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This paper investigates the extent of earnings management in the periods surrounding CEO changes by Australian firms. Evidence is presented of incoming CEOs undertaking earnings management to reduce income in the year of CEO change, with abnormal and extraordinary items being the primary vehicle through which this is achieved. This result is consistent with the notion of new CEOs engaging in an ‘earnings bath’, and is strongest for non–routine CEO changes, where the opportunities to manage earnings are greatest. Extending prior work, classification of CEO changes as routine or non–routine is based on an expanded information search, and this provides insights into the CEO change process and identifies problems with simpler mechanistic classification methods. Additionally, detailed information of the operation of the modified Jones model for estimating expected accruals is presented, and this is consistent with such models having low explanatory power in identifying abnormal accruals.
Peter Wells (Sat,) studied this question.