Roles of CEOs and information in financial reports, contracts, organizations, and markets

This dissertation studies the multiple roles of chief executive officers (CEOs) and financial information, and it consists of four chapters. Chapter 1 reviews selectively the literature on: (i) the determinants and the consequences of CEO turnover; (ii) the relationship between CEO turnover and earnings management; and (iii) the effects of CEO career concerns and overconfidence on financial reporting. The CEO turnover literature finds robust evidence that CEO turnovers are preceded by poor accounting performance or poor stock market performance. There is also extensive evidence for the relationship between CEO turnover and earnings management and for the effects of CEO overconfidence on financial reporting. However, there is inconclusive evidence regarding market reactions to CEO turnover announcements, post-turnover performance improvements, the relationship between earnings quality and CEO turnover, and the effects of career concerns on financial reporting. Chapter 2 addresses the following question. In the wake of recent financial crises and corporate failures, CEOs are often blamed for their overconfidence leading to earnings manipulation and excessive risk. How is it then that these overconfident CEOs obtain job offers in the first place? In an agency model with CEO overconfidence and public regulation, this paper provides conditions under which earnings manipulation and CEO overconfidence can increase the ex ante firm value and the interim market valuation of the firm. Moreover, it is socially optimal for a regulatory body to impose a lenient policy on earnings manipulation rather than a zero-tolerance policy. These results provide an explanation for why earnings manipulation and CEO overconfidence can co-exist even under firm-value-maximizing corporate governance and public regulation. The dark side, however, is that the firm bears greater risk and is more likely to go bankrupt ex post. Chapter 3 examines the effects of market competition on CEO hiring decisions by firms in a Cournot model where the hired CEOs determine the research and development investment and production level for their respective firms. The central result is that CEO overconfidence and the intensity of market competition (measured by the number of firms in the industry) have an inverted U-shaped relationship. This suggests that, in equilibrium, firms in an oligopoly hire CEOs with relatively greater overconfidence than do firms in a duopoly. As the market tends towards being perfectly competitive, strategic concerns vanish and firms hire realistic CEOs. Chapter 4 explains a `big bath', a phenomenon where a CEO manipulates a company's income statement to make poor results look even worse. In a financial reporting game played by an outgoing CEO, an incoming CEO, and outside investors in the capital market, this study identifies conditions under which a big bath can be sustained as an equilibrium outcome. In particular, when the earnings report issued by the outgoing CEO is sufficiently low, the incoming CEO’s reporting strategy will feature a big bath. The paper also generates several predictions relating the likelihood of a big bath, the sensitivity of a CEO’s reporting strategy to true earnings and a prior earnings report, and the sensitivity of the stock price to earnings reports.