We contend that accounting losses serve as a heuristic for managerial failure. If accounting losses provide crucial incremental information related to firm performance, and managerial ability, boards can use the information contained in losses to better assess CEO’s stewardship of a company’s assets. Consequently, boards are expected to re-evaluate CEO’s performance following losses, which leads to higher CEO turnover. Consistent with our expectation, we find a strong relation between losses and subsequent CEO turnover. Additionally, we find that the turnover-loss sensitivity depends on other economic factors. Consistent with the heuristic explanation, we find that that losses are indicative of serious future operating and financial problems. We also test and find that board activity increases with losses, which provides direct evidence of greater board scrutiny following losses. Our results explain why CEOs manage earnings to avoid losses and why the stock market reacts to profits, but not losses.
Dr Aloke (Al) Ghosh is a Fulbright Distinguished Chair and Professor of Accountancy at the Zicklin School of Business, Baruch College, City University of New York. Professor Ghosh has served as the Accounting Academic Fellow at the US Securities and Exchange Commission. He has taught as an adjunct or as a visiting scholar at Aalto University (Finland), American University of Paris (France), Bocconi University (Italy), Columbia University, Emory University, Indian Institute of Management (India), NJIT, Tulane University, UST-Hong Kong (Hong Kong), Victoria University of Wellington (New Zealand), Yonsei University (South Korea). Dr Ghosh has publications in the leading accounting and finance journals. He serves as an advisor to several financial institutions on accounting and finance matters. Dr Ghosh is an independent trustee and an audit committee chair of a SEC registered mutual fund. He writes a blog on matters related to accounting, auditing, finance and economics on his own website. Dr Ghosh holds a PhD in Business and Economics from Tulane University, New Orleans.