Implications of power: When the CEO can pressure the CFO to bias reports

- Presents an agency model with a CEO and a CFO.
- CEO can pressure the CFO to bias the performance measure.
- Bias can be driven by either CEO׳s or CFO׳s incentive compensation.
- With information asymmetry, powerful or non-powerful CEOs can earn rents.
- Helps explain mixed empirical findings related to compensation, bias, and rents.

Building on archival, anecdotal, and survey evidence on managers׳ roles in accounting manipulations, I develop an agency model to examine the effects of a CEO׳s power to pressure a CFO to bias a performance measure, like earnings. This power has implications for incentive compensation, reporting quality, firm value, and information rents. Predictions from the model provide potential explanations for the differing results from recent empirical studies on the impact of regulatory interventions like SOX and the extent to which the CEO׳s or CFO׳s incentives significantly impact on earnings management. The model also identifies conditions under which either a powerful or a non-powerful CEO can extract rents, which can help explain mixed empirical results on the association between CEO power and “excessive” compensation.