“Career Concerns, Financial Reporting Quality, and Efficiencies” by Professor Suil Pae
Professor Suil Pae
SKK Graduate School of Business
We show that when a career-concerned manager makes a costly unobservable investment, a tension arises between her incentive to reduce investment and the incentive to increase investment to favorably influence the market perception of her ability. Depending on the magnitude of career concerns, the manager either underinvests or overinvests, relative to the first-case in which investment is observable. Greater career concerns increase (decrease) the equilibrium efficiency if the manager underinvests (overinvests). Higher-quality reporting induces the manager to invest more and thus it increases the equilibrium efficiency in the presence of underinvestment. The second part of the paper extends the model to a setting in which reporting quality is endogenous. We show that the manager adjusts reporting quality to alleviate suboptimal investment. Specifically, the equilibrium reporting quality is higher (lower) than the first-best reporting quality if the manager underinvests (overinvests). We further show that when career concerns increase, the reporting quality diminishes. This result offers a new explanation for a recent empirical finding: earnings management tends to be pronounced in the early years of CEO tenure and then diminishes. A broader interpretation of reporting quality to include factors affecting the informativeness of financial reports offers research opportunities to examine the effect of career concerns on managers’ choice of those factors.