Internal governance and real earnings management

Qiang CHENG, Singapore Management University
Kiat Bee Jimmy LEE, Singapore Management University
Terry J. Shevlin, University of Washington


In this paper, we examine whether key subordinate executives have the incentives and ability to restrain the extent of real earnings management. Using the number of years to retirement to capture key subordinate executives’ incentives and using their relative to CEO compensation to capture their influence within the firm, we find that the extent of real earnings management decreases with key subordinate executives’ horizon and influence. In cross-sectional analyses, we find that the impact of internal governance is less important when the CEO is less myopic, is less effective when the key subordinate executives are promoted by the CEO, and is more important for firms with more complex operations where key subordinate executives’ contribution is higher, and is enhanced by the effectiveness of external governance. This paper contributes to the literature by examining how internal governance affects the extent of real earnings management. This examination is important as it sheds light on how the members of the management team work together and shape financial reporting quality.