In our paper Why Do CEOs Survive Corporate Storms? Collusive Directors, Costly Replacement, and Legal Jeopardy, which was recently made publicly available on SSRN, we consider new explanations for the puzzling result that a majority of misreporting CEOs retain their jobs.  We extend the literature by investigating the role of directors’ both personal and reputational incentives in the CEO retention decision.  Overall, our analysis improves our understanding of the CEO retention decision by 30 to 40% relative to a benchmark model based on the severity of the misreporting, the firm’s performance and risk characteristics, and traditional measures of the strength of corporate governance.

We show that two types of personal benefits make conventionally independent directors less likely to remove CEOs: loss avoidance on equity-contingent wealth and increased compensation. First, we find that in firms where independent directors emulate CEOs’ trading behavior and also engage in abnormal insider selling over the misreporting period, CEOs are 13.6% more likely to be retained.  We view independent directors’ trading as suggestive of collusion because, like CEOs and other executive directors, they personally benefit by selling their equity at inflated prices during the period over which earnings are misreported.  To the extent that the misreporting sustains the firm’s overvaluation, the fact that directors engage in abnormal selling suggests they have access to negative information about the firm that they do not reveal to shareholders.  We posit that independent directors prefer not to attract attention to their own abnormal selling.  Thus, even though dismissing the CEO could enhance shareholder value by restoring credibility, directors whose trading actions align with those of CEOs have weaker incentives to replace the CEO.

…continue reading: Why Do CEOs Survive Corporate Storms?

In our paper, Contractual Versus Actual Severance Pay Following CEO Turnover, which was recently made publicly available on SSRN, we analyze the bargaining game between the CEO and the board of directors at the time of CEO departure. We find that about 40% of S&P500 CEOs who leave their firm receive separation payments that are in excess of what the firm is legally required to give them based on their existing contract. Furthermore, we find that the average discretionary separation pay is around $8 million – close to 242% of a CEO’s annual compensation. The analysis in the paper aims to uncover the reasons behind this discretionary pay and the source of CEO power exactly at the point in time when the CEO is least likely to have any ability to bargain.

Specifically, we investigate whether CEOs who receive discretionary pay are those who have control over the board of directors or whether discretionary pay represents a tool used by the board of directors in order to help and facilitate an amicable and efficient departure of the incumbent CEO. We hypothesize that in cases when the CEO departure is voluntary, discretionary separation pay represents a governance problem. By contrast, we hypothesize that when the CEO is forced to depart, discretionary separation pay is used to help the company move on from the failed ex CEO to a better one, specifically by reducing the likelihood of a prolonged battle with the departing CEO.

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In our paper, Corporate Governance of LBOs: The Role of Boards, which was recently made publicly available on SSRN, we study whether the success of private equity-backed firms is due to their superior corporate governance or instead due to financial engineering. We focus in particular on the role of boards in LBOs and look at changes in the board when a public company is taken private by a private equity group.

We construct a new data set, which follows the board composition and financial figures of all public to private transactions that took place in the UK between 1998 and 2003. Out of these 142 transactions, 88 have private equity sponsors and are thus identified as LBOs. The remaining transactions are either pure MBOs or other types, and are used as benchmarks. We track each company two or three years before the announcement of the buyout until the exit of private equity investors or until 2010, whichever is earlier.

We find that when a company goes private, fundamental shifts in board size and composition take place. The board size decreases on average by 15% and the presence of outside directors is drastically reduced, as they are replaced by individuals employed by the private equity sponsors. We also find evidence that the board size and presence of LBO sponsors on the board depend on the “style” or preferences of the private equity firm. Overall, the boards become more in line with the type of boards that the corporate governance literature would identify as exhibiting better corporate governance. We then set to find out what role these boards play.

…continue reading: Corporate Governance of LBOs

In our study, The 2011 CEO Succession Report, which The Conference Board recently released, we document 2009-2010 succession events regarding the chief executive officer of S&P 500 companies and analyze those events in the historical context of the last two decades.

The report is organized in four parts.

Part I: CEO Succession Trends illustrates year-by-year succession rates and examines specific aspects of the succession phenomenon, including the influence on firm performance on succession and the characteristics of the departing and incoming CEOs.

Part II: CEO Succession Practices details where boards assign responsibilities on leadership development, the role performed within the board by the retired CEO, and the extent of the disclosure to shareholders on these matters.

Part III: Notable Cases of CEO Succession (2009-2010) includes summaries of 10 episodes of CEO succession that made headlines in the past two years and that were carefully chosen to highlight key circumstances of the process.

Part IV: Shareholder Activism on CEO Succession Planning (2010-2011) reviews examples of companies that have recently faced shareholder pressure in this area.

…continue reading: The 2011 CEO Succession Report

Selecting a new CEO is among the most delicate decisions a board of directors will ever face. The selection process is exposed to so many unknowns: personality, integrity, technical skills, and experience. Such intangibles are very hard to assess, let alone compare among candidates. In this evaluation, the education of a candidate may be one of the few pieces of information that is certain: the quality and relevance of that education may be debatable, but the simple facts are known and verifiable. To provide guidance to corporate boards on the validity of that indicator, this report analyzes data on the education of 1,800 individuals who served as CEOs of Standard & Poor’s Composite 1500 companies to determine the effect of education on CEO turnover and firm performance.

What makes a CEO great? Recent history has produced many successful CEOs, with vastly different backgrounds and personalities: Warren Buffett, Jack Welch, and Steve Jobs, to name just a few. As outsiders, we characterize these CEOs as “successful” because of the results they produce. Their companies have created new products, penetrated new markets, and provided substantial returns to investors and other stakeholders. It is easy to define a CEO as a great leader after his or her company has become successful; what is much more difficult is identifying a great candidate for CEO before that success has materialized.

…continue reading: Does CEO Education Matter?

In the paper, Managers Who Lack Style: Evidence from Exogenous CEO Changes, which was recently made publicly available on SSRN, we study managerial style effects in firm decisions by examining exogenous CEO changes in a panel of 8,615 Compustat firms from 1990 to 2007. The hypothesis that managers have varying preferences or traits that affect their corporate decisions has a great deal of intuitive appeal and is implicit in many discussions of leadership. Prior empirical evidence lends support to this general hypothesis and suggests that managerial style effects play a substantive role in firms’ investment and financing choices. This raises the possibility that much of the unexplained variation in these and related choices is driven by the identities of a firm’s leaders rather than more traditional factors such as various economic tradeoffs.

While prior research on this issue has generated many interesting findings, a major weakness arises from the fact that endogenous leadership changes are used to identify style effects. In this paper we overcome this weakness by identifying a large set of exogenous CEO changes arising from deaths, health concerns, and, in some parts of the analysis, natural retirements. Quite surprisingly, we find no significant evidence of abnormal changes in asset growth, investment intensity, leverage, or profitability subsequent to exogenous CEO changes.

…continue reading: Managers Who Lack Style

In the paper, Monitoring Managers: Does It Matter? which was recently made publicly available on SSRN, we investigate how boards of directors monitor management, under what circumstances they fire CEOs, and whether these actions improve performance. Boards of directors are tasked with ensuring that firms are run by competent managers who act in their shareholders’ interest by providing appropriate incentives and through “active monitoring,” that is, collecting information about the firm’s operations or the manager’s ability and firing the manager if necessary. Much of the economic literature on corporate governance and boards studies the provision of incentives and pays less attention to monitoring. In this paper, we ask if boards with large shareholders indeed engage in active monitoring and whether such monitoring in turn improves performance.

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In the paper Does Takeover Activity Cause Managerial Discipline? Evidence from International M&A Laws, which was recently made publicly available on SSRN, we examine if the market for corporate control improves corporate governance. Theory suggests that the threat of takeover is one of the most important external mechanisms for aligning the interests of managers and shareholders. While a large empirical literature analyzes the effects of takeover activity on managerial discipline, it has not been entirely successful in establishing whether an active market for corporate control enhances managerial discipline and often finds mixed results. Partly, this is because many studies rely on sources of variation in the threat of takeover that can generate serious endogeneity and omitted variable biases. For example, tests that employ the mean level of takeover activity as a proxy for the threat of takeover suffer from potential omitted variable biases since overall takeover activity is likely to be accompanied by contemporaneous macroeconomic shocks that could jointly explain management turnover. Further, tests that employ takeover defenses as a proxy for takeover threats suffer from endogeneity concerns as they are often established at the discretion of the firm.

…continue reading: Does Takeover Activity Cause Managerial Discipline? Evidence from International M&A Laws

In the paper, CEO Education, CEO Turnover, and Firm Performance, which was recently made publicly available on SSRN, we analyze the effects of CEO education on CEO turnover (firing and replacement) and firm performance. Our primary interest is on the role that CEO education plays in a firm’s decision to replace its current CEO, the role that it plays in selecting a new CEO, and on whether CEO education significantly affects performance.

We use six main measures of CEO education: whether or not the CEO attended a Top-20 undergraduate school, whether or not the CEO has an MBA, law or masters‟ degree, and whether or not the MBA or law degree is from a Top-20 program. Our study includes more than 14,500 CEO-years and more than 2,600 cases of CEO turnover from 1993-2007.

…continue reading: CEO Education, CEO Turnover, and Firm Performance

In the paper New Dogs New Tricks: CEO Turnover, CEO-Related Factors, and Innovation Performance, which was recently made publicly available on SSRN, we examine the association between CEO turnover and innovation performance in the sample period 1993-2005. We find strong empirical support for the notion that CEO turnover is associated with higher levels of innovation, which we measure with patent counts and citations. After controlling for the endogeneity of CEO turnover, we present evidence consistent with CEO turnover increasing a firm’s patent counts, patent citations, patents per research and development dollar, and citations per patent in the subsequent three and five years. We also find that internal new CEOs create more innovation than external new CEOs. Moreover, we find that relatively overconfident CEOs, CEOs with higher option compensation, and an environment with relatively high information asymmetries are associated with more (and higher quality) innovation. Finally, we find that stock-option compensation and information asymmetries are negatively associated with subsequent innovation around the time of CEO turnover.

…continue reading: CEO Turnover, CEO-Related Factors, and Innovation Performance