CFO Narcissism and Financial Reporting Quality

Sean Wang is Assistant Professor of Accounting at the University of North Carolina at Chapel Hill. This post is based on an article by Professor Wang, Mark Lang, Professor of Accounting at the University of North Carolina at Chapel Hill, and Chad Ham and Nicholas Seybert, both of the Department of Accounting & Information Assurance at the University of Maryland.

In Kurt Eichenwald’s Conspiracy of Fools, the author details the collapse of the Enron empire and places the majority of the blame on their CFO, Andrew Fastow. Fastow is credited with being responsible for engineering the special purpose entities, which hid the majority of Enron’s debt from their balance sheets. The excess leverage created risks that were opaque to Enron’s shareholders, and were largely responsible for Enron’s bankruptcy. Eichenwald’s interviews with Fastow’s colleagues portrayed him as a narcissist who would do anything for his own self-interest at the expense of the welfare of those around him.

In our paper, CFO Narcissism and Financial Reporting Quality, which was recently made publicly available on SSRN, we examine whether CFO narcissism can impact financial reporting outcomes. We focus on CFOs because of their primary role in financial reporting decisions. We conjecture that the traits of narcissism, which include exploitativeness, the domination of group decisions, a sense of self-entitlement, inflated self-perceptions, and a constant need for recognition, will result in narcissistic CFOs being more willing to exploit power and information asymmetry to engage in misreporting.

Measuring the degree of narcissism that individual CFOs possess is not an easy task. While the standard method of measuring narcissism by psychologists comes from a written Narcissistic Personality Inventory (NPI-40) questionnaire, the response rate from financial executives would likely be low and the veracity of their responses might also be questionable. Thus, we use a less obtrusive measure, their signature size, to capture the level of narcissism inherent in their personality.

While the link between narcissism and signature size is not new (we originally identified the relationship in a prior working paper), the association between narcissism and misreporting has not been previously established. Thus, we begin by examining the relation between signature size, narcissism, and misreporting in an experimental setting. In our experiment, a participant receives a $5 endowment, which must be allocated between him/herself and a partner. While the default allocation is $2.50 for the subject (and $2.50 for the partner), the students are told that others may receive different allocations. Thus, the reporting participant has the opportunity to misreport the default allocation, which would result in the participant paying himself more (and the partner less). After reporting the default allocation value, the participants then completed the full NPI-40 questionnaire.

We examine the relation between signature size (as measured by the area-per-letter of the signature on the consent form), attributes of narcissism based on NPI-40 scores, and the willingness to misreport the initial endowment. The results are striking. We find a positive and monotonic relation between quartiles of signature size and (1) the NPI-40 narcissism score and (2) the magnitude of misreporting which resulted in the subject getting paid more, and the partner getting paid less. With regard to (1), the top five statements associated with signature size were as follows:

  1. I can usually talk my way out of anything.
  2. I find it easy to manipulate people.
  3. I can read people like a book.
  4. Everybody likes to hear my stories.
  5. I can make anybody believe anything I want them to.

These statements were interesting to us because they suggest the types of attributes that may be associated with a tendency to misreport, i.e. a manager who is willing to misreport would also be likely to feel that they can easily manipulate others, talk their way out of anything, and make others believe whatever they want.

Having documented the link between signature size, narcissism and misreporting in an experimental setting, we next examine archival data to investigate the association between notarized CFO signature sizes and financial reporting outcomes for publicly traded firms. We find that narcissistic CFOs are more willing to manage earnings (both by altering accrual accounting estimates and manipulating real operations), resulting in financial disclosures that mask the true economic performance of the firm. In addition, narcissistic CFOs are less likely to recognize losses in a timely manner, consistent with a willingness to cover up past mistakes. We also find that the firms of narcissistic CFOs are more likely to have ineffective internal controls and suffer from a higher number of internal control weaknesses. Finally, as a consequence of a higher degree of financial misreporting, we find that narcissistic CFOs are more likely to have their annual financial reports restated.

While our primary focus was on the linkage between CFO narcissism and financial reporting, we also compared results based on CFO signature size to those based on CEO signature size. Given their direct role in the financial reporting process, we expected CFOs to have greater influence on financial reporting quality than CEOs. As expected, CFO narcissism is substantially more predictive of financial reporting quality than CEO narcissism, which was generally unpredictive of the financial reporting outcomes, except in the cases where strategic changes in real operations were used to manage earnings. These results are consistent with the CFO and CEO roles within the firm. The CFO oversees the financial reporting process, while the CEO maintains control of investment decisions and other strategic operations. (Note: In a separate SSRN paper, we examine the consequences of CEO narcissism and investment policy).

Overall, our study experimentally validates an association between (1) signature size and narcissism, and (2) narcissism and misreporting. Our real world results linking CFO signature size to earnings management are consistent with our experimental results. CFOs with higher levels of narcissism have, on average, a lower level of financial reporting quality and a higher probability of restatements.

The full paper is available for download here.

 

 

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