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PAR
22,3 CEO turnover around earnings
restatements and fraud
Judy K. Land
180 School of Business, North Carolina Central University,
Durham, North Carolina, USA

Abstract
Purpose – This paper aims to examine whether restatement firms with certain restatement
characteristics are more likely to have chief executive officer (CEO) turnover within a year of the
restatement announcement, and whether these same firms are later subject to regulatory action by the
US Securities and Exchange Commission.
Design/methodology/approach – The empirical analysis uses a logistic regression to test a
sample of firms that restated earnings during the years 1996-1999.
Findings – The results show significant associations between measures of the severity of earnings
restatement and the probability of CEO turnover. Also, restatement firms with CEO turnover are more
likely to be issued an SEC Accounting and Auditing Enforcement Release in the years after the
restatement, indicating that financial fraud has occurred.
Research limitations/implications – The results may not generalize to a more recent time period
because the sample of firms is from the 1996-1999 time period.
Originality/value – This study provides a link between CEO turnover and restatement
characteristics within a sample of restatement firms.
Keywords Earnings, Chief executives, Employee turnover, Financial reporting, Fraud,
United States of America
Paper type Research paper

Pacific Accounting Review
Vol. 22 No. 3, 2010
pp. 180-198
q Emerald Group Publishing Limited
0114-0582
DOI 10.1108/01140581011091666
1. Introduction
In the USA, the tremendous number of earnings restatements by US firms in the past
years has been the subject of much discussion by both the popular press and by the
officials at the Securities and Exchange Commission (SEC) (Turner, 2002). The popular
press contains many articles on firms that face enormous pressures from Wall Street to
maintain stock prices and to meet analyst forecasts. As restatements generally report
bad news such as profits turning to losses, overstatements of revenues, and other
accounting irregularities, the consequences of restatements are often severe (Palmrose
et al., 2004a, b). A firm restatement is often followed by a change in chief executive
officer (CEO) or other top manager. In press articles, the change in management is often
blamed on the restatement. Anecdotal evidence suggests that for some firms, the CEO
turnover is related to the accounting restatement, as the following excerpt illustrates:
Shares of the Scotts Co.’s stock slid 7.7 percent yesterday after the lawn-care company
reported its 1995 earnings had to be scaled down and that Theodore J. Host, president and
chief executive, had resigned. Chairman Tadd C. Sietz, the former chief executive, was named
interim head of the Marysville, Ohio-based company. He acknowledged that the earnings
restatement “was certainly a factor” in Host’s resignation (Williams, 1996).
The author gratefully acknowledges the helpful comments of Jeff Abarbanell, Raghavan
Iyengar, Mark Lang, and Ira Weiss. This paper is based on the author’s dissertation at the
University of North Carolina at Chapel Hill.
While the academic literature in accounting and finance has extensively studied CEO CEO turnover
turnover, not many have made a direct connection between the characteristics of a
financial accounting “event” such as a restatement and the probability of CEO
turnover. This paper investigates whether the characteristics of earnings restatements
influence the probability of CEO turnover. It empirically tests whether there is a link
between the type and severity of an accounting error restatement and the firing or
resignation of the top manager of a firm. While other consequences of restatements are 181
also significant, resulting in large negative market reactions, an increase in the cost of
capital (Hribar and Jenkins, 2004), and lower overall earnings quality (Wu, 2002;
Anderson and Yohn, 2002), one can argue that one of the most significant
consequences of a restatement is the replacement of its CEO, as it can be quite costly
for a firm to replace its top manager. This paper attempts to show that there are factors
related to the restatement that can predict which restatement firms will have a change
in CEO, and identify the specific factors that matter the most in predicting the
turnover.
This study also addresses whether evidence in a restatement is likely to result in
management change when the likelihood of fraud is highest. When internal controls
and monitoring mechanisms are weak or have failed, an accounting restatement could
be the first indication that accounting fraud has occurred. If the restatement
announcement provides evidence consistent with higher levels of earnings
management such as a large error in previously reported net income, it is an
empirical question whether this leads to a higher chance of a management change as
boards may facilitate this change in the interest of stockholders and other interested
parties. In addition, after finding the factors that are most likely to influence the CEO
turnover event, the analysis tests whether the firms that have a change in CEO are also
likely to be issued a SEC Accounting and Auditing Enforcement Release (AAER),
indicating that there is some validity in the firm’s decision to change CEOs. Last, there
is a test of whether the time from the restatement announcement to the CEO turnover
announcement is related to restatement characteristics. Although Desai et al. (2006)
and others (Agrawal and Cooper, 2007), show that restatement firms more often
experience management turnover than non-restatement firms, they generally do not
attempt to determine what factors in a restatement may be associated with the
turnover. As restatement characteristics have been shown to be associated with other
consequences of restatements such as the market reaction to the announcement of a
restatement (Palmrose et al., 2004a, b) and director turnover (Srinivasan, 2005), they
may also contribute to the event of CEO turnover.
The sample includes 230 US firms that restate earnings. In total 45 percent of
sample firms have a change in CEO within a year of the restatement. The results in this
paper provide support for the hypothesis that certain types and characteristics of an
error restatement increase the likelihood of CEO turnover after the restatement.
Measures that describe the severity of a restatement such as the length of time a
restatement period covers and whether a restatement is revenue related can increase
the probability of CEO turnover for restatement firms. Unlike the prior papers on
turnover, these results indicate that within the sample of restatements, there is
variation in the probability of turnover. This finding is consistent with the idea that
when the expectation of fraud is highest, managers are likely to lose their jobs, an idea
that the results of Hennes et al. (2008) also support. In addition to this, tests show that
PAR when CEO turnover occurs in relation to more severe restatements, fraud is more likely
22,3 to occur in these firms, as these firms are more likely to be subject to an AAER by the
SEC in the years following the restatement. Last, since the sample of firms includes
restatements and CEO turnover, an analysis with this subsample of firms indicates
that the time between restatement and turnover is significantly associated with several
restatement characteristics and also with firms that are later issued AAERs. Unlike the
182 findings of other related papers, I find that the firms’ restatement characteristics do
matter in predicting CEO turnover, and that the firms with CEO changes are the ones
that are later subject to regulatory enforcement. This paper contributes to the existing
literature and can provide evidence for settings where there are no sweeping
governance changes like those implemented in the USA after the passage of the
Sarbanes-Oxley Act (SOX).
The paper is organized as follows. Section 2 discusses prior literature on
restatements and CEO turnover, and the motivation for this paper. Section 3 discusses
the hypothesis development and Section 4 presents the research design. Section 5
describes the sample selection procedure used to gather the data. Section 6 presents
descriptive statistics and section 7 discusses regression results. Section 8 includes an
additional analysis, Section 9 provides robustness tests and Section 10 concludes.

2. Related literature and motivation

Prior literature on managerial consequences after earnings manipulation and fraud has
been mixed. Agrawal et al. (1999) find little evidence of high turnover for firms
engaging in fraud and are surprised by this result because fraud can create certain
incentives for firms to change their top managers. Beneish (1999) also finds that there
are no adverse consequences to managers for financial reporting fraud. Others have
shown evidence that managers, either CEOs, CFOs, or both, are punished by job losses
after the event of a restatement (Desai et al., 2006; Burks, 2010; Agrawal and Cooper,
2007; Arthaud-Day et al., 2006). Desai et al. (2006) find that managers of firms restating
suffer reputational consequences compared to managers of firms that do not restate,
but their analysis does not take into account the fact that not all restatements are the
same. Several other recent papers (Hennes et al., 2008; Burks, 2010) do take into account
that restatements have differing severity, but focus on years after the Enron event and
the passage of the SOX in 2002. Hennes et al. (2008) examine CEO and chief financial
officer (CFO) turnover, and focus on whether the management turnover consequences
of the restatement are associated with managements’ intention to violate GAAP. Burks
(2010) investigates the rates of turnover, and composes his own measure of severity.
Prior to the SOX Act, there may have been other mechanisms that functioned to lessen
the causes of earnings restatements. Richardson et al. (2002) discuss how firms with
lesser external financing needs are less likely to restate, and so are firms that are less
subject to capital market pressures. Dezoort and Stanley (2007) find that there is a
negative relation between auditor tenure and likelihood of a financial restatement.
Because this study includes a sample that is pre-SOX, from the years 1996-1999, results
may be generalized to settings where there is no legislation that implements the rules
that SOX does in the USA. Although many papers have used the passage of SOX in
2002 to limit the time period, the purpose of this paper is not specifically to examine the
differences before and after SOX. It is possible that legislative changes brought about
by SOX may have changed the consequences of restatements (Burks, 2010). However,
from the popular press as well as academic literature, it appears that restatements CEO turnover
became a major concern to the SEC earlier than 2002, with the increase in meetings on
auditor independence issues in 2000 and evidence that regulators attributed the
increase in restatements to lack of auditor independence (Levitt, 2000; McNamee et al.,
2000). In addition, a study by Scholz (2008) indicates that there was a substantial
increase in the frequencies of restatements starting in 2001, and that the restatement
announcements from that year resulted in much lower market reactions. Whether the 183
changing nature of restatements occurred due to increased regulation or the poor
economy, the sample of restatements in this study is chosen from a sample of firms
prior to those events.
Many recent papers have investigated the consequences of the restatement on the
top manager in restatement firms. Desai et al. (2006) find that firms that restate are
more likely to experience CEO turnover than firms that do not restate. Their sample of
146 firms is taken from a report published by the General Accounting Office
(GAO-03-138) from years 1997 and 1998 (United States General Accounting Office,
2002). They find that 50 percent of restating firms experience CEO turnover within two
years of the restatement compared to 24 percent of matched firms. Their logistic
regression is estimated on restatement and matched control firms. They include an
indicator variable for restatement firms, as well as control variables for prior returns
and profitability. They find that their restatement variable is significant even after
controlling for determinants of management turnover, but they do not include any
restatement characteristics in their regression. The focus of their paper is on the
reputational consequences on the managers of restatement firms, and they are
primarily concerned with whether managers suffer significant losses in income and
reputation following a restatement. Agrawal and Cooper (2007) also find that CEO
turnover is higher for firms that restate earnings for their sample of pre-SOX firms.
They take subsamples of the restatement firms to test whether firms with different
characteristics have different effects on CEO turnover. They find that for firms with
lower market reactions around the announcement date and with negative restated
earnings, there is a substantial difference in turnover, but for firms with more quarters
restated and larger restatements, there are no significant differences in CEO turnover.
Hennes et al. (2008) emphasize that it is important to distinguish between firms that
have irregularities vs errors in restating firms, and although they find that CEO
turnover is much higher in samples of firms restating due to irregularities, they do not
find that their measure of severity of the restatement is significant. In contrast to Desai
et al. (2006) and Agrawal and Cooper (2007), all of the tests in this analysis are done
within a sample of restatements firms, and the hypothesis predicts variation within the
sample of restatement firms, not across two different samples. Therefore, a control
sample is not part of the analysis in this paper. The paper questions whether some
characteristics of restatements are more indicative of the likelihood of turnover than
others, and also whether certain restatements where turnover occurs are likely to lead
to fraud. The motivation behind this analysis is to determine whether managers that
are more likely to be engaging in fraud are the ones that are losing their jobs. If there
are incentives to change managers after earnings manipulation occurs, it is of interest
to determine whether the “right” managers are being punished. As a test of this, I
include a variable for fraud in the last logistic regression. Also, unlike all the prior
PAR papers, I test whether the time between a restatement and CEO turnover matters in
22,3 relation to the firm’s restatement characteristics.
There are also papers focused on other managerial positions that are affected by
restatements. Specifically, Burks (2010), Hennes et al. (2008) and Collins et al. (2009)
analyze CFO turnover around earnings restatements. Collins et al. (2009) find that
restatement firms with CFO turnover are also likely to have CEO turnover, and that the
184 firms with CFO turnover are more likely to be subject to an AAER compared to a
matched set of control firms. The limitation of this study is that the paper focuses
solely on CEO turnover, and not on other managerial positions.
Determinants of management turnover that are separate from accounting
restatements have also been studied in the literature. The evidence suggests that
management turnover is often preceded by poor firm performance, as measured by
stock prices, and poor earnings. Warner et al. (1988) documents that prior stock
performance is inversely related to the probability of management change. Weisbach
(1988) and Murphy and Zimmerman (1993) both show that prior earnings changes are
related to increased turnover. Poor earnings performance is also documented by Denis
and Denis (1995) who find a statistically significant decrease in the level of operating
income/total assets for firms with forced turnover. Why firms dismiss their CEOs is a
question that has been analyzed by much of the literature, and much of the focus has
been on the performance of stock prices and accounting changes that occurred prior to
the dismissal.
Restatements are likely to show evidence of earnings manipulation. Many are
followed by large negative stock price reactions because the restatement provides
evidence of really bad news. For some restatements, there is evidence that the
management has tried to manipulate earnings, as these restatements try to correct
multiple years of errors and change large numbers of positive earnings into negative
numbers. There are other restatements that are not as severe and do not result in large
negative market reactions. For these firms, the restatement is merely a one time
accounting error that does not result in any significant consequences. Although the
SEC and many others have been concerned about the large increase in restatements,
not all restatements are the same, and certainly the information provided by
restatements about firms and their managers are also not the same in degree. For firms
where the restatement is not as severe, boards may not be inclined to force a CEO
change. However, with evidence of possible fraud, unless the firm has weak internal
monitoring systems or ineffective boards (Huson et al., 2001), it seems more likely that
this would result in boards taking action to replace or fire their CEOs. It may be costly
to change CEOs, but by firing their CEO, firms may be able to place some of the blame
of the restatement on the CEO, allowing them to possibly recover some of the
reputation that they lost from restating earnings (Agrawal and Cooper, 2007). Thus, for
certain types of restatements, CEO turnover often occurs around the restatement.
Accordingly, after controlling for other determinants of management turnover, I
examine whether specific characteristics of earnings restatement are correlated with
the probability of a CEO leaving a firm.

3. Hypothesis development
The objective of this paper is to investigate whether certain characteristics of earnings
restatements lead to the increased probability of CEO turnover. CEO turnover in this
paper is defined as a CEO or president of a firm that loses his job as a result of firing, CEO turnover
resignation, or a change in leadership. The majority of the firms with CEO turnover
occur after a restatement (74 percent) and a number of firms (26 percent) experience
turnover prior to the restatement. In the empirical literature on restatements, studies
have investigated the market reactions to the announcement of restatements. Both
Palmrose et al. (2004a, b) and Anderson and Yohn (2002) document that the nature and
type of restatement influences the subsequent market reaction to the announcement of 185
the restatement. Specifically, Palmrose et al. (2004a, b) find that the market reaction to
the restatement announcement is associated with fraud, larger negative income
restatements, auditor-initiated restatements, and the pervasiveness of the restatement.
Anderson and Yohn (2002) document that there is a significantly larger negative
reaction for firms with revenue recognition problems, and that the amount of the
income restated is also associated with the announcement returns. Srinivasan (2005)
finds that the severity of the restatement increases the probability of board turnover.
Because variables describing earnings restatements have a documented association
with certain consequences of restatements, these characteristics may also be useful in
predicting the likelihood of other important events such as management turnover. It is
also likely that the more severe the restatement, the higher the probability of fraud and
the more serious the accounting problem. Similar to Palmrose et al. (2004a), which
studies stock price reactions to restatements, this analysis uses two measures of the
severity of the restatement. The first is duration and the second is magnitude. Duration
is calculated by measuring the number of quarters over which the firm restates.
Magnitude is defined as the absolute value of income restated as a proportion of total
assets. Both these measures are an indication of the degree of the accounting error
involved in a restatement. Prior literature has already shown that the more serious and
larger the error is, the larger the stock market reaction is to the announcement of the
error (Palmrose et al., 2004a, b). I expect that the error amount and time periods
included in the restatement will affect the consequences for firms’ management. I
hypothesize that the larger the error amount and longer the time periods included in
the restatement, the higher the likelihood of CEO turnover.
Most earning restatements are initiated by firms’ management, and many occur
after a review or investigation of accounting policies. For other firms, however, the
restatement is initiated by either the auditor or by the SEC. Prior literature has
documented that the initiator of the restatement affects the market reaction to the
announcement of the restatement. Specifically, it documents that the market
consequences are different depending on who initiated the restatement. Palmrose et al.
(2004a, b) find that auditor initiated restatements are perceived as negative signals by
the market because the expected cost of monitoring increases when auditors initiate a
restatement. Similarly, the expectation is that for firms where the auditor initiated the
restatement, the probability of turnover will be higher. This study uses an indicator
variable equal to one if the restatement is auditor initiated. Firms in the sample time
period also had restatements that were initiated by the SEC. Because many of these
firms had restatements that were perceived as more technical in nature, the
consequences of these restatements are not as severe. For these firms, I also use an
indicator variable equal to one for the restatements initiated by the SEC and predict
that firms are less likely to have CEO turnover if the restatement was initiated by the
SEC.
PAR Another characteristic of a restatement that gives us information on the importance
22,3 of the accounting problem is whether the restatement involves revenue. For the
restatements that primarily relate to revenue recognition issues, the restatement calls
into question the reliability of the historical accounting numbers as well as the growth
and profitability of the future, and may indicate a more serious problem for the
company. Revenue recognition violations of GAAP are also the number one reason for
186 Accounting and Auditing Enforcement Releases, as shown in a paper by Dechow et al.
(1996). Anderson and Yohn (2002) and Wu (2002) find that this type of restatement is
significantly negatively related to the market reaction to the restatement
announcement. I predict that revenue-related restatements will result in a higher
likelihood of CEO turnover.
As the above variables may result in large market reactions on the day of the
announcement of the restatement, I also include the cumulative stock market reaction
around the announcement. This variable, CAR1, is measured using the market model
and then calculating cumulative abnormal returns from day 2 1 to day þ 1 around the
announcement of the restatement. Although this variable is not related directly to the
restatement, it is one of the consequences of the restatement that may have bearing on
whether or not a manager loses his/her job. To calculate abnormal returns, the market
model used is the following:

E ð Rit Þ ¼ ai þ bi Rmt
where:
E(Rit) is the expected return for firm i; and
Rmt is the equal weighted market return.
For the firms in the sample, parameter estimates for each firm are estimated using
CRSP daily data from [2 250, 2 151] days prior to the restatement event date.
Next, for the abnormal returns for each firm, the following equation is calculated
where parameter estimates from above market model are used:


ARit ¼ Rit 2 ai þ bi Rmt

where:
ARit is the abnormal returns; and
Rit is the actual return.
Palmrose et al. (2004a, b) have shown that the market reaction to restatements are
significantly associated with fraud, income decreasing restatements, and those
attributed to the SEC or firms’ management. Hennes et al. (2008) also use a similar
measure for announcement returns in their paper, and find that substituting the
abnormal returns measure for their severity measure is significant in explaining
management turnover. I predict that the lower the return around the event of the
restatement, the higher the likelihood of CEO turnover.
In addition to the analysis of the characteristics of the restatement, an important
question that arises from the above analysis is whether firms with more severe
restatements that changed CEOs are likely to have engaged in fraud. To measure
fraud, I include a fraud variable that is equal to one if the firm is subject to an AAER CEO turnover
related to the firm restatement in the years following the restatement and zero
otherwise. Palmrose et al. (2004a, b) find that firms restating earnings from fraud suffer
much larger market reactions than those that do not involve fraud. Collins et al. (2009),
find a higher likelihood of firms subject to an AAER for firms with CFO turnover. I
predict that the fraud variable will have a positive relation to the likelihood of CEO
turnover for restatement firms. 187
Control variables
In addition to the variables above that are attributed to the restatement firm, I also
include control variables that have been associated with management turnover in the
literature. Warner et al. (1988) finds that past stock returns are a better predictor of CEO
turnover than absolute performance. Consistent with the literature on CEO turnover, I
include a measure for past return performance, Preterns. Similar to the calculation of
announcement day returns (CAR1), market model parameters are estimated for each
firm as explained above, and the sum of the abnormal returns is calculated from 150 days
to 30 days prior to the announcement of the restatement (Preturns). Denis and Denis
(1995) also show that forced resignations of top managers are preceded by declining
stock returns and decreasing operating income as a fraction of total assets. Weisbach
(1988) and Murphy and Zimmerman (1993) document poor performance as measured by
changes in earnings prior to executive changes. For the earnings performance measure, I
calculate the variable EarnCh, which is defined as the change in earnings (current net
income minus past year’s net income) divided by lagged total assets. As an additional
measure of firm performance, I include return on assets, Roa. Last, as a control for size, I
include total assets, Tas. As additional controls, corporate governance variables may be
considered for future studies, as they are not included in this paper.

4. Research design
The logistic regression takes the following form:
PRðCEO turnover ¼ 1Þ ¼ f Þa0 þ a1 Magnitude=Duration þ a2 Audcause þ a3
SEC þ a4 Revr þ a5 Car1 þ a6 EarnCh þ a7 Roa þ a8 Preturns þ a9 Tas þ a10 FraudÞ

where:
CEOturnover ¼ 1 for CEO turnover and 0 otherwise.
Magnitude ¼ absolute value of amount of income restated divided by total
assets.
Duration ¼ number of quarters of restatement, where one quarter is 0.25.
Audcause ¼ 1 if auditor initiated restatement and 0 otherwise.
SEC ¼ 1 if SEC initiated restatement and 0 otherwise.
Revr ¼ 1 if revenue related restatement and 0 otherwise.
CAR1 ¼ cumulative abnormal returns (2 1, þ 1) around the announcement
of restatement.
PAR EarnCh ¼ current year’s net income minus past year’s net income divided by
22,3 lagged total assets.
Roa ¼ current year net income divided by lagged total assets.
Preturns ¼ cumulative abnormal returns from days (2 150, 2 30) before event
of restatement announcement.
188 Tas ¼ total assets.
Fraud ¼ 1 if SEC issues an AAER related to the firm restatement and 0
otherwise.

5. Data collection and sample

Searching the Factiva database by using the words “restatement and earnings” for the
years 1996-1999, I find a sample of firms that restate previously reported financial
results. The sample years occur many years before the passage of SOX in the USA as
previously discussed, and also likely before the SEC may have increased the focus on
firms restating net income. The error restatements in my sample of firms are all
corrections of errors in previously issued financial statements. Error corrections are
discussed in APB No. 20, and are covered in the same literature as accounting changes
and prior period adjustments. Errors are also said to be a result of “mathematical
mistakes, mistakes in the application of accounting principles, or oversight or misuse
of facts that existed at the time the financial statements were prepared” (APB No. 20,
para. 13). The majority of firms in my sample report errors that are overstatements,
meaning that the number originally reported in the financial statement was larger than
the restated number that corrects the mistake. There are also firms that report
understatements which make up approximately 18 percent of sample firms. All the
restatements in the sample consist of firms that announce errors in previously reported
earnings. These include firms that report bad news such as profits turning to losses,
changing initially reported research and development write-offs, overstatements of
revenues, and other accounting irregularities. For each firm in the sample, I gather the
information about the restatement from press releases and from 10-Ks from SEC’s
Edgar web site. I also attempt to determine whether there is CEO turnover around the
restatement announcement. CEO turnover in my sample are firms that have a CEO that
leaves the firm within one year before or after the restatement. The one-year time
period was selected for ease of searching. Other related papers have used the time
periods of six months (Hennes et al., 2008, one year (Burks, 2010), and 24 months (Desai
et al., 2006). The Lexis Nexis database is used to determine whether firms that restated
were subject to an SEC Accounting and Auditing Enforcement Release in the years
after the restatement.
The number of restatements for each year is shown in Table I. The sample includes
230 firms from the years 1996-1999 with available data from Compustat and CRSP. For
those firms, there are a total of 103 (45 percent) firms that have CEO turnover within
the year of the restatement. The majority of firms have CEO turnover due to CEO
resignation. The other reasons are that the CEO was fired, or replaced because of a new
CEO being appointed. The sample has a high proportion of firms that have
resignations (76 percent), and although it is difficult to determine whether these
resignations are forced turnovers or not, since these firms all have restatements, the
turnover from these firms are more likely than not to be forced rather than voluntary. CEO turnover
None of the CEO changes are a result of CEO retirements, as those are more likely to be
voluntary in nature.
Figure 1 shows the number of firms that have turnover within a year of the
restatements. The columns in the histogram represent the number of firms with
turnover during a one-month period and the highest column in the figure corresponds
to the first month after a restatement announcement. 189

6. Descriptive statistics
Table II provides descriptive statistics for the sample firms. The sample statistics
indicate that for firms that have CEO turnover around the restatement, there are
significant differences in the means and medians of the Magnitude and Duration of the
restatement. Firms with turnover consequences restate larger amounts of net income
as a proportion of total assets, and also restate for longer time periods. Firms that have
turnover also have a significantly higher proportion of firms that have revenue related
restatements. The significant differences between these variables are consistent with
the idea that these restatements are a much more serious event for firms that have a
change in CEO.

Year Firms – no turnover Firms – CEO turnover Total

1996 12 14 26
1997 27 26 53
1998 36 31 67
1999 52 32 74
Total firms 127 103 230
Table I.
Note: CEO turnover is defined by a CEO who leaves a firm within 12 months of a restatement Firm characteristics

Figure 1.
Histogram of CEO
turnover date relative to
restatement date
PAR
CEO turnover No CEO turnover
22,3 Mean Median Mean Median T-stat p-value Z-stat p-value

Magnitude 0.11 0.04 0.05 0.02 2.85 0.005 3.25 0.0006

Duration 1.44 1.0 0.81 0.75 5.36 0.0001 4.66 0.0001
Audcause 0.15 0 0.06 0 2.01 0.05 2.07 0.02
190 SEC 0.19 0 0.31 0 2 2.12 0.04 2 2.07 0.02
Revr 0.40 0 0.21 0 3.06 0.003 3.06 0.001
CAR1 20.15 20.10 20.07 20.04 2 3.24 0.001 2 3.08 0.001
EarnCh 20.15 20.08 20.15 20.005 2 0.04 0.97 2 3.72 0.0001
Roa 20.11 20.02 20.09 0.01 2 0.52 0.60 2 2.53 0.006
Preturns 20.06 20.09 20.10 20.10 0.47 0.64 0.40 0.35
Total assets 1,323 108 1,063 114 0.56 0.58 0.09 0.46
Fraud 0.40 0 0.09 0 5.71 0.0001 5.60 0.0001
Number of firms 103 127
Notes: CEOturnover ¼ 1 for CEO turnover and 0 otherwise; Magnitude ¼ absolute value of amount
of income restated divided by total assets; Duration ¼ number of quarters of restatement where one
quarter is 0.25; Audcause ¼ 1 if auditor initiated restatement and 0 otherwise; SEC ¼ 1 if SEC
Table II. initiated restatement and 0 otherwise; Revr ¼ 1 if revenue related restatement and 0 otherwise;
Descriptive statistics – CAR1 ¼ cumulative abnormal returns (2 1, +1) around the announcement of restatement;
restatement firms with EarnCh ¼ change in net income divided by lagged total assets; Roa= net income divided by
CEO turnover and lagged total assets; Preturns ¼ cumulative abnormal returns in the days (2150, 230) before
restatement firms with no restatement event; Fraud ¼ 1 if SEC issues an AAER related to the firm restatement and 0 otherwise;
turnover Z-stat is computed from the Wilcoxon signed-rank test

Comparing the size of both samples, there is no significant difference in size as

measured by total assets. There are significant differences in the means for both the
SEC variable, and for the Audcause variable, consistent with turnover firms being less
likely to have an SEC related restatement and more likely to have an auditor initiated
restatement. For the EarnCh variable, it appears that restatement firms that have
change in CEOs have a significantly lower median change in earnings prior to the
restatement. Mean market return around the announcement of the restatement for my
entire sample is -11 percent, which is consistent with the results found in other
restatement papers (Palmrose et al., 2004a, b; Wu, 2002). For firms with turnover, the
mean prior returns, Preturns, is 2 6 percent and mean return around the restatement,
CAR1, is 2 15 percent. For firms that just restate earnings but do not have CEO
turnover, mean returns prior to the restatement is 2 10 percent, and CAR1 is 2 7
percent. Tests of differences between the two groups indicate that there are significant
differences in the mean and median of CAR1, but no difference in Preturns. Firms with
CEO turnover are also more likely to be subject to an AAER, as shown by the
significant difference in the Fraud variable.
Table III presents Pearson correlation coefficients for the variables. The results
indicate that, as expected, the CEO turnover variable is positively and significantly
correlated with both measures of restatement severity, Magnitude and Duration, and
also correlated with revenue recognition restatements and auditor caused
restatements. The variable is significantly negatively correlated with SEC caused
restatements and CAR1. Spearman correlation coefficients are consistent with the
Pearson coefficients. Also in Table III, it appears that CAR1 is significantly related to
several of the restatement variables, specifically Magnitude, Duration, and Revr,
 CEOCH Magnitude Duration Audcause SEC Revr Car1 EarnCh Roa Preturns Tas Fraud
CEOCH
Coefficient 1.0 0.25 0.27 0.136 2 0.10 0.21 2 0.32 2 0.03 2 0.035 0.024 2 0.005 0.37
p-value 0.0002 0.0001 0.04 0.13 0.001 , 0.0001 0.63 0.60 0.72 0.95 , 0.0001
Magnitude
Coefficient 0.27 1.0 0.18 2 0.006 0.006 0.07 0.05 2 0.12 2 0.41 0.05 2 0.15 0.12
p-value , 0.0001 0.005 0.93 0.93 0.26 0.44 0.08 , 0.0001 0.44 0.025 0.07
Duration
Coefficient 0.28 0.26 1.0 0.21 0.09 0.17 2 0.07 0.07 0.06 0.02 2 0.01 0.31
p-value , 0.0001 , 0.0001 0.002 0.14 0.009 0.31 0.31 0.36 0.71 0.84 , 0.0001
Audcause
Coefficient 0.14 0.09 0.24 1.0 2 0.17 2 0.03 2 0.07 0.01 0.01 0.02 2 0.01 0.06
p-value 0.04 0.15 0.0002 0.01 0.70 0.29 0.86 0.87 0.78 0.83 0.35
SEC
Coefficient 2 0.10 2 0.06 0.14 2 0.17 1.0 2 0.17 0.20 0.06 0.04 0.09 0.23 2 0.16
p-value 0.12 0.39 0.04 0.01 0.01 0.003 0.36 0.57 0.16 0.0005 0.02
Revr
Coefficient 0.21 0.09 0.13 2 0.03 2 0.17 1.0 2 0.02 2 0.16 2 0.09 2 0.02 2 0.03 0.26
p-value 0.001 0.18 0.04 0.70 0.01 0.76 0.02 0.18 0.76 0.66 , 0.0001
Car1
Coefficient 2 0.33 2 0.19 2 0.06 2 0.09 0.23 2 0.17 1.0 2 0.02 0.018 0.14 0.11 2 0.37
p-value , 0.0001 0.004 0.39 0.17 0.0004 0.01 0.74 0.79 0.03 0.09 , 0.0001
EarnCh
Coefficient 2 0.23 2 0.18 2 0.02 2 0.07 0.04 2 0.19 0.02 1.0 0.58 2 0.12 0.05 2 0.08
p-value 0.0004 0.007 0.79 0.32 0.57 0.004 0.76 , 0.0001 0.08 0.45 0.24
Roa
Coefficient 2 0.12 2 0.25 2 0.03 2 0.05 0.04 2 0.13 0.04 0.61 1.0 2 0.13 0.11 2 0.04
p-value 0.06 0.0002 0.68 0.44 0.59 0.04 0.53 , 0.0001 0.05 0.09 0.55
Preturns
Coefficient 0.01 2 0.04 0.0008 0.03 0.13 2 0.03 0.20 2 0.04 2 0.06 1.0 0.05 0.02
p-value 0.83 0.57 0.99 0.68 0.05 0.61 0.003 0.53 0.38 0.43 0.80
Tas
Coefficient 2 0.006 2 0.51 0.15 0.03 0.19 2 0.004 0.09 0.10 0.28 0.03 1.0 0.04
p-value 0.92 , 0.0001 0.03 0.65 0.002 0.96 0.15 0.12 , 0.0001 0.64 0.54
Fraud
Coefficient 0.37 0.15 0.30 0.06 2 0.16 0.26 2 0.34 2 0.18 2 0.003 2 0.04 0.14 1.0
p-value , 0.0001 0.02 , 0.0001 0.35 0.02 , 0.0001 0.0001 0.005 0.96 0.55 0.04
Notes: Pearson correlation coefficients (top right) and Spearman correlation coefficients (bottom left); CEOCH ¼ 1 for CEO turnover and 0 otherwise. Magnitude ¼ absolute value
of amount of income restated divided by total assets; Duration ¼ number of quarters of restatement where one quarter is 0.25; Audcause ¼ 1 if auditor initiated restatement and 0
otherwise; SEC ¼ 1 if SEC initiated restatement and 0 otherwise; Revr ¼ 1 if revenue related restatement and 0 otherwise; CAR1 ¼ cumulative abnormal returns (2 1, +1) around
the announcement of restatement; Roa ¼ net income divided by lagged total assets. Preturns ¼ cumulative abnormal returns in the days (2 150, 2 30) before restatement event;
Tas ¼ total assets; EarnCh ¼ change in net income divided by lagged total assets; Fraud ¼ 1 if SEC issues an AAER related to the firm restatement and 0 otherwise

Correlation coefficients
CEO turnover

Table III.
191
PAR indicating that the severity of the restatement is associated with the market
22,3 consequences of the restatement.

7. Results
The logistic regression results for the sample of firms with turnover are reported in
Table IV, separately for the two measures of severity, Magnitude and Duration. The
192 regression is first estimated without control variables to determine whether
restatement characteristics by themselves are likely to be significant in the
regression. Results show that the likelihood of CEO turnover increases with both
measures of severity of the restatement, as coefficients on Magnitude and Duration are
positive and significant. Contrary to the results found in Agrawal and Cooper (2007),
the severity of the restatement is likely to result in CEO turnover. Both measures of
severity, the amount restated and the number of periods involved, indicate that the
accounting restatement involved is likely to be a significant one. With respect to the
other restatement characteristics, it appears that the coefficient for auditor caused
restatements is positive in both regressions, but only significant in the one with
Magnitude. For SEC-related restatements, although coefficients are negative in both
regressions, only the one with Duration is significant. The SEC was involved in many
of the restatements that were related to in-process research and development starting
in 1999. It has been shown that these restatements were not as serious and resulted in
smaller event day returns (Palmrose et al. (2004a, b)). Also, these types of restatements
tend to be income-increasing restatements and the consequences of these restatements
have been shown to be different from income-decreasing restatements (Srinivasan,
2005; Myers et al., 2003). Revenue-related restatements are also positive in both
regressions, but only significant in the regression with Magnitude. Last, a variable that

Coefficient
n p-value n p-value

Intercept 20.84 * * * 0.0003 2 1.32 * * * , 0.0001

Magnitude 2.80 * * 0.014
Duration 0.83 * * * , 0.0001
Audcause 0.87 * 0.07 0.32 0.54
SEC 20.32 0.35 2 0.66 * 0.07
Revr 0.77 * * * 0.01 0.52 0.11
CAR1 21.85 * * 0.03 2 1.96 * * 0.02
Pseudo-R 2 0.16 0.24
Likelihood ratio 29.6 * * * ,0.0001 45.0 * * * , 0.0001
Number of observations 230 230
Notes:
PRðCEO turnover ¼ 1Þ ¼ f ða0 þ a1 Magnitude=Duration þ a2 Audcause þ a3 SEC þ a4 Revr þ
Table IV. a5 Car1Þ
Logistic regression CEOturnover ¼ 1 for CEO turnover and 0 otherwise; Magnitude ¼ absolute value of amount of
includes firms with CEO income restated divided by total assets; Duration ¼ number of quarters of restatement where one
turnover around the quarter is 0.25; Audcause ¼ 1 if auditor initiated restatement and 0 otherwise; SEC ¼ 1 if SEC
restatement and firms initiated restatement and 0 otherwise; Revr ¼ 1 if revenue related restatement and 0 otherwise;
with no turnover, no CAR1 ¼ cumulative abnormal returns (21, +1) around the announcement of restatement; *, * *, * * *
controls denote significance at the 10 percent, 5 percent and 1 percent level respectively
is likely to increase CEO turnover is CAR1, which is significant in both regressions, CEO turnover
and an indication that the market reaction to the announcement of the restatement is an
important factor in the management turnover decision. The negative coefficient on
CAR1 is consistent with the idea that the larger the negative market reaction, the
higher the probability of turnover. This result is not surprising given that the prior
literature has shown that large negative market reactions are associated with fraud
and revenue recognition issues. 193
When the control variables are added to the regression, Table V indicates that the
coefficients on Magnitude, Duration, and CAR1 are still in the same predicted direction
as well as significant. Coefficients on Audcause, SEC, and Revr are in the predicted
directions and significant in the same regressions as in Table IV. For the control
variables, I do not find that Preturns, poor stock returns prior to the restatement, or the
profitability measures, Roa and EarnCh, are significantly associated with CEO turnover.
In the event that a firm restates earnings, it appears that the management turnover
decision is more likely influenced by the characteristics of the restatement than by any of
the control variables that are included in the regression. Desai et al. (2006) show that
there is a significant penalty for the managers of firms that restate earnings. However,
they do not include variables related to the restatement, and also do not control for the
market reaction to the announcement of the restatement. It is possible that their variable

Coefficient
n p-value n p-value

Intercept 20.89 * * * 0.0002 2 1.41 * * * , 0.0001

Magnitude 3.62 * * * 0.009
Duration 0.85 * * * , 0.0001
Audcause 0.82 * 0.09 0.25 0.62
SEC 20.51 0.16 2 0.82 * * 0.03
Revr 0.80 * * * 0.01 0.51 0.12
Car1 22.04 * * 0.02 2 2.18 * * * 0.01
EarnCh 0.06 0.81 0.11 0.64
Roa 0.37 0.52 2 0.42 0.41
Preturns 0.22 0.31 0.19 0.39
Tas 0.00 0.12 0.00 0.14
Pseudo-R 2 0.19 0.25
Likelihood ratio 34.3 * * * ,0.0001 48.7 * * * , 0.0001
Number of observations 230 230
Notes:
PRðCEO turnover ¼ 1Þ ¼ f ða0 þ a1 Magnitude=Duration þ a2 Audcause þ a3 SEC þ a4 Revr þ
a5 Car1 þ a6 EarnCh þ a7 Roa þ a8 Preturns þ a9 TasÞ
CEOturnover ¼ 1 for CEO turnover and 0 otherwise; Magnitude ¼ absolute value of amount of
income restated divided by total assets; Duration ¼ number of quarters of restatement where one
quarter is 0.25’ Audcause ¼ 1 if auditor initiated restatement and 0 otherwise; SEC ¼ 1 if SEC Table V.
initiated restatement and 0 otherwise’ Revr ¼ 1 if revenue related restatement and 0 otherwise; Logistic regression
CAR1 ¼ cumulative abnormal returns (2 1, +1) around the announcement of restatement; includes firms with CEO
EarnCh ¼ change in net income divided by lagged total assets’ Roa ¼ net income divided by turnover around the
lagged total assets; Preturns ¼ cumulative abnormal returns in the days (2150, 230) before restatement and firms
restatement event; Tas ¼ total assets; *, * *, * * * denote significance at the 10 percent, 5 percent and 1 with no turnover,
percent level respectively including controls
PAR for restatement really captures not just the event of the restatement, but instead reflects
22,3 certain characteristics of the restatement that indicate the significance of the accounting
problem. Their restatement dummy variable could also be capturing omitted correlated
variables that should be included in their regression.
This paper shows that there is variation among restatement firms, and that in
comparing firms that all restate earnings, some restatements are significantly more
194 likely to result in turnover than others. Also, for these firms, the restatement
characteristics are likely to be important factors that influence the decision on whether
to retain a manager or not. It appears that in firms where managers are likely engaging
in more aggressive accounting procedures, increasing the likelihood that fraud
occurred, the managers are more likely to experience job loss.
For the next regression, the logistic regression is changed to include an additional
variable to test whether firms with CEO turnover are actually more likely to be fraud
related. Table VI shows that the Fraud variable is positively and significantly
associated with CEO turnover, indicating that firms with the CEO changes are likely to
be involved in fraudulent actions where intentional actions led to the restatement. In
addition to this, the measures of the severity of the restatement are still positive and
significant, the SEC variable is negative and significant and the coefficients on Revr

Coefficient
n p-value n p-value

Intercept 21.04 * * * ,0.0001 2 1.42 * * * , 0.0001

Magnitude 3.39 * * 0.02
Duration 0.72 * * * 0.0004
Audcause 0.81 * 0.10 0.30 0.58
SEC 20.40 0.28 2 0.69 * 0.08
Revr 0.59 * 0.08 0.42 0.24
Car1 20.98 0.29 2 1.29 0.17
EarnCh 0.12 0.65 0.18 0.51
Roa 0.31 0.62 2 0.45 0.42
Preturns 0.17 0.45 0.15 0.51
Tas 0.00 0.25 0.00 0.25
Fraud 1.56 * * * 0.0001 1.26 * * * 0.003
Pseudo-R 2 0.26 0.30
Likelihood ratio 50.4 * * * ,0.0001 57.8 * * * , 0.0001
Number of observations 230 230
Notes:
PRðCEO turnover ¼ 1Þ ¼ f ða0 þ a1 Magnitude=Duration þ a2 Audcause þ a3 SEC þ a4 Revr þ
a5 Car1 þ a6 EarnCh þ a7 Roa þ a8 Preturns þ a9 Tas þ a10 FraudÞ
CEOturnover ¼ 1 for CEO turnover and 0 otherwise; Magnitude ¼ absolute value of amount of
income restated divided by total assets; Duration ¼ number of quarters of restatement where one
quarter is 0.25; Audcause ¼ 1 if auditor initiated restatement and 0 otherwise; SEC ¼ 1 if SEC
initiated restatement and 0 otherwise; Revr ¼ 1 if revenue related restatement and 0 otherwise;
CAR1 ¼ cumulative abnormal returns (2 1, +1) around the announcement of restatement;
EarnCh ¼ change in net income divided by lagged total assets; Roa= net income divided by
lagged total assets; Preturns ¼ cumulative abnormal returns in the days (2150, 230) before
Table VI. restatement event; Tas ¼ total assets. Fraud ¼ 1 if SEC issues an AAER related to the firm
Logistic regression with restatement and 0 otherwise; *, * *, * * * denote significance at the 10 percent, 5 percent and 1 percent
fraud level respectively
and Audcause are still positive and significant in one of the regressions. These results CEO turnover
are consistent with Hennes et al. (2008), where the results show that class action
lawsuits are more likely for firms with irregular restatements.

8. Additional analysis – time between restatement date and CEO turnover

date
As another test of the predictive ability of the restatement characteristics, I run another 195
regression in the following form:
Time ¼ a0 þ a1 Magnitude þ a2 Duration þ a3 Audcause þ a4 SEC þ a5 Revr

þ a6 Car11 þ a7 Fraud
where Time ¼ the number of days between the restatement announcement date and
CEO turnover announcement date.
The purpose of this regression is to determine whether the timing between
restatement and CEO turnover announcement date is related to the characteristics of
the restatement. In this regression, the sample of firms is composed of only the firms
that experienced CEO turnover within the year of the restatement. For this regression, I
predict that the time between the restatement date and the turnover date should be
negatively related with the severity of the restatement (as measured by Magnitude and
Duration), negatively related to auditor caused restatements, revenue related
restatements, fraud, and positively related to SEC caused restatements.
Results are reported in Table VII. I find that although the severity of the restatement
as measured by Magnitude has a negative coefficient as predicted, the coefficient is not
significant. The coefficients on Revr and CAR1 are both negative, as expected, but also
insignificant. The coefficient on Duration is positive and significant, contrary to
predictions. For the Audcause variable, the coefficient is positive and significant,
contrary to predictions. It appears that for auditor initiated restatements, there is a
longer time period between the turnover announcement and the restatement
announcement. Since the number of firms drops to 103, it may be that there is not
as much variation in firms that had both restatements and turnover, and that by
increasing the sample size, I might find stronger results. Importantly, for the Fraud
variable, the coefficient is negative, as predicted, and highly significant, consistent
with the idea that for firms that commit fraud, the faster the CEO turnover occurs, the
more likely that the turnover is related to the restatement event.

9. Robustness checks
Alternative specifications of the model were implemented to determine robustness of
the results in the paper (results not tabulated). Gilson (1989) found that
financially-distressed firms are likely to result in managerial turnover. As an added
control, I use a proxy for leverage, measured by long-term debt divided by total assets,
and include it in the regression. After running the regression, the coefficient on
leverage in the logistic regression is 0.82 ( p-value 0.34, pseudo r-square 24 percent)
indicating that there is no association between leverage and turnover. With the
addition of leverage, the sample size decreases to 205, but the results are consistent
with previously reported results, with the variables Duration, SEC, and CAR1 still in
the same predicted direction and significant. In another test, I include an additional
PAR
Coefficient
22,3 n p-value n p-value

Intercept 121.9 * * * ,0.0001 96.8 * * * , 0.0001

Magnitude 269.2 0.26
Duration 21.5 * * 0.05
196 Audcause 79.0 * * * 0.01 62.2 * 0.06
SEC 56.2 * * 0.05 43.5 0.12
Revr 24.88 0.83 2 17.2 0.47
Car1 224.9 0.67 2 46.5 0.43
Fraud 267.8 * * * 0.008 2 84.6 * * * 0.001
R2 0.19 0.17
Number of observations 103 103
Notes:
Time ¼ a0 þ a1 Magnitude þ a2 Duration þ a3 Audcause þ a4 SEC þ a5 Revr þ a6 Car11 þ a7 Fraud
Time ¼ days between restatement announcement date and CEO turnover announcement date;
Magnitude ¼ dollar amount of restated net income divided by total assets; Duration ¼ number of
quarters of restatement where one quarter is 0.25; Audcause ¼ 1 if auditor initiated restatement and 0
otherwise; SEC ¼ 1 if SEC initiated restatement and 0 otherwise; Revr ¼ 1 if revenue related
Table VII. restatement and 0 otherwise; CAR1 ¼ cumulative abnormal returns (2 1, +1) around the
OLS regression includes announcement of restatement; Fraud ¼ 1 if SEC issues an AAER related to the firm restatement
restatement firms with and 0 otherwise; *, * *, * * * denote significance at the 10 percent, 5 percent and 1 percent level
CEO turnover respectively

measure in the logistic regression to determine whether the direction of the restatement
matters. Adding this additional variable, however, does not change any of the results
found in Table VI, as all variables are the same in direction and significance, and the
variable on the direction of the restatement is also insignificant.
To address multicollinearity issues, I include a test for multicollinearity by running
an ordinary least squares (OLS) regression of my model (instead of the logistic
regression), and implement the variance inflation factor (VIF) test. The VIF statistics in
the regression range from 1.05 to 1.86, and since all the VIF statistics are fairly low, the
results do not indicate the existence of multicollinearity.

10. Summary and conclusion

This study analyzes 230 US firms with earnings restatements to determine whether
certain restatement characteristics lead to an increased probability of CEO turnover.
Results indicate that firms with more severe restatements (as measured by Magnitude
and Duration), and with large negative market reactions are more likely to have a
change in CEO. These findings suggest that financial accounting problems can
influence management turnover decisions. In the event that a firm restates earnings, it
appears that CEO turnover may be driven by factors other than stock price or earnings
performance. The evidence in this paper shows that the characteristics of earnings
restatements may be useful information in determining what consequences will occur
for firms’ managers in the event that there is an error in earnings.
The evidence in this paper also helps to address the inconsistent evidence in the
literature on the consequences to managers following fraud or an earnings restatement.
The results in this paper are consistent with other related papers (Desai et al., 2006;
Agrawal and Cooper, 2007; Collins et al., 2009) finding that managers are likely to be CEO turnover
punished in the event that earnings management has occurred. More importantly, I find
that when there are more severe cases of restatements, there is a higher likelihood of
management change. These results are likely to be important information for investors
and regulators who are interested in knowing whether managers suffer consequences
after certain types of earnings restatements. The paper also provides evidence that firms
that have a change in CEO are more likely to be committing accounting fraud, as shown 197
by the higher likelihood of these firms being issued SEC Accounting and Auditing
Enforcement Releases in the years after the restatement. This finding shows that the
decision by a restatement firm to have a change in CEO is likely a right decision, as firms
in which CEOs lose their jobs are the ones where fraud likely occurred.

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