Interim CEOs engage in considerably more earnings manipulation than their permanent successors, according to a new study.
The study, which appears in the current issue of the Academy of Management Journal, found that such a strategy pays off for them, increasing the likelihood that they will be promoted to the top job on a permanent basis.
The study's authors, Guoli Chen of INSEAD, Shuqing Luo of National University of Singapore, Yi Tang of Hong Kong Polytechnic University, and Jamie Y. Tong of University of Western Australia, wrote that acting CEOs “actively manage their impressions on key stakeholders by engaging in income-increasing earnings management, thereby improving their promotion prospects when the interim period ends.”
They warn company boards to think carefully before appointing an interim CEO and caution that if such a "succession is unavoidable, the firm and its board should aim to achieve a clear and realistic target during the interim period. Importantly, the promotion decision should not be based purely on symbolic performance. Moreover...directors [should] possess the necessary knowledge and expertise to assess the interim CEO."
Having a high proportion of directors with finance or accounting backgrounds tends to reduce the amount of earnings inflation by acting CEOs, while reducing the likelihood that an interim boss who does pump up earnings will get the job permanently. Coverage by many stock analysts tends to achieve the same goal. The presence of directors who are not stretched too thin by more than three company-board memberships also helps prevent earnings-managing interim CEOs from getting the official job.
The study's findings are based on an analysis of financial statements of 138 companies that appointed interim CEOs. Each was paired with a firm in the same industry that had a CEO departure at about the same time but selected a permanent replacement for the position. Firms were matched by the likelihood of appointing an interim CEO in a succession episode based on company size, age and financial performance as well as on the succession environment—the departing CEOs' tenure and age and whether the departure was planned or unplanned and due to dismissal, death or poor health.