based EM.
Earnings are widely used by investors to evaluate firms' prospective performance and managers are tempted to manipulate earnings to influence short-term stock prices. The incentives to engage in earnings management (EM) are stronger around initial public offerings (IPOs) due to the high level of information asymmetry between managers and investors. Prior research on EM around IPOs has provided evidence for positive abnormal accruals in the year of issue and a negative relation between at-issue abnormal accruals and post-issuelong-run stock performance, suggesting that managers manipulate earnings to mislead investors (Aharony, Lin, & Loeb, 1993; DuCharme, Malatesta, & Sefcik, 2004; Friedlan, 1994; Gramlich & Sorensen, 2004; Roosenbloom & van der Goot, 2003; Teoh, Welch, & Wong, 1998a; Teoh, Wong, & Rao, 1998b). Given the prevalence of the EM issue, researchers have extensively explored the determinants of EM, such as firm-level factors (e.g.,firm size, firm performance, leverage, growth, corporate governance, financing needs, and target beating) and external factors (e.g.,capital requirements and regulations; see Dechow, Ge, & Schrand, 2010, for a review). In the IPO context, several studies suggest the significance of external parties such as auditors, underwriters, venture capitalists, and credit rating agencies in restraining EM by IPO firms (Gounopoulos & Pham, 2017; Hochberg, 2012; Lee & Masulis, 2011; Morsfield & Tan, 2006; Venkataraman, Weber, & Willenborg, 2008; Wongsunwai, 2013). Moreover, increasing attention has been paid to examining manager-level factors driving EM. Research on the effects of managerial characteristics on accounting choices is primarily based on the upper echelons theory (Hambrick, 2007; Hambrick & Mason, 1984), which postulates that managerial background characteristics may partially influence top managers' decision-making and organizational outcomes. Prior literature has documented the link between earnings quality and several managerial characteristics such as CEO reputation (Francis, Huang, Rajgopal, & Zang, 2008), superstar CEOs (Malmendier & Tate, 2009) and managerial ability (Demerjian, Lev, Lewis, & McVay, 2013). However, to the best of our knowledge, the impact of CEOs' financial experience on EM around IPOs remains unexplored.