Rhetorical Big Baths Following CEO Turnovers

Abstract

This paper sheds light on the open issue as to whether incoming CEOs’ income-reducing accounting decisions misrepresent firm performance and serve the purpose of setting a low benchmark for the incoming CEO’s tenure by blaming her or his predecessor for poor performance. Investigating the textual tone in earnings press releases (EPRs) in the years surrounding CEO turnovers, we find that incoming CEOs use negative tone to an extent that cannot be explained by current firm performance or proxies for expected future performance. We confirm this result for past- or present-oriented language after controlling for tone in forward-oriented EPR statements. This rules out that our results are due to incoming CEOs conveying relevant information about the firm’s future situation that is not contained in financial figures. Moreover, the phenomenon of “rhetorical big baths” is more common to forced turnovers, when the incoming CEO is overconfident, or among turnovers, where the incoming CEO takes a big bath by means of discretionary accruals or write-downs. All in all, our results document opportunistic behavior consistent with the hypothesis that incoming CEOs strategically try to bias the perception of market participants about their firm’s situation downwards.

Keywords: CEO turnover, big bath, textual analysis JEL codes: G30, M41

JEL Classification: G30, M41