How Deep is your Bath? Cross-Country Differences in Earnings Management Following CEO Turnovers

Abstract

This study documents that big bath accounting following CEO turnovers is pervasive worldwide and shows that the extent to which CEOs engage in big bath accounting is associated with the degree of discretion they have available in their respective countries. Our analysis is based on a new country-level measure for managerial discretion derived from a questionnaire survey with more than 500 strategy consultants from 35 countries. In addition, we find that newly incoming outsider CEOs and CEOs following non-routine or performance-induced turnovers engage in more earnings management than other incoming CEOs. Lastly, we find that big bath accounting following CEO turnovers is achieved through the management of working capital accruals, provisions, and impairment items. In all of these more detailed analyses, the level of negative discretionary accruals is associated with the discretion available to CEOs in the respective countries. Additional findings reveal no association between legal-based investor protection measures and the extent to which CEOs engage in big bath accounting across countries, presumably because the legal regulations underlying these measures are not relevant in CEO turnover situations and therefore do not constrain newly incoming CEOs. In contrast, our measure is not limited to legal aspects of investor protection but reflects the multidimensionality of managerial decision-making.

Keywords: Managerial Discretion, CEO Turnover, Earnings Management, Discretionary Accruals, Cross-country Differences; Survey-based Measure