CEO Tenure and Earnings Management

Abstract

This study examines changes in CEOs’ incentive to manage their firms’ earnings during their tenure as CEO. We show that earnings are more likely to be overstated in the early years than in the later years of CEOs’ service, and that this association is weaker for firms with greater institutional ownership. This result is consistent with CEOs’ incentive to favorably influence the market’s perception of their ability in the early years of their service by overstating their firms’ earnings. CEOs with higher ability are more likely to survive the multiple retention/dismissal decisions during their early years as CEO, and thereby establish a reputation of high ability. Subsequently, these CEOs will have the incentive to avoid overstating earnings to prevent the loss of their reputation. We also show that earnings overstatement is significantly greater in the CEOs’ final year of service than in their other years in office, and this result obtains only after controlling for earnings overstatement in the early years of their service. This result is consistent with the horizon problem of departing CEOs, and also suggests that a lack of control for earnings overstatement in the early years of CEOs’ service could be a reason for the mixed evidence on this issue in the literature.

Keywords: CEO Career Concerns, CEO Reputation, Horizon Problem of Departing CEOs, Earnings Management

JEL Classification: G14, M41