Earnings Management and the Role of Moral Values in Investing

Posted by ARC Commitee - Jan 15, 2024
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In a world where financial returns often take center stage, this study sheds light on the powerful role of moral values in investment decisions. This research delves into how investors perceive CEOs based on their engagement in earnings management and how these perceptions, coupled with the investors’ own moral values, influence their investment choices.

The study primarily revolves around the concept of earnings management – the practice where CEOs can legally influence reported earnings. In laboratory experiments, we found that when CEOs engage less in earnings management, investors perceive them as more committed to honesty. This perception of a CEO’s honesty plays a significant role in investment decisions, but in a balanced manner.

Specifically, a CEO’s perceived commitment to honesty influences how much weight investors place on the CEO’s future financial returns. Investors tend to become less sensitive to differences in promised returns when they perceive a CEO to be more committed to honesty. But the study also highlights differences in how ‘proself’ (self-oriented) and ‘prosocial’ (socially-oriented) investors react to these perceptions.

Proself investors, who focus more on personal gain, still value a CEO’s commitment to honesty, balancing it against the potential financial returns. On the other hand, prosocial investors, who consider broader social and moral implications, are more influenced by the CEO’s perceived honesty as such, often placing moral values ahead of financial returns.

What’s intriguing about these findings is the shift in focus from purely financial motives to the incorporation of ethical considerations in investment decisions. The study demonstrates that morality is not just a niche interest; it plays a significant role in the decision-making process for various types of investors. This insight is pivotal, especially in an era increasingly focused on sustainable and responsible investing. The research not only expands our understanding of investor behavior but also underscores the importance of ethical leadership in the corporate world. CEOs’ commitment to honesty and moral values isn’t just a matter of personal integrity – it’s a strategic element that can significantly sway investor decisions and shape the future of businesses.

 

Rajna Gibson, Matthias Sohn, Carmen Tanner, and Alexander F. Wagner

European Accounting Review, forthcoming

available at: https://www.tandfonline.com/doi/full/10.1080/09638180.2023.2291408

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