Details
| Original language | English |
|---|---|
| Pages (from-to) | 1249-1281 |
| Number of pages | 33 |
| Journal | Journal of Business Economics |
| Volume | 92 |
| Issue number | 8 |
| Early online date | 19 May 2022 |
| Publication status | Published - Oct 2022 |
Abstract
Following executive turnovers big bath accounting is often observed. We investigate a new manager’s earnings management incentives in his first year in office in a two-period model with career concerns and earnings’ lack of timeliness. We determine the optimal incentive contract and decompose the manager’s equilibrium earnings management into two components: an explicit incentive resulting from the compensation contract and an implicit incentive from career concerns. While career concerns always motivate the manager to shift earnings backwards, the optimal contract induces the manager to either shift earnings forwards or backwards. In particular, we show that with optimal contracts a "negative" big bath may result in equilibrium, i.e., the manager may inflate earnings after a CEO turnover. We demonstrate how the optimal contract and the equilibrium earnings management strategy depend on the earnings’ timeliness, the precision of the initial information about the manager’s ability and the intensity of competition for CEOs. Our results may help to explain why big bath accounting after a CEO turnover is observed in many but not in all cases.
Keywords
- Big bath accounting, Career concerns, CEO turnover, Contracting, Earnings management
ASJC Scopus subject areas
- Business, Management and Accounting(all)
- Business and International Management
- Economics, Econometrics and Finance(all)
- Economics and Econometrics
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In: Journal of Business Economics, Vol. 92, No. 8, 10.2022, p. 1249-1281.
Research output: Contribution to journal › Article › Research › peer review
}
TY - JOUR
T1 - Big bath accounting and CEO turnover
T2 - the interplay between optimal contracts and career concerns
AU - Hensel, Tim
AU - Schöndube, Jens Robert
N1 - Funding Information: The authors gratefully acknowledge financial support from Dr. Werner Jackstädt Fellowship. We would like to thank Christian Hofmann (the editor), two anonymous reviewers, Nicola Bethmann, Barbara Schöndube-Pirchegger, Georg Schneider and participants in the VHB-conference at Magdeburg for valuable comments.
PY - 2022/10
Y1 - 2022/10
N2 - Following executive turnovers big bath accounting is often observed. We investigate a new manager’s earnings management incentives in his first year in office in a two-period model with career concerns and earnings’ lack of timeliness. We determine the optimal incentive contract and decompose the manager’s equilibrium earnings management into two components: an explicit incentive resulting from the compensation contract and an implicit incentive from career concerns. While career concerns always motivate the manager to shift earnings backwards, the optimal contract induces the manager to either shift earnings forwards or backwards. In particular, we show that with optimal contracts a "negative" big bath may result in equilibrium, i.e., the manager may inflate earnings after a CEO turnover. We demonstrate how the optimal contract and the equilibrium earnings management strategy depend on the earnings’ timeliness, the precision of the initial information about the manager’s ability and the intensity of competition for CEOs. Our results may help to explain why big bath accounting after a CEO turnover is observed in many but not in all cases.
AB - Following executive turnovers big bath accounting is often observed. We investigate a new manager’s earnings management incentives in his first year in office in a two-period model with career concerns and earnings’ lack of timeliness. We determine the optimal incentive contract and decompose the manager’s equilibrium earnings management into two components: an explicit incentive resulting from the compensation contract and an implicit incentive from career concerns. While career concerns always motivate the manager to shift earnings backwards, the optimal contract induces the manager to either shift earnings forwards or backwards. In particular, we show that with optimal contracts a "negative" big bath may result in equilibrium, i.e., the manager may inflate earnings after a CEO turnover. We demonstrate how the optimal contract and the equilibrium earnings management strategy depend on the earnings’ timeliness, the precision of the initial information about the manager’s ability and the intensity of competition for CEOs. Our results may help to explain why big bath accounting after a CEO turnover is observed in many but not in all cases.
KW - Big bath accounting
KW - Career concerns
KW - CEO turnover
KW - Contracting
KW - Earnings management
UR - http://www.scopus.com/inward/record.url?scp=85130280751&partnerID=8YFLogxK
U2 - 10.1007/s11573-022-01098-5
DO - 10.1007/s11573-022-01098-5
M3 - Article
AN - SCOPUS:85130280751
VL - 92
SP - 1249
EP - 1281
JO - Journal of Business Economics
JF - Journal of Business Economics
SN - 0044-2372
IS - 8
ER -