Executive Summary:
In this paper we investigate the reputational penalties to managers of manipulating earnings. More specifically, we examine management turnover and the subsequent re-hiring of displaced managers at firms having earnings restatements. In contrast to prior research (Beneish 1999 and Agrawal, Jaffe and Karpoff, 1999), which does not find increased turnover following GAAP violations or revelation of corporate fraud, we find that 58.9% of the restating firms experience a turnover in at least one top manager within 24 months of the restatement compared to only 35.6% among age-, size- and industry-matched firms. Moreover, 92% of the displaced managers are unable to secure comparable employment within four years following the restatement announcement. Our results hold after controlling for firm performance, bankruptcy and other determinants of management turnover, and suggest that both corporate boards and the external labor market impose significant penalties on managers for violating GAAP. Also, in light of resource constraints at the SEC, our findings are encouraging as they suggest that private penalties for GAAP violations are severe and may serve as partial substitutes for public enforcement of GAAP violations.
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