Sunday, March 12, 2006
Employees often lose their jobs when their company hits an industry downturn. Turns out, so do CEOs. Traditional wisdom is that corporate boards don't hold a CEO responsible for things beyond his or her control, like market downturns. But a new study from the National Bureau of Economic Research suggests that while this may have been true in the 1970s and 1980s, it's no longer the case today.
The paper is CEO Turnover and Relative Performance Evaluation, by Dirk Jenter and Fadi Kanaan (MIT-Business). Here's the abstract:
This paper examines whether 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 to firm performance when deciding on CEO retention.
Using a new hand-collected sample of 1,590 CEO turnovers from 1993 to 2001, we document that CEOs are significantly more likely to be dismissed from their jobs after bad industry and bad market performance. A decline in the industry component of firm performance from its 75th to its 25th percentile increases the probability of a forced CEO turnover by approximately 50 percent. This finding is robust to controls for firm-specific performance. The result is at odds with the prior empirical literature which showed that corporate boards filter exogenous shocks from CEO dismissal decisions in samples from the 1970s and 1980s. Our findings suggest that the standard CEO turnover model is too simple to capture the empirical relation between performance and forced CEO turnovers, and we evaluate several extensions to the standard model.