Earnings Management and Forced CEO Dismissal

This study examines the discretionary accounting choices made by CEOs facing forced dismissal. The results support the notion that CEOs who are faced with termination engage in income-increasing earnings management in the year prior to termination. We also examine Murphy and Zimmerman's (1993) argument that poor firm performance may have led to both the CEO turnover and the discretion over accounting choices. The results indicate that firm performance and other company-specific confounding factors cannot explain away the discretionary accruals observed in firms prior to forced CEO dismissals. We also find evidence suggesting that the incoming CEOs deliberately depress earnings, i.e. taking a “big bath,” in the transition year.