Executives’ “Off-the-Job” Behavior, Corporate Culture, and Financial Reporting Risk

Robert Davidson
McDonough School of Business, Georgetown University

Aiyesha Dey
Carlson School of Management, University of Minnesota

Abbie J. Smith*
The University of Chicago Booth School of Business

June, 2013

Abstract

We examine how executives’ behavior outside the workplace, as measured by their ownership of luxury goods (low “frugality”) and prior legal infractions, is related to financial reporting risk. We predict and find that CEOs and CFOs with a legal record are more likely to perpetrate fraud. In contrast, we do not find a relation between executives’ frugality and the propensity to perpetrate fraud. However, as predicted, we find that unfrugal CEOs oversee a relatively loose control environment characterized by relatively high probabilities of other insiders perpetrating fraud and unintentional material reporting errors. Further, cultural changes associated with an increase in fraud risk are more likely during unfrugal (vs. frugal) CEOs’ reign, including the appointment of an unfrugal CFO, an increase in executives’ equity-based incentives to misreport, and a decline in measures of board monitoring intensity.

Keywords: Executive frugality, legal infractions, financial reporting risk, corporate culture.

JEL Classification Codes: G30; G34; G38

*Corresponding author: Abbie J. Smith, University of Chicago Booth School of Business, 5807 S. Woodlawn Avenue, Chicago, IL 60637. Phone: 773-702-7295; Fax: 773-702-0458; abbie.smith@chicagobooth.edu.

We thank David Cooper, Patricia Dechow, Adam Galinsky, Alan Jagolinzer, Thomas Lys, Stewart Myers, and the seminar participants at the Stanford Summer Accounting Conference and the 2011 NBER conference for very helpful comments. We also benefited from discussions with Brian Miller, Andy Leone, and Scott Turow and from the financial support of the Accounting Research Center at the University of Chicago Booth School of Business and the Institute of Fraud Prevention.

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