Elsevier

Advances in Accounting

Volume 24, Issue 2, December 2008, Pages 162-171
Advances in Accounting

The impact of accounting restatements on CFO turnover and bonus compensation: Does securities litigation matter?

https://doi.org/10.1016/j.adiac.2008.08.005Get rights and content

Abstract

This paper examines the association between accounting restatements, class-action securities litigation and chief financial officer (CFO) turnover and bonus compensation. We identify income-decreasing earnings restatements that were the result of aggressive accounting policies, and hypothesize that these restatements will result in higher CFO turnover rates, and lower bonus compensation, especially when the firm is the target of a restatement-related class-action securities lawsuit. Our results indicate that CFO turnover and bonus compensation are affected by restatements, but only when the restatement firm is the target of a class-action suit. When we expand the analyses to consider other types of executives (e.g., CEOs and COOs), we continue to find that turnover only occurs in the presence of a class-action suit. However, bonus compensation penalties to other types of executives are not limited to litigation-related restatements.

Section snippets

Introduction and synopsis

This paper examines the association between accounting restatements, class-action securities litigation and chief financial officer (CFO) turnover and bonus compensation. Prior research has documented mixed evidence that top executives (e.g., chief executive officer, president, chairman of the board) of firms restating earnings are terminated because of the restatement event. Some published (or forthcoming) studies find that non-GAAP (i.e., not in accordance with generally accepted accounting

Prior research on the causes and effects of earnings restatements

A number of prior studies have shown that restating firms underperform and are in worse financial condition than non-restating firms (e.g., Kinney and McDaniel, 1989, Defond and Jiambalvo, 1991, Desai et al., 2006, Collins, D. et al., (in press). Not surprisingly, the restatement event is associated with significantly negative abnormal returns (see, e.g., General Accounting Office, 2002, Palmrose et al., 2004). Ironically, Richardson, Tuna, and Wu (2002) argue that firms involved in

Sample selection and distribution of restatements

We begin our sample selection using a report released by the General Accounting Office on January 17, 2003 (GAO-03-395R). The report identifies 845 firms that restated earnings between the period January 1, 1997 and June 30, 2002. The first restriction we impose on our sample is that restating companies are available in ExecuComp, our source for executive compensation data. This restriction reduces the sample by 614 firms, leaving a total of 231 firms. Next, using 10-K/As and/or press releases,

Analysis of CFO turnover

In order to determine whether CFO turnover is associated with earnings restatements and whether the association between CFO turnover and accounting restatements depends on whether a securities-related class-action is filed against firms, we estimate two logistic regression models:CFOTURN1:LASTYRi,t=β0+β1ROAi,t+β2ROAi,t1+β3RETURNi,t+β4RETURNi,t1+β5LNASSETi,t+β6TRENDLASTYRi,t+β7RESTATEi,t+ɛi,tCFOTURN2:LASTYRi,t=γ0+γ1ROAi,t+γ2ROAi,t1+γ3RETURNi,t+γ4RETURNi,t1+γ5LNASSETi,t+γ6TRENDLASTYRi,t+γ7SUIT

Descriptive statistics and univariate analyses

We next summarize the financial performance data, relative CFO termination frequency and CFO compensation data between restatement firms and control firms. To lend comparability to prior work and to consider the fact that CFOs and CEOs are part of the same executive team, we contrast CFOs with CEOs. Table 2 reports statistics unconditional on litigation status for both our sample firms and the control firms, while Table 3 reports the statistics for only our restatement sample firms conditioned

Conclusion

We examine the penalties imposed on CFOs as a result of earnings restatements stemming from aggressive accounting. Using a sample of 81 restatements firms and 81 control firms, we find that earnings restatements are associated with higher rates of CFO turnover and lower CFO bonus compensation. However, penalties are only imposed on CFOs when the earnings restatement led to class-action securities litigation. Further, we find that CFO penalties are contingent upon litigation even after

Acknowledgements

We gratefully acknowledge the helpful comments of Larry Abbott, Davit Adut, Amy Hillman, Surya Janakiraman, Arianna Pinello, Ed Swanson, Jerold Zimmerman, participants at the 2004 KPMG Doctoral Student Accounting Association Research Meeting, participants at the 2005 AAA Annual and 2006 AAA Management Accounting Section meetings, and workshop participants at The University of Texas at San Antonio and Texas Tech University. We would also like to thank William Baber, Sok-Hyon Kang and Lihong

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    1

    The authors thank their respective business schools for their financial support. Juan Manuel Sanchez also thanks the KPMG foundation for the financial support.

    2

    Tel.: +1 205 348 5780.

    3

    Tel.: +1 479 575 6113.

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