Research Question:
When does CEO inauguration be accompanied with good news disclosure?
Keywords:
TMT, voluntary disclosure, succession planning, corporate governance
Related Studies
The retirement and inauguration of a CEO represent turnover in the top management team (TMT) of a firm. This transition of power happens frequently, for instance, every day six CEOs left their job from American public companies, according to a survey (Hindle, 2008). TMT turnover affects shareholder’s perception of the value of the firm, via a mechanism of uncertainty about firms’ future operations (Bills et al., 2017). Therefore, practitioners have been looking for clues that signal success leaderships. Recent studies have inquired about CEO biographies which seem to warrant an increase in post-succession performance, such as board experience, military backgrounds, personal lavish spending, possessing charismatic traits, or simply at a younger age (Harrell, 2016). Despite the relentless efforts, most CEO turnover events were followed by a decrease in firm value.
“The market reacts negatively to announcements of top executive departures, especially when the CEO is dismissed or leaves to take up another job.” (Dedman & Lin, 2002)
A firm’s market value is a function of investors’ perceptions of its managers’ ability to anticipate and respond to future changes in the firm’s economic environment (Healy & Palepu, 2001). Given the market has incomplete information about new CEOs’ ability, shareholders require a premium to keep holding the stock of the firm enduring a TMT turnover, hence inevitably increase firm’s cost of capital. Past research in accounting literature supports this perspective, based on evidence form audit fee. In effect, CEO succession influences the perception of reporting risk amongst auditors, who charge higher audit fees for firms with new CEOs. The audit fee increases dissipate over time as the new CEO stays longer at the firm, “reinforcing the inference that audit fees increase in response to the uncertainty surrounding a new CEO” (Bills et al., 2017).
To mitigate shareholder perception, firm has incentive to provide good news disclosure as an attempt to reduce the turnover-induced uncertainty. This conjecture receives initial support from Dedman and Lin (2002), who document that firms release good news around the same time as announcing CEO departures to counter the potential bad news caused by CEO departure announcements. Moreover, a recent study shows that top executives (e.g., CEO) exert the influence to firm’s voluntary disclosure choices, based on a track of managers across firms over time (Bamber et al., 2010). Follow-on research also sheds light on firm’s good news disclosure in the terminal year when the focal CEO retires. Cassell et al. (2013) show that retiring CEOs are more likely to issue forecasts of future earnings, and that they issue such forecasts more frequently in their terminal year relative to other years during their tenure with the firm. Further, retiring CEOs’ terminal-year forecasts of future earnings are more likely to convey good news and are more optimistically biased relative to pre-terminal years. Although CEO turnover event is two-fold (i.e., departure and inauguration), past studies systematically focus on just departure. There lacks a research over how new CEO is associated with voluntary disclosure of good news in the literature.
Among the very few studies in this vein, Meng et al. (2013) find that involuntary and negative CEO turnover (i.e., dismissal, health and death, and forced resignation) is negatively associated with corporate environmental disclosure, pointing to the fact that successors dispose a differential attitude toward disclosure. Chen et al. (2015) also document a differential preference of interim CEO who is more likely to conduct impression management through earning management behaviours. Lastly, Park and Yoo (2016) argue that CEOs with short tenures have more strong incentives to signal their ability to the labour market so that they can build proper reputation. In brief, recent studies examine the disclosure choice of the newly inaugurated CEO and document a tendency for good news disclosure around his turnover.
Hypothesis 1: CEO inauguration is associated with an increase in good news disclosure.
In addition, this relation might be less positive if the new CEO has proven capability in the focal firm, i.e., relay succession. In other words, succession planning mitigates turnover-induced uncertainty, as regulator’s recent ruling encouraging board to prepare for succession. In one of its October 2009 releases , the SEC identified succession planning as one of the board’s “key functions” implying that inadequate succession planning or non‐disclosure of it may be viewed as evidence of insufficient board oversight (Tao & Zhao, 2019). In this stream of literature, corporate governance scholarship has showed the benefit of succession planning absorbed by the stock price.
First, shareholders value the smooth turnover, as share price reactions to the disclosure of top executive departure are significantly affected by whether the board announces a replacement CEO (Dedman & Lin, 2002). Second, succession planning can serve as a tool for smooth turnover, as documented by Behn et al. (2005) that firms with an heir apparent already designated upon the death of the CEO have significantly higher cumulative abnormal returns on the date of death than firms that have not identified an heir apparent. To enhance this argument, in the CEO turnover-audit fee relation examined by Bills et al. (2017) there is also an attenuating effect upon careful CEO succession planning (i.e., promoting an “heir apparent”) against auditors’ perceptions of higher risk. In the same way, firms with relay successions achieve higher post-turnover accounting performance, higher long-term stock returns, and lower volatility (Tao & Zhao, 2019). To sum up, careful succession planning releases positive information about the candidate prior to the turnover event, which reduces the needs of disclosing good news post-succession.
Hypothesis 2: Relay succession negatively moderates the relation between CEO inauguration and good news disclosure.
To the best of our knowledge, good news disclosure of new CEO inauguration has not been widely published. To fill this void, this proposal aims to investigate the relation between CEO inauguration and firm voluntary disclosure. The success of this research will contribute to the management talent signalling hypothesis of Trueman (1986, as reviewed by Healy and Palepu (2001)) that talented managers have an incentive to make voluntary earnings forecasts to reveal their type. The earlier that investors receive information, the more favourable will be their assessment of the manager’s ability to anticipate future changes and the higher will be the firm’s market value. In addition, this research also attempts to complement the work by Kothari et al. (2009) by extending the antecedents of manager good news disclosure into CEO turnover.
Reference
Bamber, L. S., Jiang, J., & Wang, I. Y. (2010). What’s My Style? The Influence of Top Managers on Voluntary Corporate Financial Disclosure. The Accounting Review, 85(4), 1131-1162. https://doi.org/10.2308/accr.2010.85.4.1131
Behn, B. K., Riley Jr, R. A., & Yang, Y.-w. (2005). The Value of an Heir Apparent in Succession Planning. Corporate Governance: An International Review, 13(2), 168-177. https://doi.org/https://doi.org/10.1111/j.1467-8683.2005.00415.x
Bills, K. L., Lisic, L. L., & Seidel, T. A. (2017). Do CEO succession and succession planning affect stakeholders’ perceptions of financial reporting risk? Evidence from audit fees. The Accounting Review, 92(4), 27-52.
Cassell, C. A., Huang, S. X., & Sanchez, J. M. (2013). Forecasting without Consequence? Evidence on the Properties of Retiring CEOs’ Forecasts of Future Earnings. The Accounting Review, 88(6), 1909-1937. https://doi.org/10.2308/accr-50526
Chen, G., Luo, S., Tang, Y., & Tong, J. Y. (2015). Passing Probation: Earnings Management by Interim CEOs and Its Effect on Their Promotion Prospects. Academy of Management Journal, 58(5), 1389-1418. https://doi.org/10.5465/amj.2013.0351
Dedman, E., & Lin, S. W. J. (2002). Shareholder wealth effects of CEO departures: evidence from the UK. Journal of Corporate Finance, 8(1), 81-104. https://doi.org/https://doi.org/10.1016/S0929-1199(01)00027-X
Harrell, E. (2016). Succession planning: what the research says. Harvard Business Review, 94(12), 70-74.
Healy, P. M., & Palepu, K. G. (2001). Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature. Journal of accounting and economics, 31(1), 405-440. https://doi.org/https://doi.org/10.1016/S0165-4101(01)00018-0
Hindle, T. (2008). Guide to Management Ideas and Gurus (Vol. 42). John Wiley & Sons.
Kothari, S. P., Shu, S., & Wyspcki, P. D. (2009). Do Managers Withhold Bad News? Journal of Accounting Research, 47(1), 241-276. https://doi.org/https://doi.org/10.1111/j.1475-679X.2008.00318.x
Meng, X. H., Zeng, S. X., Tam, C. M., & Xu, X. D. (2013). Whether Top Executives’ Turnover Influences Environmental Responsibility: From the Perspective of Environmental Information Disclosure. Journal of Business Ethics, 114(2), 341-353. https://doi.org/10.1007/s10551-012-1351-1
Park, S. Y., & Yoo, K. H. (2016). CEO career concerns and voluntary disclosure. Journal of Applied Business Research (JABR), 32(6), 1603-1628.
Tao, R., & Zhao, H. (2019). “Passing the Baton”: The effects of CEO succession planning on firm performance and volatility. Corporate Governance: An International Review, 27(1), 61-78. https://doi.org/https://doi.org/10.1111/corg.12251