CEO’s personal legal liability and earnings management

ABSTRACTThis paper examines the incentive effect of the personal legal liability for a CEO. Exploiting a unique Chinese law that a legal representative of a firm bears personal legal liability for a firm’s illegal activities, we document a decrease in earnings management when the CEO is also the firm’s legal representative. Additional analysis shows that the impact of a CEO’s legal liability on earnings management is more salient when the CEO is externally recruited, lacks family background, and when the firm faces enormous litigation risk. The findings are robust to endogeneity and after accounting for the CEO’s characteristics. Our study contributes to managerial legal liability, law and finance, and financial reporting research.KEYWORDS: CEOpersonal legal liabilitylaw and financeearnings managementJEL CLASSIFICATION: G14G34M41 Disclosure statementNo potential conflict of interest was reported by the author(s).Additional informationFundingThe work was supported by the National Natural Science Foundation of China [No.72372134].