CEO Regulatory Focus, Decision Frames, and Earnings Management

Strategy scholars have increasingly noted the influence of the psychological characteristics of executives on corporate strategy and performance. Synthesizing theories on regulatory focus and framing effect, in this study we examine the role of CEO regulatory focus (i.e., promotion and prevention focus) and decision frames (i.e., gain and loss frames) reflected in earnings management decisions. Specifically, we predict that under two conditions, promotion focus under a gain frame and prevention focus under a loss frame, a CEO’s subjective utilities and probabilities of the attainable gains in earnings management become heightened. This, in turn, ultimately leads to his/her intensified tendency to manipulate earnings. Conversely, a CEO’s promotion (prevention) focus under a loss (gain) frame decreases his/her perceived utilities and probabilities of the attainable gains in earnings management, subsequently leading to diminished tendency to manipulate earnings. Using a seven-year panel data of U.S. manufacturing firms between 2011 and 2017, we find general support for our hypotheses. The results indicate that the psychological characteristics of CEOs, along with their framing of performance, have a significant impact on their earnings management decisions. Overall, our study highlights the importance of understanding the psychological underpinnings of the earnings management behavior.