Are Entrenched Managers’ Accounting Choices More Predictive of Future Cash Flows?

Abstract

We examine the role manager entrenchment has on firms’ financial reporting quality. More specifically, we test whether entrenched managers’ reported accruals deviate from industry norms and whether entrenched managers’ abnormal accruals are more (or less) predictive of future cash flows. Consistent with implications from prior research, we find that firms with entrenched managers generally report lower levels of abnormal accruals (in an absolute sense), but the abnormal accruals utilized by entrenched managers are more predictive of future cash flows. Contrary to a more traditional view of manager entrenchment, our evidence suggests that entrenched managers report higher quality abnormal accruals. While prior research provides evidence that manager entrenchment is associated with negative economic outcomes, we argue that attempts to limit entrenchment are unlikely to improve financial reporting quality and may actually lower quality. Future corporate governance should consider not only the level but also the quality of the association between accounting choices and manager entrenchment.

Keywords: Manager Entrenchment, Abnormal Accruals, Shareholder Rights, Financial Reporting Quality

JEL Classification: M41, K22