Are CEOs Replaced For Poor Performance? Effects of Takeovers and Governance on CEO Turnover

AuthorSwarnodeep HomRoy
Publication Date01 May 2015
Swarnodeep HomRoy*
This article analyzes the risk of CEO turnover in US firms over the period
19932011. There is an increase in the CEO turnover rate and a 41% decline in
median tenure. Where firm performance is poor, CEOs are increasingly replaced,
either by the board or in the process of the firm being taken over. US corporate
governance regulations had some success in mitigating the agency problem. In
the wake of those reforms, CEO turnover outcomes are more strongly associated
with firm performance. The declining CEO tenure may have structural impacts
on CEO pay.
Poor performing CEOs are more readily replaced if the internal governance of
the firm is strong. Similarly, with an efficient market for corporate control,
poor performing firms are more likely to be taken over. The CEOs of such
firms may then face a higher risk of being dismissed (Jensen, 1988, Mikkelson
and Partch, 1997). The likelihood of being dismissed is a major constraint on
CEO behaviour, with loss manifest in managerial reputation, prolonged unem-
ployment and reduced future earnings (Fama, 1980; Fee and Hadlock, 2004).
This article analyzes the impact of internal governance and takeovers on
CEO turnover in S&P 1500 firms for the period 19932011. Specifically, we
compare the risk of CEO exit due to internal reasons (poor performance,
active shareholders, etc.) with that due to the firm being taken over. The sam-
ple period, 19932011, overlaps with the fifth (19922000) and the sixth
(20032008) merger waves and also with the last decade of intense regulatory
scrutiny on corporate governance.
This allows us to examine the impact of
the market for corporate control and of new corporate governance regulations
on the risk of dismissal faced by US CEOs.
*Lancaster University
A number of governance regulations like the Sarbanes Oxley Act (2002), NASDAQ and
NYSE reforms (2002) and FASB (123) became effective from 2002. By concurrence both of
their timing and objectives, we are unable to separate their impact.
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12068, Vol. 62, No. 2, May 2015
©2015 Scottish Economic Society.
The central findings of this article suggest that CEOs are increasingly being
replaced for poor performance, either by the board of directors or through
takeover. We attempt to control for the potential endogeneity associated with
poor performing firms being more readily acquired. Although qualitatively
similar to the findings of Mikkelson and Partch (1997), by controlling for
more governance parameters, we find a stronger impact of takeover on CEO
turnover. We also find that CEOs of target firms are at greater risk in the
event of an acquisition by an overseas firm. Our results also indicate that the
corporate governance and stock market reforms of 2002 had some effect in
mitigating the agency problem.
This article contributes to several strands of research. While similar studies
on CEO turnover exist for the United Kingdom (Gregory-Smith et al., 2009),
we present a comprehensive analysis of the dynamics of CEO turnover for the
US using a wider range of governance controls. We identify a secular rise in
CEO turnover in the last two decades. This is the first study to show evidence
that CEOs are at greater risk with foreign takeovers. Finally, our findings are
relevant to the debate on the impact of corporate governance regulations on
managerial discipline. Consistent with the findings of Murphy and Zabonjik
(2004) and Kaplan and Minton (2012), median CEO tenure has been signifi-
cantly lower, falling from 8.8 to 5.1 years in the period following the gover-
nance reforms. Thus, the period of rapidly rising CEO pay is also
characterized by an increased likelihood of CEO turnover.
The article is structured as follows: section II summarizes relevant literature
on CEO turnover, the impact of acquisitions on the probability of CEO exit
and the use of duration models for estimating hazards of CEO exit. Section
III discusses the data and presents descriptive statistics. In section IV, we dis-
cuss the specification of the duration model and associated robustness issues.
Section V presents the results of the empirical analysis, with section VI pre-
senting the conclusions.
CEO turnover and firm performance
Dismissal threat acts as a constraint on managerial actions. Using a sample of
443 large US firms from 1993 to 1998, Fee and Hadlock (2004) find that where
a dismissed CEO finds a new engagement, it is generally in a smaller firm and
with a 20% decrease in pay. The recent literature on CEO turnover is sparse.
A stylized result from this strand of research is that CEOs of poor performing
firms, on average, are more likely to be replaced. Conyon (1998) and Gregory-
Smith et al. (2009) find a significant association of CEO dismissal with firm
performance for UK CEOs. However, the influence of governance on CEO
turnover risk is reportedly weaker. In drawing upon the managerial power
hypothesis of CEO entrenchment, Brunello et al. (2003) argue that significant
ownership in the firm of the CEO weakens internal monitoring and makes it
costly for the acquiring firm to replace the incumbent.
Scottish Journal of Political Economy
©2015 Scottish Economic Society

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