Do CEOs and Principal Financial Officers Take a "Bath" Separately or Together?: An Investigation of Discretionary Accruals Surrounding Appointments of New CEOs and PFOs

This study presents the first targeted examination of changes in financial reporting surrounding the appointment of both new CEOs and Principal Financial Officers (PFOs). We identify companies that appoint new CEOs and PFOs in the period 1995 to 2002 and find that the change in discretionary accruals is negative and significant in the year of hire (from t-1 to t) for firms appointing a new CEO or both a new CEO and PFO (i.e., the “big bath”), but not for firms appointing only a new PFO. We also find that firms appointing both executives in the same year report significant increases in discretionary accruals in the subsequent year (from t to t+1) and for the combined two-years surrounding the joint appointments (from t-1 to t+1). However, similar increases are not found for firms hiring only one of these executives. Additional analyses indicate that our results are robust when examining other discretionary financial reporting choices (i.e., special items, extraordinary items and discontinued operations), and that the type of compensation contract offered by the firm (i.e., having a high bonus component) is not significantly related to the changes in discretionary accruals surrounding these appointments. Our findings contribute to the corporate governance and executive turnover literature and provide evidence of a heightened financial reporting effect when firms concurrently appoint both new CEOs and PFOs.