Mandatory CEO Retirements,Discretionary Accruals,and Corporate Governance Mechanisms

Abstract

Prior research predicts that retiring CEOs will attempt to increase reported earnings in their final year in order to receive larger bonus payments (the short horizon hypothesis) (Murphy and Zimmerman [1993]). An alternative incentive to increase earnings in final years may come from the desire to secure lucrative post-retirement board seats. Brickley et al. (1999) find that performance in the departing CEO's final four years is positively related to: (1) the probability of the CEO retaining his or her board seat after departure, and (2) the probability of securing other post-departure board seats. We extend research in this area by expanding the pre-turnover event window to four years, by examining only CEO turnovers that are the result of a mandatory retirement policy, and by controlling for corporate governance factors, CEO stock ownership and post-retirement board seat retention. We find evidence of earnings management in departing CEOs' final year and final two years, with the evidence being stronger when the CEO retained his or her board seat after retirement; that independent directors and CEO stockholdings appear to mitigate the earnings management; and that institutional stockholders appear to exacerbate earnings management in CEOs' final years.