Earnings Management and Annual General Meetings: The Role of Managerial Entrenchment

The Financial Review 48 (2013) 259–282

Earnings Management and Annual GeneralMeetings: The Role of Managerial

EntrenchmentJohn Banko

University of Florida

Melissa B. Frye∗University of Central Florida

Weishen WangCollege of Charleston

Ann Marie WhyteUniversity of Central Florida

Abstract

We examine earnings management around the annual general meeting (AGM) and assessthe influence of managerial entrenchment. Consistent with prior research, we show positiveand statistically significant abnormal returns surrounding AGMs regardless of the level of man-agerial entrenchment. We find evidence of significant earnings manipulation primarily amongentrenched managers. Specifically, they manage abnormal accruals downward two quartersprior to the AGM and significantly increase abnormal accruals in the quarter immediately

∗Corresponding author: Department of Finance, College of Business Administration, University of CentralFlorida, 4000 Central Florida Blvd., Orlando, FL 32816-1400; Phone: (407) 823-3097; Fax: (407) 823-6676; E-mail: [email protected].

We thank the anonymous referees, Robert Van Ness (the editor), and seminar participants at the FinancialManagement Association annual meetings.

C© 2013, The Eastern Finance Association 259

260 J. Banko et al./The Financial Review 48 (2013) 259–282

before the AGM. Our evidence is consistent with AGMs triggering managers to disseminateinformation in a manner that shapes the market’s perception of the firm.

Keywords: annual general meeting, earnings management, managerial entrenchment, share-holder proposals

JEL Classifications: G34, M41

1. Introduction

Annual general meetings (AGMs) are mandatory for a company’s board andmanagement. One of the primary purposes of the meeting is to elect the board ofdirectors, but any issue within shareholder control can be discussed at the meeting.The meetings provide an important platform for stockholders to advise or disciplinemanagement. For instance, shareholders can submit proposals and vote on importantissues including disapproving executive compensation plans and conducting proxyfights.

A number of academic studies question the value of the meetings (Jong, Mertensand Roosenboom, 2006) and even call for phasing out the mandatory requirementfor general shareholder meetings (Stratling, 2003; Sjostrom, 2006). Other studiesshow that the meetings do influence managerial behavior by increasing the pressureon managers to show positive performance. For example, Dimitrov and Jain (2011)show that earnings, dividends, management forecasts and stock split announcementabnormal returns are higher prior to AGMs, consistent with stock price manipulationby managers. They find that the stock price increases significantly during the periodleading up to the AGM, but this price run-up is subsequently reversed. This evidencesupports the notion that the AGM triggers managers to disseminate informationin a manner that influences the market’s perception of the firm. In this study, wefocus on a technique that management can use to influence the market: earningsmanagement. We examine abnormal accruals in the quarters leading up to the annualmeeting under the assumption that the additional scrutiny surrounding the AGMincreases the pressure on managers to window dress and present the firm favorablyto shareholders. In addition, we consider whether managerial entrenchment affectsthe extent of earnings manipulation around the AGM.

Using a sample of Standard & Poor’s (S&P) 1500 firms, we measure the an-nouncement period returns surrounding the annual meeting following Brickley (1986)and Dimitrov and Jain (2011) and examine the source of the information driving theabnormal returns. We also examine the pattern of abnormal accruals beginning twoquarters prior to the AGM and ending two quarters following the AGM and testthe hypothesis that the extent of earnings management is influenced by managerialentrenchment. Our primary results are as follows. First, we confirm Dimitrov andJain’s (2011) finding of positive and statistically significant abnormal returns in the

J. Banko et al./The Financial Review 48 (2013) 259–282 261

pre-meeting period, suggesting that important information is disseminated. However,Sarbanes Oxley (SOX) appears to have reduced managers’ ability to manipulate mar-ket perceptions as evidenced by significantly lower, albeit positive abnormal returnsin the post-SOX period. We show that shareholder proposals are an important sourceof information driving the abnormal returns. Both firms with passing and failing pro-posals gain in the pre-meeting period, suggesting that the market values shareholderactivism regardless of whether or not it results in change. If the proposals subse-quently fail, the gains are largely reversed in the post-meeting period. The pattern ofabnormal returns across the pre- and post-meeting periods also varies based on thelevel of entrenchment and earnings management.

Second, we find a clear pattern of executives managing earnings around annualmeetings. However, earnings management is not uniform across all manager types.Entrenchment does affect managerial behavior with entrenched managers engagingin significantly more earnings manipulation. Managers could perceive many benefitsof earnings management, including higher compensation and higher returns. Sinceentrenched CEOs are less likely to be disciplined, they appear to be more likelyto engage in earnings manipulation. Indeed, our results support Dechow, Sloan andSweeney (1996), who attribute earnings management to weak monitoring. In addition,we show that entrenched managers manage earnings downward two quarters priorto the meeting, but manage them upward in the quarter immediately prior to theAGM. This behavior strongly suggests manipulation around the AGM by entrenchedmanagers. We also find that abnormal accruals are lower in the post-SOX period, butentrenched managers are still associated with significantly higher levels of earningsmanagement.

Our study makes several important contributions to the literature. We explicitlymeasure abnormal accruals on a quarterly basis surrounding the AGM and examinethe effect of managerial entrenchment. While Dimitrov and Jain (2011) highlightmanagement’s tendency to manipulate earnings news, they do not examine abnormalearnings accruals leading up to the meeting nor do they consider the role of manage-rial entrenchment. Although Dechow, Sloan and Sweeney (1996) find that earningsmanipulation is systematically related to weaker external and internal monitoringmechanisms, they do not answer the question of whether the annual meeting trig-gers manipulation. Similarly, while Zhao and Chen (2008a, b) show that firms withstaggered boards, a measure of managerial entrenchment, are less likely to manageearnings, they examine earnings management in general without reference to an im-petus like the AGM. Further, their use of annual data can obscure manipulations fromquarter to quarter as would likely be the case surrounding AGMs. We overcome theselimitations by identifying an experimental setting where the influence of managerialentrenchment on earnings management is hypothesized to be strong.

A further contribution of our study is that we examine the effect of SOX on thepropensity to manage earnings. Among other provisions, SOX requires CEO/CFOcertification of financial statements, making executives more vulnerable to legalaction. In effect, earnings management activities could have become more personally


costly to managers in the post-SOX era. In practice, these costs range from the loss ofmanagerial reputation or future employment opportunities (Liang, 2004) to criminalprosecution for fraudulent activities. In fact, Cohen, Dey and Lys (2008) show thataccrual based accounting increased prior to SOX, but declined significantly followingits passage. Our results, coupled with these findings, suggest that SOX reduced theextent of earnings management around annual meetings.

2. Literature review and hypotheses

In this section, we review the evidence on the effect of AGMs. We also develophypotheses related to earnings management and managerial entrenchment.

2.1. Effect of AGMs

Providing a check on management is perhaps the most obvious justificationfor mandatory annual meetings (Sjostrom, 2006). However, studies question the im-portance of the meetings. Jong, Mertens and Roosenboom (2006) examine annualshareholder meetings in the Netherlands and conclude that they do not afford share-holders any significant influence on management. Sjostrom (2006) concludes thatthe meetings are meaningless and costly and should not be required annually. Theexistence of staggered boards, plurality voting, the nomination process of directors,and the difficulty of proxy fights can all serve to reduce the importance of the annualmeeting.

In contrast, several recent studies show that annual meetings matter. Cai, Garnerand Walking (2009) find that although poorly performing directors and firms receiveover 90% of votes cast at the AGM, fewer votes do lead to lower “abnormal” CEOcompensation and a higher probability of removing poison pills, classified boards,and CEOs. They also find that directors in firms with entrenched managers receivefewer votes. In effect, shareholders withhold their votes to express their dissatisfactionwith certain directors. Del Guercio, Cole and Woidtke (2008) show that “vote-no”campaigns in director elections are linked to increased CEO turnover followingthe AGM. Dimitrov and Jain (2011) show that managers manipulate stock pricessurrounding the annual meetings resulting in significant abnormal returns in thepre-meeting period. The result confirms early work by Brickley (1986) that showspositive abnormal returns surrounding the AGM.

2.2. Earnings management and the abnormal returns

As a consequence of revenue recognition and revenue-expense matching princi-ples under an accrual accounting system, net income and cash flows from operationsare often different with the difference being attributable to total accruals. Teoh, Welchand Wong (1998) present some examples of how current accruals can be altered. Firmscan change current accruals by advancing recognition of revenues with credit sales,


delaying recognition of expenses after cash is advanced to suppliers, or assuming alow provision for bad debts.

With respect to current accruals, some portion is mandated by the change in thefirm’s business condition and is not discretionary. However, some current accrualsare subject to managerial discretion, and are thus, the target of earnings management.Studies have found evidence of earnings manipulations by managers prior to impor-tant corporate events, such as issuance of new securities (Teoh, Welch and Wong,1998; Liu, Ning and Davidson, 2010), granting executive options (Coles, Hertzeland Kalpathy, 2006), exercising options (Bartov and Mohanram, 2004), and splittingstocks (Louis and Robinson, 2005). One important feature of earnings managementis that as time passes, the manipulated accruals reverse (Bartov and Mohanram, 2004;Louis, 2004).

Better earnings can lead to increased managerial compensation or job secu-rity. Several specific motives are often cited for why managers manipulate earnings.Window dressing the financial statements prior to the offering of securities to thepublic, avoiding debt covenant violations, or reducing regulatory costs or increas-ing benefits are often mentioned as motivating factors (Healy and Wahlen, 1999).Empirically, Healy (1985) shows a strong relation between accruals and bonus con-tracts, suggesting earnings management is rewarded through higher compensation.DeAngelo (1988) finds that during a proxy contest, incumbent managers exercisetheir discretion to improve reported earnings. Dechow and Sloan (1991) report thatCEOs in their final years in office, increase reported earnings by reducing researchand development (R&D) spending. Both studies show an increase in the frequencyof earnings management in periods when top managers’ job security is threatened.Farrell and Whidbee (2003) find an inverse relation between the likelihood of CEOturnover and the difference between realized and expected earnings.

Prior research suggests that markets cannot completely unravel, for valuationpurposes, the component of accruals driven by managerial opportunism. Collinsand Hribar (2000) provide evidence that managers could be able to game capitalmarkets. Specifically, the market appears to consistently overestimate the persistenceof the accrual component of earnings and, therefore, overprice them. Support forthis can be found in studies suggesting that earnings management prior to equityissues affects share prices, and appears to be responsible for high issuing prices andsubsequent poor stock performance (Teoh, Welch and Wong, 1998). Teoh, Welchand Wong (1998) suggest initial public offering investors can be guided by earningsbut are not fully aware that earnings can be inflated by the generous use of accruals.As information is revealed over time, investors can lose optimism resulting in aprice correction. Furthermore, Dechow (1994) finds that current earnings are betterpredictors of future cash flows than are current cash flows. Investors view earningsas value-relevant data that are more informative than cash flow data.

If AGMs are important, managers should have a tendency to release favorableinformation in the days preceding the AGM in addition to managing earnings up-ward. Therefore, we expect to observe more positive abnormal returns in the days


surrounding the AGM consistent with Brickley (1986). However, the work by Brick-ley predates the significant debates about the value of AGMs and the passage ofSOX. Dimitrov and Jain (2011) also provide evidence that AGMs trigger managersto disseminate information in a manner that influences the market’s perception ofthe firm. To the extent that managers release earnings information with the goal ofaltering market perceptions surrounding the AGM, we expect the abnormal returnsto be greater for firms that manage earnings more aggressively. Thus, we formulateHypothesis 1:

H1: The abnormal returns associated with information released sur-rounding the AGM will be more favorable for firms engaged ingreater earnings management.

2.3. Managerial entrenchment and earnings management

The literature provides evidence regarding the potential costs associated withaccruals manipulation. As earnings management becomes more aggressive, managersface increased risk of scrutiny from auditors and regulators and become more vulner-able to lawsuits. Desai, Hogan and Wilkins (2006) find that reputational penalties tomanagers when firms announce earnings restatements, including job loss and reducedjob opportunities.1 Dechow, Sloan and Sweeney (1996) show that firms experiencesignificant increases in their costs of capital when earnings manipulations are madepublic.

Despite the potential downside to earnings management, Liang (2004) arguesthat earnings management involves economic trade offs. He notes that given produc-tivity differences over time, there is an incentive to use different bonus schemes indifferent periods. The bonus schemes give managers an incentive to manage earn-ings for personal gain, but suppressing these incentives could be too costly for thefirm suggesting that some level of earnings management can be beneficial. He alsoargues that a zero tolerance stance on the part of regulators can cause agency costs torise and concludes that earnings management is an equilibrium outcome from bothan agency and a regulatory perspective. Dutta and Gigler (2002) also show that itcould be suboptimal for shareholders to prohibit earnings management, and earningsmanagement can have the added benefit of reducing the cost of obtaining a reliableforecast.

Given these findings, we propose two alternative views regarding the effect ofentrenchment on earnings management. The first view suggests that entrenched man-agers have less incentive to manage earnings. Several studies corroborate this view.Zhao and Chen (2008a) show that firms with more entrenched managers (proxied

1 This finding is similar in spirit to Ashraf, Chakrabarti, Fu and Jayaraman (2010) who find directors sufferreputational damage from adopting antitakeover provisions.


by staggered boards) manage earnings less. Stein (1988) argues that takeover threatsprovide an important motivation for managerial myopia. Since entrenched managersface reduced takeover threats, such managers are more likely to focus on the firm’slong-term strategic policy rather than short-term issues such as earnings manage-ment. Consistent with this idea, Pugh, Page and Jahera (1992) find that on passageof antitakeover amendments, managers adopt a longer-term view with respect tocapital expenditures and R&D. These prior studies suggest that entrenched managersshould be less likely to manage earnings before shareholder meetings. Based on thesearguments we formulate Hypothesis 2:

H2: Entrenched managers will engage in less earnings managementprior to the AGM.

The second view suggests that entrenched managers can actually have a greaterincentive to manage earnings. Empirical evidence clearly shows that entrenchedmanagers are associated with poor performance (Gompers, Ishii and Metrick, 2003;Bebchuk, Cohen and Ferrell, 2009). In addition, the literature suggests that per-sonal financial incentives exist for managers to have high earnings. For example,Healy (1985) and Holthausen, Larcker and Sloan (1995) find evidence that managersmanipulate earnings to “game” bonus schemes. Similarly, Bergstresser and Philip-pon (2006) also find a link between CEO incentives and the use of discretionaryaccruals.

While the above papers suggest that personal incentives exist for all CEOs tomanage earnings, the lack of monitoring could allow entrenched CEOs greater free-dom to pursue such personal gains. Dechow, Sloan and Sweeney (1996) find earningsmanipulation is systematically related to weaker external and internal monitoring, andfirms manipulating earnings are more likely to have management-dominated boards,CEO duality, and a CEO who is also the founder. Conversely, they show that suchfirms are less likely to have an audit committee or an outside blockholder. The rep-utational penalties could also be lower than those of nonentrenched managers whoface less job security. In other words, the downside risk to an entrenched managerfor manipulating earnings could be minimized, thus providing a clear motivation forfirms with entrenched managers to window dress earnings prior to the annual meet-ing. In addition, Fahlenbrach (2009) finds a positive relation between the numberof antitakeover provisions a firm has adopted and CEO annual compensation. WhileFahlenbrach does not directly examine earnings management, a link can be made tothe findings of Healy (1985) and Holthausen, Larcker and Sloan (1995), suggestingentrenched managers can earn higher bonuses by engaging in earnings management.Based on these arguments we formulate Hypothesis 2A:

H2A: Entrenched managers will engage in more earnings managementprior to the AGM.


3. Data and methods

In this section, we outline the method used to estimate abnormal accruals anddiscuss the sample construction.

3.1. Quarterly discretionary current accruals

Firms announce their annual performance prior to their annual meetings. Inaddition, firms report quarterly financial data during the interval between the release ofthe annual data and the shareholder meeting. Since these quarterly earnings reports arecloser to the annual meeting, they are more likely to be manipulated by managementto affect shareholders’ perceptions regarding the firm’s financial status. Thus, wefocus on quarterly discretionary earnings in this study, which is different from otherstudies like Zhao and Chen (2008a,b), who use annual earnings.

Prior studies have classified total accruals into current accruals and long-termaccruals. Current accruals are adjustments involving short-term assets and liabilities.Long-term accruals are adjustments involving long-term net assets. Some examplesinclude decelerating depreciation, decreasing deferred taxes, and realizing unusualgains. Since managers have greater discretion over current accruals than over long-term accruals, it is likely that current accruals can be more easily manipulated thanlong-term accruals. Therefore, most finance studies focus on current accruals (Teoh,Welch and Wong, 1998; Xie, Davidson and DaDalt, 2003).

We use the method outlined by Gong, Louis and Sun (2008) to estimate theabnormal accruals. For each calendar quarter and two-digit Standard Industrial Clas-sification (SIC) code industry group, the following model is estimated using all firmsthat have the necessary data on Compustat:

CAi =4∑

j=1

λj−1Qj,i + λ4� SALESi + λ5 PPEi + λ6 LCAi + λ7 ASSETSi + εi,

(1)where CAi is total accruals for firm i as in Gong, Louis and Sun (2008); Q is a binaryvariable having value of 1 for fiscal quarter j; �SALES is the quarterly change insales; PPE is property, plant and equipment at the beginning of the quarter; LCA iscurrent accruals in the previous quarter; ASSETS is total assets at the beginning of thequarter. All variables in the equation are scaled by the total assets at the beginning ofthe quarter.

From Equation (1), we estimate the abnormal accruals (AA), that is, the re-gression residuals. For each quarter and each industry (two-digit SIC code), wecreate five portfolios based on the firm’s return on assets (ROA) from the same quar-ter in the previous year. The performance-adjusted abnormal accruals for a samplefirm are the firm-specific abnormal accruals minus the median abnormal accrualsfor its respective industry-performance-matched portfolio. As pointed out by Gong,Louis and Sun (2008), the portfolio benchmarking approach not only controls for


performance, but also controls for random effects arising from other events thatcould affect accruals or other managerial incentives to manage earnings.

The Gong, Louis and Sun (2008) approach adds controls for quarters and years,removing or at least alleviating the possible seasonality of abnormal discretionaryaccruals. We estimate the model over the full sample period as well as the pre- andpost-SOX periods, defined as pre- and post-2002 respectively. Once we have theabnormal accruals, we analyze the relation between abnormal accruals and entrench-ment by estimating Fama and MacBeth (1973) models for the full sample period aswell as the pre- and post-SOX periods.

3.2. Managerial entrenchment

We use the entrenchment index (Eindex) created by Bebchuk, Cohen and Ferrell(2009) as a measure of managerial entrenchment. This index is the sum of six dummyvariables that proxy for the most important antitakeover provisions, which are mostlikely to capture entrenched managers. The six provisions are staggered boards, limitsto shareholder bylaw amendments, supermajority requirements for mergers, limits tocharter amendments, poison pills, and golden parachutes. These provisions greatlyprotect incumbent managers from corporate takeovers. Bebchuk, Cohen and Ferrell(2009) show that the entrenchment index is negatively associated with firm value.Thus, firms with the highest index values are often referred to as having the highestmanagement power and, thus, greater managerial entrenchment. We classify firmsas having a relatively high level of entrenchment if the Eindex is greater than 2 (thesample median).2

3.3. Controls

We include several control variables in the model. Board size can serve as aproxy for the board’s monitoring effectiveness. Yermack (1996) finds that firm valueis negatively related to board size and suggests that smaller boards are usually moreeffective and efficient. Thus, board size should be positively related to earnings man-agement. Prior research finds that companies with independent boards are much lesslikely to report abnormal accruals and engage in earnings management (Dechow,Hutton and Sloan, 1996; Xie, Davidson and DaDalt, 2003). This finding suggeststhat earnings management will be reduced when the board is comprised of moreoutside directors. Institutional ownership can also influence the extent of earningsmanagement, although the direction is not obvious. As institutional ownership in-creases, firms could feel additional pressure to manage earnings. Alternatively, since

2 We also use CEO duality, since prior studies suggest that CEOs that are also the chair are more likely to beentrenched. We find no significant relation between duality and abnormal accruals. Thus, the antitakeoverprovisions seem to better capture entrenchment with respect to earnings management.


institutional investors can serve a monitoring role, earnings management could bereduced.

Executive share ownership or stock option compensation can also affect theincentives of the managers to manage earnings. Bergstresser and Philippon (2006)find that when the CEO’s potential total compensation is more closely tied to thevalue of stock and option holdings, firms are more likely to use discretionary ac-cruals to manipulate reported earnings. We control for the percentage of shares heldby executives and the total number of options the top executives hold as reportedin ExecuComp, including exercisable and unexercisable options. Larger firms andfirms with strong growth prospects could also be associated with greater earningsmanagement. We expect audit committee independence to be inversely related toearnings accruals (Klein, 2002). Post-SOX, all companies are required to have inde-pendent audit committees, although not all companies comply or meet the InvestorResponsibility Research Center (IRRC) standards of independence. Highly leveredfirms and firms with weaker prior performance (as measured by ROA) could alsohave a greater propensity to engage in window dressing around the annual meeting.We also control for the number of shareholder proposals voted on at the meeting. Alarger number of proposals could suggest a more contentious meeting.

3.4. Sample construction

Data for the Eindex are obtained from IRRC and RiskMetrics. Similarly, di-rector data are also obtained IRRC/RiskMetrics, which we aggregate to the firmlevel. Compensation data are from ExecuComp aggregated to the firm level.3 In-stitutional holdings data are obtained from 13F filings. We use the RiskMetricsdatabase on Shareholder Proposals to obtain the number of proposals voted on at theAGM. Stock price, returns, and accounting information are taken from CRSP andCompustat.

We merge quarterly earnings information including CUSIP, quarterly reportending date (the date on which firm’s fiscal quarter ends), and quarterly reportingdate (the date on which the firm reports its quarterly performance) from Compustat.To facilitate this, we identify the quarter whose reporting date immediately precedesthe annual meeting date as shown in Figure 1. This quarter is the focus of our inves-tigation, although we also examine earnings two quarters before the annual meetingand two quarters following the meeting. Figure 1 illustrates the time dimension forthe variables. As shown, we match the annual governance variables with quarterlyearnings before the meetings for consistent periods.

We do not have a balanced panel of data for the S&P 1500. For our study,we must merge three focal data sets including: Director Data (1996–2009: provides

3 We compress the ExecuComp data from the option granting level to the individual executive level and tothe firm level. Many firms make multiple option grants during a year.


Figure 1

Time relation between events and variables

20,814 observations), ExecuComp (1992–2009: provides 33,540 observations), andthe Governance Index (1990–2009: provides 33,430 observations). This merge resultsin a data set with 12,159 observations. The accounting and stock return informationfrom Compustat and CRSP form an annual data set centered on the annual meeting.To this annual data set, we add quarterly data. This step reduces the sample to 10,228observations. Our final sample period ranges covers 1996–2009.

To reduce the effect of spurious outliers, we trim the data by deleting the top andbottom 1%.4 We trim the data based on abnormal accruals, the entrenchment index,board size, the percentage of independent directors, the book-to-market ratio, andexecutive shares resulting in 7,116 observations. We exclude the year 2002, whichrepresents the year SOX was passed. We are left with about 5,800 observationsfor the final analyses. In our regression analyses, our sample is further reduced toapproximately 3,400 due to missing variables from the various data sources. Thegreatest loss is from institutional holdings.

4. Empirical results

Table 1 presents summary statistics over the full sample period as well asduring the pre- and post-SOX periods. The median entrenchment index is 2.0 for thefull sample period, but the index has increased in the post-SOX period to a mean of2.491. The average board has just over nine members of which 69.1% are independentdirectors. This percentage increases in the post-SOX period. The largest institutionalinvestors own approximately 8% of the shares outstanding.

4 Reported results are qualitatively similar when we use untrimmed data.


Table 1

Summary statistics

This table provides summary statistics from 1996 to 2009 for the full sample period and the pre- andpost-SOX periods. Eindex is the entrenchment index; Board size is the number of directors on the board;Percent outside directors is the percentage of outside directors on the board; Institutional ownership isthe maximum percentage of shares held by institutional investors; Executive shares is the percentage ofshares held by the top executives; Executive options is the natural log of the number of options held bytop executives reported in ExecuComp; Firm size is the natural log of total assets; Book-to-market is theratio of the book value of the firm to the market value; Audit independence is the percent independentdirectors on the auditing committee; Leverage is long term debt divided by total asset; ROA is the returnon assets two quarters immediately before annual meeting; and Proposals is the number of governancerelated proposals from shareholders.

Variable N Mean Median Pre-SOX mean Post-SOX mean

Eindex 5,800 2.331 2.000 2.116 2.491Board size 5,800 9.221 9.000 9.541 8.984Percent outside directors 5,800 0.691 0.714 0.639 0.729Institutional ownership 4,008 0.076 0.076 0.070 0.082Executive shares 5,800 0.029 0.007 0.033 0.027Executive options 5,727 7.352 7.362 7.102 7.536Firm size 5,800 7.471 7.327 7.376 7.541Book-to-market 5,800 0.463 0.393 0.477 0.453Audit independence 5,100 0.922 1.000 0.860 0.955Leverage 5,770 0.181 0.169 0.201 0.165ROA 5,800 0.014 0.014 0.013 0.015Proposals 5,800 0.331 0.000 0.225 0.411

Table 2

Timing of the annual meeting

This table reports the timing of the annual general meeting relative to the calendar and fiscal quarter endingdate, and other timing differences between key dates.

Calendar quarter Fiscal quarter

Meeting immediately after Number of Number ofquarterly report observations Percentage observations Percentage

1 3,747 64.60 5,107 88.052 480 8.28 68 1.173 689 11.88 17 0.294 884 15.24 608 10.49All observations 5,800 100.00 5,800 100.00

Table 2 presents information about the timing of annual meetings. Approxi-mately 88% of annual meetings take place after the firm’s first fiscal quarter, whileonly about 10% of firms hold their meetings after the fourth fiscal quarter. In calen-dar quarters, the corresponding numbers are 65% and 15%, respectively. This result


strengthens our approach of using quarterly earnings rather than annual data. Also,there appears to be little managerial discretion in setting meeting dates.

4.1. Abnormal returns surrounding AGMs

As a starting point, we examine the abnormal returns in response to informationdisseminated surrounding the AGM as a basis of comparison to Dimitrov and Jain(2011) and Brickley (1986).5 We extend Dimitrov and Jain’s (2011) findings byexamining the type of information conveyed leading up to the AGM and whetherthe abnormal returns vary with the level of entrenchment, earnings management, andwith the passage of SOX.

We measure abnormal returns as residuals computed from the simple marketmodel with the CRSP Value Weighted portfolio as the benchmark. The estimationperiod of the model is from event day −250 to event day −46, where the annualmeeting date is event day 0. All stock price data are obtained from CRSP. We followDimitrov and Jain (2011) and examine cumulative abnormal returns (CARs) 40 daysbefore and 40 days after the meeting. Dimitrov and Jain (2011) suggest managersstart providing information to the market approximately 30 days prior to the AGM,but use 40 to be conservative.6

Table 3, Panel A, shows the overall results. Over the full sample period, firmsgain an average of 2.16% over the (−40, 0) window, significant at the 1% level. Inthe post-meeting period (0, +40) the abnormal returns are insignificant, although thecumulative effect of the pre- and post-meeting periods (−40, +40) is positive andsignificant. These results reaffirm Dimitrov and Jain’s (2011) findings of significantpositive CARs during the pre-meeting period.

The pre-SOX results in Panel A are qualitatively similar to the overall results,except that there is evidence of reversal in the (0, +40) window. In the post-SOXperiod the gains to shareholders are significantly lower relative to the pre-SOX period.In the pre-SOX period, firms gain an average of 4.12% in the pre-meeting periodcompared to 0.72% in the post-SOX period. This result suggests that the new reportingrules associated with SOX could have weakened the information content of the AGM.

We also explore the type of information being conveyed at the annual meeting.While Dimitrov and Jain (2011) find positive abnormal returns surrounding theAGM, they provide no evidence regarding the type of information that is conveyed.However, we find evidence regarding the sort of new information being released. Westart by searching the Wall Street Journal for anecdotal evidence about the informationdisclosed at the AGM. Our search shows that many companies use the AGM to shareinformation. For example, IBM announced an expansion of its division linked to the

5 Brickley (1986) finds positive abnormal returns around shareholder annual meetings, but their datapredate the significant debates about the value of AGMs and the passage of SOX.

6 Our own search of the news surrounding the AGM also supports a longer event window.


Table 3

Abnormal returns surrounding the annual meeting

This table shows cumulative abnormal returns (CARs) surrounding the annual meeting. CARs are alsoestimated for subsets based on the outcome of the shareholder proposals. The median entrenchment indexis used to partition the sample into high and low entrenchment groups and the median level of abnormalaccruals is used to partition the sample into high and low earnings management firms. The t-statistics arein parentheses.

Panel A: Overall and pre- and post-SOX results

CAR(−40, 0) CAR (0, +40) CAR (−40, +40)

All observations 0.0216*** −0.0027 0.0178***

(10.037) (−1.407) (5.744)Pre-SOX period 0.0412*** −0.0062* 0.0323***

(10.67) (−1.78) (5.788)Post-SOX period 0.0072*** −0.0002 0.0072**

(2.99) (−0.09) (2.067)Difference 0.0340*** −0.0061 0.0251***

(7.82) (−1.51) (3.98)

Panel B: Abnormal returns based on proposal outcome

Proposals passed 0.0436** 0.0153 0.0595**

(2.34) (1.05) (2.27)Proposal fail 0.0191*** −0.0083*** 0.0095***

(7.381) (−3.71) (2.62)Difference 0.0245** 0.0236** 0.0500***

(1.95) (2.18) (2.84)

Panel C: Abnormal returns based on extent of managerial entrenchment

High entrenchment 0.0215*** 0.0031 0.0240***

(7.144) (1.13) (5.57)Low entrenchment 0.0218*** −0.0081*** 0.0125***

(7.08) (−2.86) (2.79)Different −0.0003 0.0112*** 0.0115*

(0.05) (2.83) (1.84)

Panel D: Abnormal returns based on extent of earnings management

High earnings management 0.0183*** −0.0049* 0.0122***

(5.92) (−1.78) (2.74)Low earnings management 0.0248*** −0.0001 0.0230***

(8.11) (−0.35) (5.25)Difference −0.0065 −0.0040 −0.0108*

(1.49) (1.01) (−1.73)

***, **, * indicate statistical significance at the 0.01, 0.05 and 0.10 level, respectively.

mortgage industry. Microsoft announced it was dropping its bid to acquire Yahoo. AtDisney’s AGM, they announced free access to many of their classic television showsonline at Disney.com. Starbucks used the AGM to announce a new customer rewardprogram, a new social network website, as well as new espresso machines designedto allow customers access to the barista.


However, we find the bulk of the news articles (about 64%) focus on shareholderproposals and the passage/failure of such proposals. In light of this finding, we usedata provided by RiskMetrics to identify shareholder proposals and the outcome ofthe vote on such proposals. We estimate CARs based on the whether the proposalspassed or failed. Firms in the “proposals passed” group have at least one proposalthat received shareholder approval during the year. Otherwise, the firm is classified inthe “proposals failed” group. The results are shown in Panel B of Table 3. Firms withpassing proposals gain an average of 4.36% in the pre-meeting period, significantat the 5% level. These gains are permanent showing the market anticipates andrewards successful shareholder proposals. Firms with failed proposals also gain inthe pre-meeting period (1.91%), but this gain is significantly lower than the firmswith passing proposals. Since the outcome of the proposals is not known in the pre-meeting period, the gains suggest that the market values shareholder activism.7 Whenthe proposals fail, the gains are reversed with the firms losing an average of 0.83%in the post-meeting period.

In Panel C, we report the results based on the level of managerial entrenchment.We classify firms as exhibiting a high level of entrenchment if the firm’s level ofentrenchment exceeds the median, low otherwise. The significant positive reactionis evident regardless of the level of entrenchment in the pre-meeting period. In thepost-meeting period, however, we find evidence of significant reversal among firmswith low levels of entrenchment. In untabulated results, we analyze the likelihoodof receiving or passing shareholder proposals based on the level of managerial en-trenchment. We find that as entrenchment increases, both the odds of receiving andpassing shareholder proposals increases. Thus, the lack of a reversal among highentrenchment firms could be related to the fact their shareholder proposals were suc-cessful. Thus, our results suggest the AGM is meaningful to firms with entrenchedmanagement.

Panel D shows the results for subsets based on the extent of earnings man-agement. We classify firms as exhibiting a high level of earnings management ifthe firm’s level of earnings management exceeds the median, low otherwise. Firmswith high levels of earnings management have a significant positive reaction in thepre-meeting period. These gains are reversed in the post-meeting period consistentwith Dimitrov and Jain (2011). Dimitrov and Jain (2011) interpret the reversal asevidence that a large part of the pre-meeting gain is temporary because the positiveinformation released in the pre-meeting period appears to be subsequently contra-dicted. However, low earnings management firms experience significant gains in thepre-meeting period that are not subsequently reversed. This result suggests firms thatmanage earnings less are not advancing good news to the pre-meeting period or aredoing so to a lesser extent.

7 Our findings are consistent with prior literature on proposals. For example, Ertimur, Ferri and Stubben(2010) find that proposal voting allows shareholders to apply pressure to management, even when proposalsare nonbinding. Similarly, Buchanan, Netter and Yang (2009) find that firms make governance changesafter receiving a proposal, suggesting shareholder proposals matter.


Table 4

Abnormal accruals by quarter

This table shows abnormal accruals (AA) over the quarters surrounding the annual meeting over the fullsample period and the pre- and post-SOX periods.

Full sample Post-SOX minusPre-SOX Post-SOX Pre-SOX

AA by quarter N Mean Mean Mean Mean

(−2) 5,681 −0.003 −0.004 −0.002 0.002**

(−1) 5,800 0.001 0.002 0.001 −0.001(+1) 5,670 0.001 0.001 0.001 0.000(+2) 5,620 0.000 0.000 0.000 0.000(−1) minus (−2) 5,681 0.004*** 0.005*** 0.003*** −0.002**

(+1) minus (−1) 5,670 0.000 −0.001 0.001 0.002(+2) minus (+1) 5,588 −0.001*** −0.001* −0.002*** −0.001


Overall, our results are consistent with prior literature supporting the no-tion of AGMs as important informative events. We provide evidence that share-holder proposals are one of the information drivers of the abnormal returns, andthat the levels of earnings management and entrenchment influence the pattern ofreturns.

4.2. Earnings management before and after the annual meeting

Table 4 presents quarterly AA around the AGM. We report accruals from twoquarters prior to the meeting (−2), to two quarters after the meeting (+2). We alsoreport changes from quarter to quarter. The mean AA ranges from −0.003 in Quarter(−2) to virtually zero in Quarter (+2). The change from quarter to quarter is mostinformative. The abnormal accrual increases by 0.004 significant at the 1% level,during the interval from (−2) to (−1). The result shows a propensity to increaseaccruals as the meeting draws closer. No significant change is observed from thequarter before the meeting (−1) to the quarter following the meeting (+1). However,over the period from Quarter (+1) to Quarter (+2) the AA is negative, suggestingthat the accruals are reversed after the meeting. These results also highlight that thegreatest amount of earnings management occurs in the quarter immediately beforethe annual meeting, consistent with the significance of the AGM.

Comparing the pre- and post-SOX eras, we find that abnormal accruals aregenerally lower in the post-SOX period. However, the basic pattern is consistentacross time; abnormal accruals increase prior the meeting followed by significantreversals in the post-meeting quarters.

In Figure 2, we examine in event time the evolution of discretionary earnings.Specifically, we plot both levels of AA (the bottom line), changes in AA (the bar chart)


Figure 2

Abnormal accruals and actual minus forecast earnings

This figure plots the level of mean abnormal accruals (bottom line), the change in abnormal accruals(bar chart) and the frequency that reported earnings surpass forecasted consensus earnings (top line) fortwo quarters prior to the meeting (–2), the quarter immediately preceding the meeting (–1), one quarterimmediately after the meeting (+1), and two quarters immediately after the meeting (+2). Actual MinusForecast indicates the frequency that firm exceeds the market consensus.

as well as the frequency that firms’ reported earnings surpass forecasted consensusearnings (the top line).8 The level of AA increases before the annual meeting anddecreases significantly after the meeting. Similarly, the change in abnormal accrualsis positive prior to the AGM, but negative following the meeting. Examining thedifference between actual and forecasted (consensus) earnings (the top line), weobserve similar findings. The vast majority of firms beat the forecast in the quartersimmediately surrounding the AGM. The percentage declines significantly by Quarter(+2). This result supports the notion that managers believe AGMs are important,since they manage earnings more prior to the AGM.

4.3. Managerial entrenchment and earnings management

Table 5 shows the change in AA by entrenchment from Quarter (−2) to Quarter(−1). Over the full sample period, the change in mean AA is 0.0056 for the highentrenchment group compared to 0.0028 for the low entrenchment group. The differ-ence is significant at the 1% level suggesting that entrenched managers show a greater

8 The consensus earnings data are from First Call.


Table 5

Abnormal accruals, entrenchment, and SOX

This table shows the relation between changes in abnormal accruals (AA) and entrenchment over the fullsample period and the pre-and post-SOX periods from quarter (−2) to quarter (−1).

Change in mean AA from quarter (−2) to (−1)

Full sample period Pre-SOX Post-SOX Pre-SOX minus Post-SOX

High entrenchment 0.00555 0.00757 0.00398 0.00360***

Low entrenchment 0.00277 0.00349 0.00192 0.00157Difference 0.00278*** 0.00409*** 0.00206**


tendency to manage earnings, consistent with H2A. Given our earlier findings of pos-itive abnormal returns coupled with greater job security, entrenched managers couldfeel very little down side risk of managing earnings. Prior literature also suggests acompensation motive. Healy (1985) shows managers often manipulate earnings to“game” their bonus schemes. In addition, we find that abnormal accruals are lower inthe post-SOX period, but entrenched managers are still associated with significantlyhigher levels of earnings management.

Table 6 reports results using Fama-MacBeth regressions on the determinants ofthe change in abnormal accruals. Models 1, 2, and 3 cover the full sample period,whereas Model 4 includes pre-SOX observations, and Model 5 includes only thepost-SOX observations. As shown in Models 1 and 2, the change in abnormal accru-als is positively related to entrenchment, suggesting that highly entrenched managersengage in earnings manipulation prior to the annual meeting. These managers arepresumably more isolated from monitoring and thus appear to be more likely toengage in earnings management. Our findings provide further support for H2A in amultivariate setting. In Model 3, we focus on the six individual components of theEindex separately. Contrary to Zhao and Chen (2008a,b), we find that the presence ofa staggered board is positively related to abnormal accruals. A possible explanationfor the difference in results is that they use annual data whereas we focus on quarterlydata. Since earnings management around the annual meeting occurs in the quartersimmediately preceding the meeting, quarterly data allow us to measure the relationmore accurately. Poison pill provisions are also positively related to accruals con-sistent with the broader results of the entrenchment measure. The provisions relatedto bylaws, supermajority rules, charter amendments, and golden parachutes are allinsignificant. The results for the pre-SOX and post-SOX periods focus on the broadentrenchment measure and mirror the results for the full sample period. Entrench-ment is positively related to the change in AA, consistent with entrenched managersengaging in more earnings manipulation. When we include shareholder proposals inthe model (Models 1 and 3), our key findings continue to hold, but the proposals haveno significant explanatory power.


Table 6

Changes in abnormal accruals and entrenchment

This table shows the relation between entrenchment and the change in abnormal accruals from quarter(–1) to quarter (–2) over the full sample period, pre-SOX, and post-SOX periods. Staggered board placesthe directors into different classes who serve overlapping terms. Limit ability to amend bylaws limitsshareholders’ ability to amend the corporate bylaws. Supermajority is a charter provision that establishvoting requirements for mergers that are higher than the threshold requirements of state law. Limit abilityto amend charter limits shareholders’ ability to amend the corporate charter. Poison pill provides holderswith special rights in the case of a triggering event like a hostile takeover bid. Golden parachute is aseverance agreement that provide compensation to senior executives on an event such as termination,demotion, or resignation following a change in control. These provisions are dummy variables equal to 1if the firm has that antitakeover provision. Other variables are as previously defined.

Full sample Full sample Full sample Pre-SOX Post-SOXName Model 1 Model 2 Model 3 Model 4 Model 5

Intercept −0.029 −0.023 −0.000 −0.015 −0.029(−1.39) (−1.24) (−0.01) (−0.41) (−1.68)

Entrenchment 0.014** 0.011*** -– 0.008** 0.014***

(2.44) (3.53) (2.26) (2.88)Staggered board — — 0.015** — —

(2.41)Limit ability to amend bylaws — — −0.017 — —

(−1.30)Supermajority — — −0.011 — —

(−1.31)Limit ability to amend charter — — −0.004 — —

(−0.91)Poison pill — — 0.014** — —

(2.11)Golden parachute — — −0.004 — —

(−0.98)Board size −0.001 −0.001 0.000 −0.001 −0.001

(−0.79) (−1.16) (0.07) (−0.46) (−1.47)Percentage of outside directors 0.005 −0.002 −0.012 −0.025** −0.016**

(0.48) (−0.26) (−0.47) (−2.75) (−2.24)Institutional ownership 0.067 0.052 0.182 0.142 −0.019

(1.06) (0.83) (1.50) (1.35) (−0.31)Executive shares −0.003 −0.013 −0.068 −0.121 0.071

(−0.07) (−0.25) (−1.10) (−1.37) (1.53)Executive options −0.000 −0.000 −0.001 −0.001 0.000

(−0.05) (−0.24) (−0.18) (−0.33) (0.08)Firm size 0.004** 0.005** 0.002 0.006 0.004*

(2.42) (2.22) (0.96) (1.50) (2.01)Book-to-market −0.010 −0.008 −0.008 −0.011 −0.006

(−1.61) (−1.32) (−0.72) (−1.04) (−0.83)Audit independence 0.003 0.004 −0.022* 0.012 0.003

(0.30) (0.49) (−1.71) (0.76) (0.42)Leverage −0.018 −0.020 0.003 −0.005 −0.032*

(−1.19) (−1.38) (0.13) (−0.19) (−2.04)

(Continued)


Table 6 (continued)

Changes in abnormal accruals and entrenchment

Full sample Full sample Full sample Pre-SOX Post-SOXName Model 1 Model 2 Model 3 Model 4 Model 5

ROA −0.124*** −0.159*** −0.061 −0.118*** −0.191**

(−2.47) (−3.05) (−0.72) (−3.76) (−2.18)Proposals 0.002 — −0.000 — —

(0.44) (−0.02)Adjusted R-square 0.044 0.037 0.023 0.031 0.042

Number of observations 3,414 3,414 3,414 3,414 3,414


In Table 7, we explore abnormal accruals in the two key quarters precedingthe meeting (Quarter (−2) and (−1)) in more detail. Specifically, Table 7 shows theresults when the level of abnormal accruals is used as the dependent variable overthe full sample period, the pre-SOX period, and the post-SOX period. The intent isto determine which quarter’s accrual is driving the relation between entrenchmentand AA. In Quarter (−2), the coefficient on entrenchment is negative and statisticallysignificant in all three sample periods (Models 1, 3, and 5). The result implies thatentrenched managers manage earnings downward two quarters prior to the meeting.However, in Quarter (−1), the coefficient estimate on entrenchment is positive andstatistically significant in the full sample period, consistent with earnings beingmanaged upward by entrenched managers in the quarter immediately precedingthe meeting. These results highlight the need to examine quarters individually asannual data could mask underlying differences. Although the results for Quarter(−1) are insignificant in the pre- and post-SOX subperiods, the pattern is still broadlyconsistent with the propensity for entrenched managers to manage earnings upward inQuarter (−1) relative to Quarter (−2). Combined, these findings imply that managersmanipulate earnings downward then upward prior to the AGM. The result providesadditional strength to our argument that managers view the AGMs as important.

5. Robustness

We verify the robustness of our results in numerous ways. In addition to the Gong,Louis, and Sun (2008) approach, we follow Louis (2004) to estimate the followingdiscretionary current accrual model for each industry based on the two-digit SICcode:

CAi =4∑

j=1

αjQj +2009∑

t=1997

βtYt+λ1(� SALESi − � ARi) + εi, (2)


Table 7

Abnormal accrual levels and entrenchment by quarter

This table shows the relation between entrenchment and abnormal accruals (AA) in Quarter (–2) andQuarter (–1) over the full sample period and the pre- and post- SOX periods. All variables are as previouslydefined.

Full sample Pre-SOX Post-SOX

AA AA AA AA AA AAQuarter Quarter Quarter Quarter Quarter Quarter

(−2) (−1) (−2) (−1) (−2) (−1)Name Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Intercept 0.015 0.002 0.017 0.026** 0.013 −0.017(1.67) (0.19) (1.10) (2.28) (1.23) (−1.26)

Entrenchment −0.007*** 0.005** −0.004* 0.004 −0.009*** 0.006(−4.01) (2.27) (−1.98) (1.65) (−3.93) (1.66)

Board size −0.000 −0.001*** −0.000 −0.002** −0.000 −0.001**

(−0.11) (−3.91) (−0.08) (−2.88) (−0.09) (−2.82)Percentage of 0.001 0.006 −0.001 −0.010 0.003 0.018**

outside directors (0.37) (0.84) (−0.10) (−1.50) (0.69) (2.44)Institutional ownership −0.028 −0.018 −0.112** −0.055 −0.038 0.011

(−0.65) (−0.65) (−2.33) (−1.21) (−0.74) (0.34)Executive shares 0.010 −0.004 0.091 −0.035 −0.054 0.020

(0.27) (−0.19) (1.60) (−1.03) (−1.63) (0.93)Executive options −0.001 −0.001 −0.001 −0.001 −0.000 0.000

(−0.56) (−0.68) (−0.56) (−1.70) (−0.09) (0.15)Firm size −0.002 −0.002** −0.002 0.002** −0.001 0.002

(−1.66) (2.05) (−1.03) (2.21) (−1.71) (1.37)Book-to-market 0.009 0.004 0.004 0.001 0.013** 0.007**

(1.64) (0.79) (0.43) (0.05) (2.33) (2.77)Audit independence −0.001 −0.002 0.010 0.010 −0.011** −0.011*

(−0.30) (−0.30) (1.45) (1.31) (−2.38) (−1.81)Leverage 0.009 −0.011 −0.008 −0.014 0.022** −0.009

(0.88) (−1.05) (−0.49) (−0.62) (2.41) (−1.15)ROA 0.114** −0.082** 0.083** −0.117* 0.139* −0.055

(2.84) (−2.12) (2.80) (−1.79) (2.06) (−1.22)Adjusted R-square 0.010 0.027 −0.001 −0.044 0.018 −0.016Number of 3,414 3,470 1,270 1,296 2,144 2,174

observations


where CA is the current accruals of firm i, Q is a binary variable taking the value of 1in fiscal quarter j, Y is a binary variable taking the value of 1 in fiscal year t, �SALESis the quarterly change in sales, �AR is the quarterly change in accounts receivables.Current Accruals (CA) are defined as the change in noncash current assets minus thechange in current liabilities plus the change in debt in current liabilities. All variablesare scaled by the assets at the beginning of the quarter. Abnormal current accrualsare the difference between CA and the value predicted by the model. We estimate


Equation (2) for firms with the same two-digit SIC code. The results are qualitativelysimilar to those reported using the Gong, Louis, and Sun (2008) method.

Next, we verify our regression analyses by using numerous alternative specifi-cations. When we use pooled-data regressions and include a SOX dummy variable,the results are robust. Additionally, since our measure of abnormal accruals is perfor-mance adjusted, the need for ROA in the models is reduced. All results are robust toexcluding ROA. Our analyses use the maximum ownership position of institutionalownership as a control variable. Findings are qualitatively similar using aggregateinstitutional ownership levels.

To verify whether the patterns of accruals we find are indeed attributable to theAGM, we run some simple falsification tests. Specifically, we repeat our analyses onaccruals for non-AGM quarters. We find that entrenchment is generally unrelated toabnormal accruals in nonmeeting quarters (except as shown in Table 7). The resultstrengthens our findings on the importance of the AGM.

We also explore the response of sophisticated investors to earnings managementaround the AGM. Specifically, we regress the change in institutional shareholdingson abnormal accruals. We find no significant relation, consistent with notion thatsophisticated investors are not fooled by earnings management.

For our analyses of announcement returns, we follow Dimitrov and Jain (2011)and report results using a longer event window. However, we also use a traditionalevent window of (−1, +1). This window allows us to capture any “surprise” informa-tion conveyed at the meeting such as unexpected shareholder proposal passage or fail-ure, director elections, or other announcements. Again, we find positive, significantannouncement effects. Thus, the passage or failure of shareholder proposals and otherrevelations at the AGM convey information to the market even on the announcementdate. Finally, we follow Dimitrov and Jain’s (2011) approach of calculating CARs assimply size adjusted returns. Our market adjusted CARs are highly correlated withtheir measure and results are qualitatively similar under both approaches.

6. Conclusions

We examine whether the annual meeting influences managerial actions. We showthat the stock market reacts positively to AGMs and find that shareholder proposalsare an important source of information driving the abnormal returns surrounding theAGM. Both firms with passing and failing proposals gain in the pre-meeting period.If the proposals subsequently fail, the gains are largely reversed in the post-meetingperiod. We also show that the pattern of abnormal returns varies based on the level ofentrenchment and earnings management. Returns are higher for firms with entrenchedmanagers and firms who have higher levels of abnormal accruals. AGMs could beparticularly important for shareholders of firms with entrenched managers who areoften difficult to discipline.

We also show that entrenched managers engage in significantly more earningsmanagement. While earnings management has declined following the passage of


SOX, we still find evidence that entrenched managers continue to manipulate earn-ings. Our results are consistent with Dechow, Sloan and Sweeney (1996), who findearnings manipulation is related to weaker external and internal monitoring. Weshow that entrenched managers manage earnings downward two quarters prior to themeeting and manage earnings upward in the quarter prior to the meeting.

While our study is not aimed at resolving the debate about whether annualmeetings are necessary or effective, we do provide evidence that AGMs are viewedas important events by both shareholders and managers. AGMs trigger managers tochange their behavior by manipulating earnings. Although meetings are perceived asimportant events, they come at a cost to shareholders in the form of lower qualityearnings reports.

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Earnings Management and Annual General Meetings: The Role of Managerial Entrenchment

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