CEO Turnover and Relative Performance Evaluation

Abstract

This paper shows that CEOs are fired after bad firm performance caused by factors beyond their control. Standard economic theory predicts that corporate boards filter out exogenous industry and market shocks from firm performance before deciding on CEO retention. Using a hand-collected sample of 3,365 CEO turnovers from 1993 to 2009, we document that CEOs are significantly more likely to be dismissed from their jobs after bad industry and, to a lesser extent, after bad market performance. A decline in industry performance from the 90 th to the 10 th percentile doubles the probability of a forced CEO turnover. Whether to retain or fire a CEO after bad stock price or accounting performance is one of the most important decisions made by corporate boards. Standard economic theory suggests that, when assessing the quality of its CEO, the board of directors should ignore components of firm performance that are caused by factors beyond the CEO's control. Previous studies of the relation between (arguably exogenous) market or industry performance and CEO turnover find evidence that is largely consistent with this hypothesis. However, using a larger data set that covers a more recent time period and a better methodology, we find that CEOs are significantly more likely to be fired after negative performance shocks to their peer group.Specifically, using a new data set of 2,490 voluntary and 875 forced CEO turnovers in 3,042firms from 1993 to 2009, we document that low industry stock returns and (to a lesser extent) low market returns increase the frequency of forced CEO turnovers. A decrease in the industry component of firm performance from its 90 th to its 10 th percentile doubles the probability of a forced CEO turnover. There is some evidence that boards partially filter industry and especially market performance from their assessments of CEO quality, but the filtering is much too weak to remove all of the peer performance effect. We conclude that boards allow exogenous shocks to firm performance to affect their CEO retention decisions.Standard agency theory shows that there are benefits to evaluating agents on the basis of their relative performance when agents are affected by common shocks (Holmström (1979(Holmström ( , 1982, Diamond and Verrecchia (1982)). In most of the theoretical literature on CEO dismissals, a corporate board learns the quality of its CEO from firm performance and other signals. If the board's assessment of CEO quality falls below some threshold, often the expected quality of a replacement, then the board dismisses the CEO. 1 Since CEO and CEO-firm match quality are not functions of the business cycle in these models, it follows that efficient boards do not force out

Which Skills Matter in the Market for CEOs? Evidence from Pay for CEO Credentials

“…Outgoing CEOs tend to rank lower than successor CEOs in terms of their credentials. Panel B.3 shows that average stock returns in the 12 months before a forced CEO turnover are approximately −28%, consistent with Kaplan and Minton (2012) and Jenter and Kanaan (2006). 30 We complement this baseline analysis with estimates of Equation (1) for the entire ExecuComp sample, which includes years subsequent to CEO appointments.…”

“…In robustness tests, we 18 ExecuComp roughly covers S&P 1500 firms. Parrino (1997) and Huson et al (2001Huson et al ( , 2004 use Forbes surveys; Jenter and Kanaan (2006) also use ExecuComp but only study departing CEOs for the 1993-2001 period. 19 We classify each CEO turnover according to whether it was forced or voluntary, and whether the incoming CEO is an insider or an outsider to the firm.…”

CEO ability and firm performance: Stock market and job market reactions

“…& ROE is EBITDA over total equity at the start of the year, & P/B is book value of assets plus market value of common stock less the book value of common equity divided by the book value of assets. Jenter and Kanaan (2015) show that CEOs are fired after bad firm performance caused by factors beyond their control, for example, a decline in the industry performance. For this reason, we adjust all performance measures by subtracting the industry medians from the firm performance measures.…”

The white squire defense: Evidence from private investments in public equity

“…That is, a firm adopting an ESOP will lower its earnings. Dahya et al (2002), Gibson (2003), and Jenter and Kanaan (2015) indicate that firm performance is likely a dominant determinant of CEO turnover, a CEO at a poor-performance firm is less likely to defense him-or herself by conducting ESOP. In contrast, PIPE is a source of financing that does not reduce earnings.…”