This study investigates whether CEOs exercise discretion in recognizing environmental liabilities surrounding their turnover. Extant theories on the agency problem predict that outgoing CEOs tend to boost or maintain the reported earnings in their final years (“Horizon” problem or “Cover-up”) and incoming CEOs sacrifice the reported earnings in their transitions year (“big-bath”). We find empirical evidence that incoming CEOs recognize significantly higher environmental liabilities in their transition year compared to the following years, supporting the “big-bath” hypothesis. This finding provides evidence that CEOs use environmental liabilities as a tool of earnings management surrounding their turnover in an attempt to maximize their accounting-based compensation.
The authors would like to thank participants at the 2011 AAA annual meeting in Denver and the 2011 AAA Mid-Atlantic meeting in Baltimore for their helpful comments and discussions.
Freedman, M., Park, J. and Romero, J. (2014), "Recognizing Environmental Liabilities Surrounding CEO Turnovers", Managing Reality: Accountability and the Miasma of Private and Public Domains (Advances in Public Interest Accounting, Vol. 16), Emerald Group Publishing Limited, pp. 117-143. https://doi.org/10.1108/S1041-7060(2013)0000016008Download as .RIS
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