Internal Corporate Governance, CEO Turnover, and Earnings Management

Abstract:     
CEOs who manage earnings can impose costs on shareholders. But do boards act proactively to discipline such managers, or reactively and only when the earnings manipulations lead to external consequences? Using a sample of 402 forced turnovers and 1,493 voluntary turnovers from 1992-2004, we find that the likelihood and speed of forced CEO turnover are positively related to earnings management. A CEO’s job tenure also is negatively related to how actively earnings are managed during his term in office. These results persist in tests that consider the possible endogeneity of CEO turnover and earnings management, and control for such external consequences as earnings restatements and SEC enforcement actions. The relation between earnings management and forced turnover occurs both in firms with good and bad performance, and when the accruals work to inflate or deflate reported earnings. These results indicate that at least some boards act proactively to discipline managers who manage earnings aggressively, before the manipulations lead to costly external consequences. This is consistent with the view that internal governance does in fact work to mitigate managerial agency problems.

Number of Pages in PDF File: 60

Keywords: Management turnover, earnings management, corporate governance

JEL Classification: G38, K22, K42, M41

working papers series