Big Bath Accounting in Managerial Tone Following CEO Turnovers

Abstract

Prior work has documented that incoming CEOs make accounting decisions which reduce reported firm performance. It is however unclear what motivates this so-called “big bath” behavior. For one, it might serve to give a more accurate representation of actual firm performance, when the prior CEO has falsely inflated reported firm performance. For another, big baths by incoming CEOs are argued to be motivated opportunistically, when new CEOs try to blame their predecessor for poor performance and set a low benchmark for their own tenure. Investigating the textual tone in earnings press releases in the years surrounding CEO turnovers, we find that incoming CEOs use negative tone to an extent that cannot be explained by current firm performance or proxies for expected future performance. Moreover, this phenomenon of “big bath rhetoric” is exclusive to “forced” CEO turnovers, where incoming CEOs have greater incentives and more opportunity to bias the perception about firm performance downwards. These results document opportunistic accounting behavior consistent with the hypothesis that incoming CEOs strategically try to bias the perception of market participants about their firm’s situation downwards.