Earnings management surrounding CEO changes - Evidence from S&P 500 companies

Abstract

CEO changes create suitable scenarios for earnings management research, since CEOs have the capability to manage earnings and robust personal motives relating to the situation. Prior research on the subject has provided mixed results and most on the studies in the field were made with data from 1980's and 1990's. Furthermore, the responsibilities of CEOs have become more demanding and average tenure of a CEO has shortened significantly during the last decades. Thus, there is a clear need for more contemporary analysis of the phenomenon.

This study focused on examining US based S&P 500 companies and their last CEO changes. The research method of this thesis consisted of two parts, where the first part focused on detecting all earnings management by creating earnings expectation models for each of the companies with time series regressions. Earnings estimation errors indicated earnings management. The second part examined accrual based earnings management with the Modified Jones Model (Dechow et al., 1995). In addition to the statistical results for the sample as a whole, firm-specific results were reviewed.

The results of the earnings expectation models and the Modified Jones Model, both show mean income decreasing earnings management through the whole observation period from T-2 to T+1, where the year T is the CEO change year. Thus, the cover-up theory didn't hold for the whole sample and big bath accounting theory held only partly. However firm specific results revealed some companies that had managed earnings exactly aligned with the hypotheses.