Are Entrenched Managers’ Accounting Choices More Predictive of Future Cash Flows?

Abstract

We examine the role manager entrenchment has on firms' financial reporting quality. More specifically, we test whether entrenched managers' reported accruals deviate from industry norms and whether entrenched managers' abnormal accruals are more (or less) predictive of future cash flows. Consistent with implications from prior research, we find that firms with entrenched managers generally report lower levels of abnormal accruals (in an absolute sense), but the abnormal accruals utilized by entrenched managers are more predictive of future cash flows. Contrary to a more traditional view of manager entrenchment, our evidence suggests that entrenched managers report higher quality abnormal accruals. While prior research provides evidence that manager entrenchment is associated with negative economic outcomes, we argue that attempts to limit entrenchment are unlikely to improve financial reporting quality and may actually lower quality. Future corporate governance research should consider not only the level but also the quality of the association between accounting choices and manager entrenchment.

CEO characteristics and earnings management: empirical evidence from France

“…The entrenchment of the CEO is an undesirable action because it leads to a reduction in the wealth of shareholders (Jensen, 1986). Lail and Martin (2017) find a negative relationship between CEO and earnings management through discretionary accruals for a sampling period of Compustat Capital IQ. The entrenchment expresses the will of the CEO to free themselves, totally or at least partially, from the control of the shareholders, while developing specific strategies that allow him or her to achieve the objectives: to increase his/her freedom of action, to improve his/ her discretionary power and to neutralize the various disciplinary mechanisms.…”

Restatement costs and reporting bias

“…Managerial incentives are not necessarily equity based, that is, tied to the stock price: For instance, Zhao and Chen (2008) argue that managers' preferences for living a quiet life may shape their incentives, so managers who prefer a quiet life bias less because sophisticated earnings management require additional effort. Similarly, Lail and Martin (2017) suggest that entrenched managers are less concerned about capital market pressures and performance goals, which in turn decreases their incentives to bias. These effects are captured through the manager's stochastic desire to stock price increases or decreases according to $$ x_t$$.…”

Corporate sustainability, earnings persistence and the association between earnings and future cash flows

“…However, if CSP is motivated by managerial entrenchment (Surroca and Trib ó, 2008), and managerial entrenchment leads to lower earnings quality (Lail and Martin, 2017), then we would expect a negative relation between CSP and earnings quality. Last, if CSP is motivated by competition and changes in a business environment (Flammer, 2015), CSP is not relevant to earnings quality.…”