CEO Inside Debt and Earnings Managemen

In this study, we investigate the effects of CEO inside debt, that is, deferred CEO compensation, on financial reporting practice. We find a positive relationship between CEO inside debt and earnings management. Our results support the hypothesis that CEO inside debt provides incentives for upward earnings management. The results from additional tests also show that firms whose CEOs hold high inside debt balances are more likely to attain earnings targets through accruals management. Finally, we provide evidence that such debt is associated with lower accruals quality after controlling for other types of compensation. Our findings suggest that inside debt may increase agency costs by providing incentives for earnings management rather than discouraging it as a means of reducing firm risk. Our findings provide valuable implications for various financial market entities. They suggest that shareholders need to consider the impact of inside debt in determining optimal CEO compensation contracts and that regulators and auditors should also be interested in CEO inside debt as part of their monitoring role in financial reporting. This study extends the scope of existing literature on CEO inside debt to financial reporting practice.