Mitigation: How would you, as CEO/CFO of a publicly traded manufacturing firm, mitigate the potential for serious corporate damage due to ethical and/or legal issues? Explain.
Process: What kind of process would you build into operations, culture, policy, and procedures to make sure your firm will not experience any ethical or legal issues?
Be sure to consider the effectiveness and efficiency of your solutions. You might also consider any cost-benefit analysis that might be of interest.
Despite regulatory reforms aimed at inhibiting aggressive financial reporting, earnings management persists and continues to concern practitioners, regulators, and standard setters. To provide insight into this practice and how to mitigate it, we conduct an experiment to examine the impact of two independent variables on CFOs' discretionary expense accruals. One independent variable, incentive conflict, is manipulated at two levels (present and absent)-i.e., the presence or absence of a personal financial incentive that conflicts with a corporate financial incentive. The other independent variable is CFOs' earnings management ethics ('EM-Ethics,' high vs. low), measured as their assessment of the ethicalness of key earnings management motivations. We find that incentive conflict and EM-Ethics interact to determine CFOs' discretionary accruals such that (a) in the presence of incentive conflict, CFOs with low (high) EM-Ethics tend to give into (resist) the personal incentive by booking higher (lower) expense accruals; and (b) in the absence of an incentive conflict, CFOs with low (high) EM-Ethics tend to give into (resist) the corporate incentive by booking lower (higher) expense accruals. We also find support for a mediated-moderation model in which CFOs' level of EM-Ethics influences their moral disengagement tendencies which, in turn, differentially affect their discretionary accruals, depending on the presence or absence of incentive conflict. Theoretical and practical implications of these findings are discussed.