The Pennsylvania State University
The Graduate School
The Mary Jean and Frank P. Smeal College of Business
THREE ESSAYS ON CEO REPLACEMENT IN TURNAROUND SITUATIONS
A Dissertation in
Business Administration
by
Guoli Chen
© 2008 Guoli Chen
Submitted in Partial Fulfillment of the Requirements for the Degree of
Doctor of Philosophy
August 2008
The dissertation of Guoli Chen was reviewed and approved* by the following:
Donald C. Hambrick Smeal Chaired Professor of Management Dissertation Advisor Chair of Committee
Timothy G. Pollock Professor of Management
Wenpin Tsai Associate Professor of Management
Michelle Lowry Associate Professor Finance
Dennis A. Gioia Professor of Organizational Behavior Head of the Department of Management and Organization
* Signatures are on file in the Graduate School
ii ABSTRACT
This dissertation consists of three essays on CEO replacement in turnaround situations.
The first essay aims to understand the antecedents of CEO dismissal in turnaround situations. I develop a model of CEO dismissal as a social framing contest, in which key plays try to convince and mobilize others to accept their respective claims about the wisdom of replacing or retaining the CEO. When mixed indicators of performance problems surface, the likelihood and speed of CEO dismissal becomes a function of how vigorously social arbiters personalize the poor performance by blaming the CEO, how actively the incumbents argue for their retention, and which side investors and directors try to bolster. The framing contest model substantially supplements the prevailing view that CEO dismissal is propelled by objective performance conditions and agency factors, and it will lead to much more accurate predictions of whether, and when, CEOs will be forced out.
The second essay focuses on the consequences of CEO replacement, by empirically investigating whether CEO replacement helps or hurts firms in turnaround situations. Drawing from the “fit-drift/shift-refit” idea introduced by Finkelstein and Hambrick (1996), I develop a concept of context-person fit, and address its critical role in understanding the performance consequences of CEO replacement. Specifically, the presence of predecessor’s misfit with contextual requirements will make a change of CEO particularly valuable for a troubled firm; and the successor’s fit with context tends to address the troubled firm’s needs and thus will substantially improve firm performance. With 140 CEO replacements in 223 turnaround situations for S&P 1500 index companies, I find that the stock market in general positively responds to the CEO replacement announcement in turnaround situations. However, CEO replacement per se does not have any effect on troubled firm’s subsequent performance. In
iii addition, I find considerable empirical support for the context-person fit arguments: the presence of the predecessor’s misfit and the successor’s fit with the context has positive performance implications.
The third essay represents a logical extension of the second essay by studying the initial compensation package of new CEOs hired in turnaround situations. Because of greater job demands, a more complex task, and a riskier position for successors, I argue that firms in
turnaround situations pay their new CEOs more than do comparable firms that are not in
turnaround situations, and they tend to use a higher percentage of stock-based pay. Such relations
are stronger for externally appointed CEOs. I further argue that a higher pay attracts talented
executives who are more capable, experienced, and well connected to acquire critical resources,
thus will improve post-succession performance. Results based on 94 new CEOs hired in
turnaround situations and 431 peers in non-turnaround situations provide empirical support.
iv TABLE OF CONTENTS
List of Figures ……………………………………………………………………………... viii
List of Tables………………………………………………………………………………. ix
Acknowledgements………………………………………………………………………… x
Chapter 1 – INTRODUCTION……………………………………………………………. 1
Chapter 2 – CEO DISMISSAL IN TURNAROUND SITUATIONS: A FRAMING CONTEST MODEL ………………………………………………………… 6
2.1. A Framing Contest Model …………………………………………………….. 11
2.1.1. Precipitating context: Performance problems in turnaround situations ... 11 2.1.2. Incumbent CEOs – Framing for retention ……………………………… 13 2.1.3. Social arbiters – Framing for dismissal ………………………………… 16 2.1.4. Institutional investors …………………………………………………… 19 2.1.5. Directors ………………………………………………………………… 21
2.2. A Case Example…………………………………………..…………………… 23
2.2.1. A longitudinal examination of social arbiters’ assessments of Barad ….. 24 2.2.2. Barad’s responses to each decline ……………………………………… 27 2.2.3. Institutional investors …………………………………………………... 28 2.2.4. Mattel’s Directors………………………………………………………. 29
2.3. Framing Contest for a Dismissal or Retention of CEO………………………. 29
2.3.1. Framing contest…………………………………………………………. 30 2.3.2. Effectiveness of social arbiter’s dismissal frame……………………….. 31 2.3.3. Competing and moderating forces……………………………………… 36
2.4. Conclusion……………………………………………………………………. 42
2.4.1. Research implications………………………………………………….. 43 2.4.2. Limitation and future research…………………………………………. 46
Chapter 3 – DOES CEO REPLACEMENT INCREASE THE LIKELIHOOD OF SUCCESSFUL TURNAROUND? THE IMPORTANCE OF CONTEXT- PERSON FIT ………………………………………………………………….. 48
3.1. Theoretical Background and Hypotheses………………………………………. 52
3.1.1. Main effect of CEO replacement in Turnaround Situations……………... 52
v 3.1.2. Importance of context-person fit…………………………………………. 56 3.1.2.1. Predecessor’s misfit……………………………………………… 58 3.1.2.2. Successor’s fit……………………………………………………. 63
3.2. Data and Methods……………………………………………………………… 66
3.2.1. Sample selection…………………………………………………………. 66 3.2.2. Dependent variables……………………………………………………… 67 3.2.3. Independent and context-person fit variables……………………………. 69 3.2.4. Control variables 72
3.3. Results…………………………………………………………………………..75
3.3.1. Main effect of CEO replacement in turnaround situations………………. 75 3.3.2. Predecessor’s misfit……………………………………………………… 76 3.3.3. Successor’s fit……………………………………………………………. 78
3.4. Discussion……………………………………………………………………….80
3.4.1. Theoretical implications………………………………………………….. 84 3.4.2. Limitations, supplementary analyses and future research………………... 86
Chapter 4 – DO YOU GET WHAT YOU PAY FOR? COMPENSATION OF NEW CEOS HIRED IN TURNAROUND SITUATIONS…………………………... 89
4.1. Theory and Hypotheses………………………………………………………… 91
4.1.1. Initial compensation of new CEOs in turnaround situations…………….. 91 4.1.2. Implications of new CEOs’ compensation in turnaround situations…….. 95
4.2. Initial Compensation of New CEOs in Turnaround Situations: Methods and Results…………………………………………………………………………. 98
4.2.1. Data and sample…………………………………………………………. 98 4.2.2. Dependent variables……………………………………………………… 99 4.2.3. Independent variables……………………………………………………. 100 4.2.4. Control variables………………………………………………………… 100 4.2.5. Estimation methods……………………………………………………… 102 4.2.6. Results…………………………………………………………………….103
4.3. Implications of New CEOs’ Compensation in Turnaround Situations: Methods and Results…………………………………………………………………….. 104
4.3.1. Data and sample………………………………………………………….. 104 4.3.2. Dependent variables……………………………………………………… 104 4.3.3. Independent and mediating variables……………………………………. 105
vi 4.3.4. Control variables………………………………………………………… 105 4.3.5. Estimation methods………………………………………………………. 106 4.3.6. Results…………………………………………………………………….106
4.4. Discussion………………………………………………………………………108
4.4.1. Initial compensation of new CEOs in turnaround situations…………….. 108 4.4.2. Implications of new CEOs’ compensation in turnaround situations…….. 111 4.4.3. Case examples…………………………………………………………… 114 4.4.4. Limitation and future research…………………………………………… 116
Chapter 5 – CONCLUSION……………………………………………………………….. 119
5.1. Research Implications………………………………………………………….. 121 5.2. Limitations and Future Research Direction……………………………………. 122
References………………………………………………………………………………….. 124
Appendix A – Figures………………………………………………………………………. 141
Appendix B – Tables……………………………………………………………………….. 148
vii LIST OF FIGURES
Figure 1: A Social Framing Model of CEO Dismissal …………………………………….. 141
Figure 2: Dismissal of Jill Barad, CEO of Mattel …………………………………………. 142
Figure 2a: A longitudinal Examination of Social Arbiter’s Assessments on Barad in Mattel (from Jan 1997 to Feb 2000) …………………………………… 142 Figure 2b: CEO’s Responses, Board of Directors and Institutional Investors’ Disposition (from Jan 1997 to Feb 2000) ………………………………… 143
Figure 3: The Effect of New CEO’s Context-Person Fit on Subsequent Performance …… 144
Figure 4: Two-by-two Matrix of Context-person Fit Considerations ……………………... 145
Figure 5: Initial Compensation of New CEOs in Turnaround Situations …………………. 146
Figure 5a: Antecedents of New CEOs’ Initial Compensation …………………… 146 Figure 5b: Consequences of New CEOs’ Initial Compensation…………………. 146
Figure 6: Case Illustration of new CEOs’ Initial Compensation and Post-succession Performance …………………………………………………………………….. 147
viii LIST OF TABLES
Table 1: Descriptive Analysis and Correlations………………………………………….. 148
Table 2: Initial Market Reaction to the Announcement of CEO Replacement in Turnaround Situations …………………………………………………………… 150
Table 3: Predicting the Effect of CEO Replacement on Subsequent Performance ……….. 151
Table 4: Predicting the Effect of Predecessor’s Misfit on Initial Market Reaction and Subsequent Performance ………………………………………………………… 152
Table 5: Predicting the Effect of Successor’s Fit on Initial Market Reaction and Subsequent Performance ………………………………………………………… 154
Table 6: The Moderation Effects of Predecessor’s Misfit on the Relationship between Successor’s Fit and the Likelihood of Successful Turnaround ………………….. 156
Table 7: Descriptive Analysis and Correlations……………………………………………. 157
Table 8: Predicting New CEOs’ Initial Compensation…………………………………….. 158
Table 9: Descriptive Analysis and Correlations……………………………………………. 159
Table 10: Predicting Performance Consequences of New CEOs’ Initial Compensation in Turnaround Situations …………………………………………………………… 160
ix ACKNOWLEDGEMENTS
I owe my sincere gratitude to many people who help and support me in my five years’
study toward a terminal degree. First, I would like to thank my advisor, Don Hambrick. Don, I am so lucky to have you as my mentor. I sincerely appreciate your intellectual guidance, your
patience, your encouragement and kindness. I benefited tremendously from each meeting we
had, each project we worked, and each class you taught. Your behavior and attitude influence
me substantially, and help me to become a better scholar, an enthusiastic teacher, and perhaps a
better person. It is an honor to be your student! I am also grateful to my other committee
members, Tim Pollock, Wenpin Tsai, and Michelle Lowry. Thanks for teaching me conduct
quality research, and providing your comments and suggestions on each draft of my dissertation.
My thanks also go to the outstanding faculties and staff in the department of Management
and Organization. Thanks for Toni Auman, Nicole Bodnar, Forrest Briscoe, Kelly Delaney-
Klinger, Jim Detert, Debbie Ettington, Raghu Garud, Denny Gioia, Barbara Gray, Dave Harrison,
Shirley Kovach, Chuck Snow and Linda Trevino. Special thanks go to Holly Packard who
provides fabulous administrative help.
I am fortunate to have a great cohort. Thanks go to Craig Crossland, Bred Fund, Kristine
Price, and Hong Ren for reminding me that I am not lonely in this tough yet intellectually
rewarding journey. Thanks also go to other students in our department. Particular thanks go to
my friends Dai Li and Tianxia Yang for their help in data collection.
I am indebted to my parents, my parents-in-law, my brother, and my sister, for their
unhesitant support and understanding of my pursuits over the years. Special thanks go to my
wife, Shuqing, and our daughter, Jiahui, for having accompanied me through this process. It is
to them that this dissertation is dedicated.
x Finally, financial support from the Smeal College of Business, in the forms of graduate assistantship and Smeal Dissertation Grant, is gratefully acknowledged.
xi Chapter 1
INTRODUCTION
The recent sub-prime mortgage crisis and its impact on banks, mortgage lenders, real estate investment trusts, construction companies, and may other sectors have raised concern about an economic recession in the United States, and have attracted people’s attention on troubled firms (Howarth, 2008). A retrospective look at the development of Corporate America reveals that no firm is immune from a performance decline or troubled situation. A number of legendary companies have experienced turnaround situations (e.g., IBM, Mattel, etc.) or eventually been wiped out by the market, being merged, acquired or liquidated (e.g., Enron,
Sears, etc.). Historically, although manufacturing industries, such as textile, steel, and automobiles, were among the first to face widespread turnaround situations, the problem has been becoming increasingly common in service industries (Pearce & Robbins, 1993). With today’s fast pace of technological advancement, quick changes in customer preferences, and global market competition, established companies are facing greater challenges than ever before, and are thus facing higher risks of falling into troubled situations. However, despite an increasing number of business downturns, academic studies since the late 1990s have paid less attention to
firms in turnaround situations. Part of the reason is that scholars have been drawn to think almost exclusively about corporate strategies for successful firms or companies in entrepreneurial settings. However, such a limited view is detrimental to knowledge building in the field of management (Bibeault, 1982). Therefore, to address an important but under-researched business phenomenon, my dissertation focuses on firms in turnaround situations as my overall research context, and specifically examines the leadership change in these troubled firms.
1 Why should I focus on corporate leaders? The critical role of managers in turnaround situations was implicitly and explicitly stated in the pioneering work of a group of researchers led by Schendel and Hofer (e.g., Hofer & Schendel, 1978; Schendel, Patton, & Riggs, 1976).
They argue that the core problems for firms in turnaround situations are either operational (not efficient) or strategic (weak strategic position relative to competitors). Further, they indicate that many unsuccessful turnaround attempts are due to a mismatch between the turnaround strategies
and core problems, when managers fail to diagnose the causes of their firm’s performance decline and respond inappropriately. Hofer (1980) asserted that a change in corporate leadership
is needed if a turnaround is to be successful. Bibeault (1982) made essentially the same point in his studies of 82 turnaround situations.
However, the considerable development in turnaround research (e.g., Barker & Duhaime,
1997; Barker & Mone, 1994; Robbins & Pearce, 1992), as well as a surge in upper-echelon studies after Hambrick and Mason (1984) published their seminal work (e.g., Finkelstein & Boyd,
1998; Geletkanycz & Hambrick, 1997; Wiersema & Bantel, 1992; please see Carpenter,
Geletkanycz, & Sanders, 2004, for a review), did not see an interaction between these two research streams. In other words, researchers have not duly emphasized top executives in turnaround situations (Finkelstein & Hambrick, 1996).
While many topics on corporate leaders, such as CEO succession and executive compensation, have been appealing and fascinating throughout the years, studying these topics specifically in the context of a turnaround situation is particularly intriguing. This is because (1) the attribution biases, such as the “romance of leadership” (Meindl, Ehrlich, & Dukerich, 1985;
Ross, 1977), would ascribe the extremely poor performance to incumbent CEOs, who are pushed to the frontline to hold the responsibility when firms fall into troubled situations; (2) corporate
2 governance is more likely to hit the headline when firms have performance troubles. The board is under pressure to be more vigilant in evaluating and paying the managers (e.g., Gilson &
Vetsuypens, 1993); and (3) turnaround situations typically are accompanied by mean-end ambiguities in which CEOs have greater influence on organizations due to a greater managerial discretion (e.g., Hambrick & Finkelstein, 1987).
My dissertation examines topics related to executive leadership in turnaround situations.
The following three questions have guided the development of the three essays in the dissertation:
1) Given signs of poor performance in turnaround situations, why are some CEOs more
likely to be forced out?
2) Does a change of CEO help or hurt firms in turnaround situations? Is there a
normative pattern of executive replacement we can suggest to troubled firms?
3) How does a troubled firm pay its new CEO? Does a greater amount of CEO pay
make a difference in the subsequent firm performance?
By addressing these related research questions, my dissertation examines the antecedents, consequences of CEO replacement in turnaround situations, and initial compensation package of
CEOs hired in troubled situations and its implications for firm performance. Considered together, this dissertation depicts a coherent picture of CEO replacement in turnaround situations. It first contributes to the literature of corporate turnaround by bringing the essences of top executives back to the central stage, and suggests how to combat the downward spirals of troubled firms
(Hambrick & D’Aveni, 1988; 1992). It also offers several contributions to the CEO succession and compensation literature. The social frame contest model developed in the first essay advances an understanding of the process leading to the dismissal of CEOs. By situating CEO dismissal in a social context in which the competing parties vigorously espouse their respective
3 “frames,” my model acknowledges the institutional richness of current-day CEO dismissal processes and enhances the ability to predict executive removal. The context-person fit concept developed in the second essay highlights the interaction, or fit, between contextual requirements and personal characteristics in understanding the performance implications of CEO replacement.
The boundary condition proposed in this essay helps clarify when or why a change of leader is helpful, and represents an attempt so solve the inconsistent findings in prior research. The third essay theorizes CEO compensation as an important factor that may influence post-succession performance. It also provides an argument of “contextual” determinants of CEO’s pay, and a rational explanation as to why prior research did not find a strong relationship between firm profitability and CEO compensation.
My dissertation proceeds as follows. Chapter 2 presents my first essay, in which I present a theoretical model to explain whether, and when, a CEO in a turnaround situation will be dismissed. I define firms in turnaround situations as established companies that once performed at a level of general satisfaction to all their major constituents, but no longer do so. I explain why different parties have strong biases about whether the incumbent should or should not be dismissed, and why turnaround situations represent typical cases where different parties can frame the ambiguous conditions in different ways to convince others to accept their respective dispositions. I theorize such a process as a social framing contest model, and use an in-depth portrayal of the dismissal of Ms. Jill Barad, the CEO of Mattel, to illustrate the key elements in the model. I develop a set of propositions on the framing contest engaged by social arbiters (e.g., journalists, financial analysts, and governance watchdog groups) and CEOs in their attempts to mobilize the investors and directors to accept their respective claims about the wisdom of replacing or retaining the CEO.
4 In Chapter 3 (my second essay), I shift my research focus from the antecedents to the consequences of CEO succession. I present the theory, hypotheses, methodology and results of
my empirical study of the performance implications of CEO replacement in turnaround situations.
I first discuss the potential benefits, as well as the costs, of CEO change in turnaround situations.
Then I draw on the idea of “fit-drift/shift-refit” introduced by Finkelstein and Hambrick (1996)
and develop a “context-person fit” argument in exploring the boundary conditions in which the
replacement of an incumbent is beneficial. I suggest that the context-person fit (misfit) occurs
when corporate leaders’ competences and skills align (or misalign) with the contextual
requirements. The presence of a predecessor’s misfit with the contextual requirements will make
a change of CEO particularly helpful to a troubled firm; meanwhile, a new CEO’s fit with the
contextual requirements is more likely to directly address the troubled firm’s problems, and thus
be well-received by the stock market, and bring subsequent performance improvements.
Chapter 4 contains my third essay. This empirical study is a logical extension of my second essay, with a focus on initial compensation of CEOs hired in turnaround situations.
Because CEO replacement will eventually require a successor, how the troubled firms pay their
new CEO and the performance consequences are naturally generated questions. I present how
two competing forces in turnaround situations – greater executive job demands and career risk on
the one hand, but limited organizational resources and a need to demonstrate parsimony on the
other – jointly influence the new CEO’s pay, and examine whether troubled firms improve in
proportion to what they pay their new CEOs.
In Chapter 5, the final chapter, I discuss the implications of this dissertation, identify
several limitations, and suggest a number of future research opportunities.
5 Chapter 2
CEO DISMISSAL IN TURNAROUND SITUATIONS:
A FRAMING CONTEST MODEL
CEO succession represents a major event for an organization, indicating a change of regime and, very often, a change in organizational direction. Accordingly, CEO succession has long been a prominent research topic in organizational studies (e.g., Gamson & Scotch, 1964;
Gouldner, 1954; Guest, 1962; Hermalin & Weisbach, 1998; Shen & Cannella, 2003; Vancil,
1987; Zajac, 1990; Zhang & Rajagopalan, 2004). Among all types of successions, cases of CEO dismissal in particular have great theoretical and practical significance. Compared, for instance, to succession due to mandatory retirement or death, CEO dismissal involves a political contest with clear winners and losers, and it typically signifies a desire for a major organization change – with attendant benefits and perils (Finkelstein & Hambrick, 1996; Fredrickson, Hambrick, &
Baumrin, 1988). Thus, predicting whether - and when - CEO dismissal occurs has received the most research interest among the determinants of CEO succession. This paper follows this research stream and presents an enhanced model of CEO dismissal in turnaround situations.
A firm in a turnaround situation is an established company that once performed at a level of general satisfaction to all its major constituents, but no longer does so. The performance problems can be either brief or sustained; the decline can be followed by further deterioration,
continuous trouble, or upturn recovery. Therefore, turnaround situations are fraught with ambiguity, anxieties, and uncertainties (Barker & Duhaime, 1997; Slatter, 1984). Under such an ill-defined environment, the shareholders and board of directors, as well as other stakeholders,
6 would raise a number of questions and concerns, one of which is whether the incumbent CEO
should be replaced by a new one in order to turn the troubled firm around.
The organizational decision of CEO dismissal or retention would not be an issue if the
effect of CEO succession were unambiguously predictable. But decades of empirical studies have not produced clear answers as to whether the CEO succession helps or hurts an organization (e.g., Gamson & Scotch, 1964; Helfat & Bailey, 2005; Huson, Malatesta, & Parrino,
2004; Khurana & Nohria, 2000). Some studies have found that firm performance tends to improve after a change of CEO (Huson, et al., 2004; Weisbach, 1995); some have shown the opposite (Grusky, 1963; Haveman, 1993); and yet others have found no overall effect (Gamson
& Scotch, 1964; Lieberson & O’Connor, 1972). Although further studies have incorporated contextual factors, such as the organization’s life stage or industry structure, in predicting the performance consequences of CEO succession, the conclusions so far remain mixed (Carroll,
1984; Zhang & Rajagopalan, 2004). Thus, CEO succession, and particularly dismissal, represents a classic case of a politically charged but causally ambiguous process, in which various parties have very strong preferences, but no one knows for sure whether a new CEO will bring about better or worse results. Accordingly, even though CEO dismissals essentially occur only in the context of dissatisfaction with the status quo (for instance, poor performance in turnaround situations), dismissals are not driven by a concise set of technical or economic factors; instead they are shaped by sociopolitical factors, including power, framing, and sensemaking.
In publicly-held corporations, the decision to dismiss a CEO formally resides with the board of directors (American Law Institute, 1984). Under primitive predictive models, theorists expect a board to take action in direct proportion to how poor performance has become under an incumbent CEO (Hermalin & Weisbach, 1998; Weisbach, 1988). But because such simple
7 models explain only about 10 to 20 percent of CEO dismissals (versus retention) (Fredrickson, et
al., 1988), scholars have developed more elaborate models, relying primarily on agency theory.
Under these frameworks, boards vary in their power relative to their CEOs, and they vary in their
allegiance or willingness to remove their CEOs (Boeker, 1992; Fredrickson, et al., 1988; Zajac &
Westphal, 1996). But even these enhanced models are only moderately predictive of CEO
dismissal (Finkelstein & Hambrick, 1996; Pitcher, Chreim, & Kisfalvi, 2000).
In my conception, the prevailing models are valid but lack two essential elements for
understanding whether, and when, CEO dismissal will occur. The first missing element is
consideration of the various social arbiters who have visible platforms for rendering legitimate
opinions and criticisms of the CEO and the board. These social arbiters include journalists,
security analysts, governance watchdog groups, and academics (Wiesenfeld, Wurthmann, &
Hambrick, 2008). Even though these parties do not hold direct stakes in the firm, and hence
stand to neither gain nor lose if CEO dismissal occurs, they play active, influential roles in the
dismissal process. As I shall argue, once these social arbiters are stimulated by a company’s
turnaround situation, they overwhelmingly argue for CEO dismissal.
The second missing element in prior models of CEO dismissal is incorporation of the role
of time. The decision to dismiss a CEO is generally the culmination of a time-lapsed, often protracted, process. As such, a director’s stance regarding dismissal on a given day is influenced by events that have occurred over prior days, weeks, or months. Dynamic processes of momentum, social influence, and even fatigue can be expected to affect whether, or when, a
CEO is dismissed.
I integrate these ideas in developing a model of CEO dismissal as a dynamic, social framing contest, in which key players try to convince and mobilize others to accept their
8 respective claims about the wisdom of replacing or retaining the CEO (Figure 1). The
precipitating context is a turnaround situation where the performance problems could be
interpreted and construed in different ways and thus represent a typical environment with
ambiguity, anxiety, and uncertainty. Anchoring one side of the social framing contest is the
incumbent CEO who, of course, asserts the case for retention (although, as I shall discuss, CEOs
vary in how vigorously they try to make their claims). Anchoring the other side of the contest are the social arbiters, who – I shall argue – overwhelmingly frame the case for CEO dismissal.
Standing in between, but for different reasons, are institutional investors and directors.
Institutional investors are in the middle of the contest because, of all the parties, they have the
greatest vested interest in being objectively prudent about whether CEO dismissal will be beneficial or harmful. At the same time, however, institutional investors sometimes take visible stands on the matter of dismissal, thereby reinforcing one side or the other. Moreover, institutional investors are somewhat susceptible to influence from the competing frames of CEO incumbents and social arbiters. Finally, directors are in the middle of my social framing model because they are the ultimate decision-makers about CEO dismissal vs. retention. They are the targets of, and susceptible to, the claims of the competing sides, but individual directors may also try to bolster one side or the other. It is essential to note that I avoid referring to “the board,” instead denote “directors,” because my model features the possibility that individual directors may differ in their stances about CEO dismissal; they also may differ in their susceptibility to pressures from the competing parties; and, over time, they may persuade or pressure each other in the dismissal decision.
------Insert Figure 1 here ------
9 After laying out these core arguments, I illustrate the elements and linkages of the
framework through an in-depth portrayal of the dismissal of Ms. Jill Barad, the CEO of Mattel,
the large toy company. Such a case study allows me to develop a set of propositions on the
framing contest engaged by social arbiters and CEOs in their attempts to mobilize the investors
and directors to take their claims, and specifically to discuss the factors that increase or reduce
the likelihood and speed of CEO dismissal. Finally, I conclude with a discussion of the
implications of my framing contest model for theory and practice.
My paper contributes to the literature in several ways. First, the paper helps advance
understanding of the process leading to dismissal of CEOs, a topic of enduring and central
importance for organizational theorists and strategy scholars. By situating CEO dismissal in a
social context, in which competing parties vigorously espouse their respective “frames,” my
model acknowledges the institutional richness of current-day CEO dismissal processes and
enhances the ability to predict executive removal. Second, it also contributes to the research on
corporate governance. I argue that many directors would strongly like to retain the incumbent
CEO as long as there is ambiguity surrounding the performance problems in turnaround
situations. The reasons I emphasize are owing to the heavy workloads and pressure embedded in
selecting a new CEO, as well as directors’ reluctance to repudiate their prior decision to hire the
incumbent. In addition, in contrast to the logic of agency theory, which asserts that the stance of
a given director is largely pre-ordained by his or her degree of independence and incentives to
monitor, I portray directors as malleable. They are susceptible to social pressures – from external
arbiters, from the incumbent CEO, and from each other. The passage of time can allow such
pressures to mount or dissipate, to expand or contract. Finally, by addressing the role of social arbiters in the push for CEO dismissal, this paper contributes to the literature on the socially
10 constructed executive labor market. It also adds to the growing studies that seek to understand how the social context influences organizational decisions (e.g., Chen & Meindl, 1991; Khurana,
2002; Rindova, Pollock, & Hayward, 2006).
2.1. A Framing Contest Model
2.1.1. Precipitating Context: Performance Problems in Turnaround Situations
CEO dismissal occurs essentially only when one or more influential stakeholders are dissatisfied with the status quo: a typical case is a firm in a turnaround situation. Slowdown in revenue growth, decline in market share, as well as increases in operating costs will put an established firm that once delivered generally satisfactory results to all its major constituents but no long does into a turnaround situation.
Firms in turnaround situations usually have performance problems. But, the performance can be measured and construed in various ways (Barney, 2001; Puffer & Weintrop, 1991). One party’s claim that the organization is doing badly on one or more metrics (e.g., decreasing sales) can often be offset by others’ claims that it is performing well in some other important ways (e.g., increasing margin). Similarly, one party’s assertion that performance has declined can often be countered by pointing to signs that performance is about to improve. In short, organizational performance is multidimensional, often subject to ambiguity and interpretation, which is why
CEO dismissal must be modeled as a social phenomenon instead of simply as an economic or political phenomenon. Indeed, it is probably because of the ambiguity surrounding organizational performance that empirical studies have consistently found that various forms of poor performance, while significantly associated with CEO dismissal, yield only modest predictions of that occurrence. And such ambiguity may explain why scholars persist in efforts to
11 find the specific form(s) of performance problems that yield the strongest predictions of
dismissal, variously focusing on shortfalls in profitability (James & Scoref, 1981; Wagner,
Pfeffer, & O’Reilly, 1984), revenue growth (Boeker, 1992), stock returns (Warner, Watts, &
Wruck, 1988), and failure to meet earnings forecasts (Puffer & Weintrop, 1991).
The performance problem, measured in varying ways, is an essential ingredient in all
CEO dismissals. And I acknowledge that the likelihood of dismissal goes up as a function of 1) how poor performance has become, 2) the number of key performance indicators that show problems, and 3) the duration of the problems.1 Still, as evidenced by prior research, the
likelihood of dismissing a CEO at a give point in time hinges on an array of factors that extend
well beyond concrete performance indicators. In my estimation, the ways in which competing
actors frame the performance problems in turnaround situations for (and against) dismissal play a
major role.
The idea of a frame or framing is very much analogous to the use of a picture frame to
highlight what is in the frame (e.g., an artwork) and suggests that observers ignore what is
outside the frame (e.g., the wall) (Gamson, Croteau, Hoynes, & Sasson, 1992). Originally
proposed as a cognitive process by which observers strive to comprehend complex situations
(Goffman, 1974; Daft & Weick, 1984), the concept of framing has been extended to include the purposive efforts taken by social actors to give meaning to complex or ambiguous phenomena so as to influence others’ interpretations. In this vein, research has shown that when environmental changes occur, proponents and opponents of certain views try to influence others by engaging in purposeful framing activities (Benford & Snow, 2000; Gamson & Meyer, 1996). For instance, in the battle over smoking, public health officials framed cigarettes as “products that kill” and
1 I exclude consideration of cases where the company’s problems are due to executives’ unethical or illegal behaviors (e.g., Schnatterly, 2003). Executives in these cases are very likely to be dismissed.
12 smokers as “intruders on nonsmokers’ rights,” whereas the tobacco industry framed smoking as
“a citizen’s free choice like any other choice in life” and as “a pleasurable experience similar to wine consumption with dinner” (Menashe, 1998). Through their framing activities, social actors attempt to construct and legitimate their frames in order to influence strategic outcomes (Creed,
Scully, & Austin, 2002; Kaplan, 2005). Therefore, framing activities are goal-directed and driven by social actors’ own interpretations of complex phenomena, as well as by their preferences for certain outcomes.
In an ambiguous environment such as the decision-making environment of a turnaround situation, the role of framing and framing activities becomes particularly important for key players to interpret and construct the performance problems in different ways so as to influence other parties’ perceptions and decisions. For my central research question of CEO dismissal, various parties can be considered, but four major constituents have been central in the literature.
They are incumbent CEOs, social arbiters, institutional investors, and boards of directors (Barker,
Patterson, & Mueller, 2001; Cannella & Shen, 2001; Chen & Meindl, 1991; Fredrikson, et al.,
1988; Rindova, et al., 2006; Wiesenfeld, et al., in press). As I shall now argue, the incumbent
CEO frames for his or her retention; social arbiters, once stimulated, frame for the CEO’s dismissal; institutional investors and directors, who are distinct from each other, both absorb and react to the competing frames and sometimes try to bolster one side or the other.
2.1.2. Incumbent CEOs – Framing for Retention
CEOs are very reluctant to relinquish their positions and power (Cannella & Shen, 2001).
Even under conditions of mandatory retirement, where no stigma is attached, many CEOs experience great psychological loss from the relinquishment of their status, elite identity, and
13 sense of “heroic mission” (Sonnenfeld, 1988; Vancil, 1987). Departure from the CEO position also entails considerable economic losses – of salaries, bonuses, perks, and stock options (e.g.,
Jensen & Murphy, 1987; O’Reilly, Main, & Crystal, 1988). Dismissal is especially damaging to a CEO’s prestige and social standing (e.g., Finkelstein, 1992; Useem & Karabel, 1986).
Moreover, dismissed CEOs are likely to be stigmatized in the executive market, and thus have difficulty finding comparable positions thereafter (Cannella, Fraser, & Lee, 1995; Gilson, 1990).
Prior research on corporate governance and executive turnover has consistently shown that CEOs tend to protect their vested interests and try to retain their positions even when firm performance is poor (Boeker, 1992; Cannella & Shen, 2001; Fredrickson et al., 1988; Walsh & Seward, 1991).
To the extent that CEOs fight to keep their jobs, they are oriented toward framing performance problems in ways that support their retention. For instance, because the reasons for performance decline are usually multi-dimensional and not easily unfolded (Hambrick &
Schecter, 1983; Slatter, 1984), CEOs tend to frame the causes of a turnaround situation as the result of factors outside their – or any potential replacement’s – control (Bettman & Weitz, 1983).
For example, Bowman (1976) has documented that less successful food processing companies complain about the weather and government price controls, but talk less about their product/market portfolio and plans to accommodate the coming changes in their environment.
The framing activities emphasizing external attribution describe the performance decline as an event or sets of conditions that CEOs have little control over, and thus CEOs should not be responsible for their firms’ performance downturns.
Another common “corrective action” taken by embattled CEOs is to fire other executives that they blame as really responsible for the company’s problems (Boeker, 1992). For instance,
Mr. Carpenter, the former CEO of Bausch & Lomb, fired the president and COO when Bausch
14 & Lomb lowered its earnings outlook in August 2000. Such scapegoating serves the dual purpose of possibly placating critics who want to see certain actions and sending the message
that individuals other than the CEO are the real culprits. CEOs under criticism may also claim
that they have already launched corrective actions and, moreover, assert that their removal would
jeopardize the implementation or efficacy of those actions.
In addition, the unclear future of firms in turnaround situations also provides CEOs with
opportunities to frame the current downturn as a temporary stumble from which their firm will
soon recover. They may assert that the problems are not as bad as some suggest; such a tactic
might especially involve pointing to favorable indicators (e.g., increased margins) to counter
concern about unfavorable indictors (e.g., sales declines). They can also use impression
management or rhetoric techniques to show their confidence in their firm’s future prospects
(Elsbach & Sutton, 1992; Hambrick, Finkelstein, & Mooney, 2005). For instance, although Kraft
Food’s performance did not show any sign of improvement in early 2004, its CEO, Mr.
Deromedi, was very optimistic. In many public announcements and investor meetings, he
claimed that Kraft was well-positioned and remaining on the right track.
The ultimate aim of the embattled CEO’s framing activities is to hold onto his or her job.
But interim goals, or other subtexts, may also be at work. For example, by aggressively
countering critics or blaming other executives, the CEO may forestall his or her removal long
enough for performance to improve. In short, the CEO can “buy time” in the hopes that his or her
own actions, a shift in market conditions, or just sheer luck will soon bring about better business results.
In this vein, it is interesting to consider just how vigorously a given CEO will argue in an
effort to hold onto his or her job. Even though we expect that CEOs generally frame for their
15 retention, they will vary in how hard and long they will put up a verbal fight. CEOs might make
minimal efforts to frame for their retention if 1) they have lucrative pre-set severance contracts, 2) they are of an advanced age and not interested in continuing their careers, or 3) they are inwardly pessimistic about their chances of improving company performance or are unwilling to engage in the difficult efforts required to attempt a turnaround. Thus, a CEO’s degree of aggressiveness in arguing for retention may reflect his or her “inside information” about the firm’s prospects.2
2.1.3. Social Arbiters – Framing for Dismissal
Prior theory and research has largely ignored the substantial and growing role of social arbiters in influencing the CEO dismissal process. Social arbiters are those parties who “possess prominent and legitimated platforms for rendering assessments of firms and the individuals associated with them” (Wiesenfeld, et al., in press). These arbiters include the press (Chen &
Meindl, 1991; Rindova, et al., 2006), financial analysts (Hong, Kubik, & Solomon, 2000;
Zuckerman, 1999), and governance watchdog groups and academics (Gallo & Knez, 2002). Like economic exchange partners (e.g., suppliers and customers), social arbiters exist outside the boundaries of the focal firm but still hold sway over the firm’s activities (Dyck & Zingales,
2002); unlike economic exchange partners, social arbiters do not have any vested interest in the focal firm, and hence neither gain nor lose if the firm bows to their pressure.
To understand the role of social arbiters in influencing CEO dismissals, it is important to point again to the ambiguity that typically surrounds a company’s performance shortfall in turnaround situations. Like other types of decision-makers, social arbiters interpret ambiguous
2 Some CEOs may aggressively frame for retention to improve their ultimate negotiations for severance packages (Yermack, 2006). After all, passivity in the face of criticism could be construed as a tacit concession of culpability. A lack of fight from the CEO could lead the board to fully punish the wrong-doer – both with dismissal and a hard landing, and, it could further stigmatize the CEO in any search for future positions.
16 and complex stimuli through the web of their own predispositions (Molden & Higgins, 2004;
Starbuck & Milliken 1988). Even if they strive to be fair and professional, they are boundedly
rational, and therefore act on the basis of their own attributional, cognitive, and emotional biases
(Kahneman, 2003; Ross, 1977; Tversky & Kahneman, 1974). As I shall now argue, once social
arbiters are alerted to a company’s performance problems and choose to voice their assessment about the firm’s CEO, they overwhelmingly raise doubts about the wisdom of retaining the CEO.
Their criticism of the CEO may be oblique or direct, it may be mild or strong, but social arbiters generally frame the case for a faltering CEO’s dismissal.
Social arbiters tend to frame for CEO dismissal both because of their own biases and their anticipation of their constituents’ biases. In particular, social arbiters – like others – may succumb to the fundamental attribution error, which is the tendency for observers to seek simple, internal attributions for outcomes that have complex, external causes (Ross, 1977). The human tendency is to try to pinpoint – and particularly to personalize – the origins of complicated events.
The organizational variation of this bias is “the romance of leadership,” which involves the crediting or blaming of leaders for organizational outcomes (Meindl, Ehrlich, & Dukerich, 1985).
The romance of leadership is most pronounced when performance is extreme, so therefore, we can especially expect its influence on all observers, including social arbiters, when company performance is poor or deteriorating in turnaround situations.
Beyond the effects of their own human biases, social arbiters are guided by the anticipation of their constituents’ biases (Fligstein, 1997; Tetlock, 2002). Social arbiters’ sensemaking processes are embedded in a broader social context, and thus they will be attentive to, and motivated by, their constituents’ preferences. By successfully anticipating and catering to their constituents’ preferences, arbiters will enhance their own market acceptance and
17 professional advancement (Fligstein, 1997). Thus, even if journalists, for instance, could surmount their own romance of leadership, they would still be aware of their audiences’ desire for simple explanations for complex phenomena; and they would therefore tend to attribute poor performance to corporate leaders (Hayward, et al., 2004). Similarly, if journalists anticipate that their readers tend to derive pleasure from the misfortunes of business elites, they would render negative evaluations of CEOs whose firms are in trouble (Dyck & Zingales, 2002; Miller, 2006).
And governance watchdog groups, eager to demonstrate that they are indeed being watchful, will tend to raise alarm about a company’s leadership, rather than advocate patience or a wait-and-see attitude.
Social arbiters also can be expected to succumb to the human tendency toward motivated cognition, the inclination to see what one wants to see. As Molden and Higgins (2004:297) noted,
“. . . . individuals’ preferences for certain outcomes often shape their thinking so as to all but guarantee that they find a way to believe, decide, and justify whatever they like.” Motivations for desired outcomes not only will affect how social arbiters search for information, but also how they evaluate and interpret it (e.g., Dunning, 1999; Kunda, 1987; Tetlock, 1998). Thus, once arbiters believe that a company’s performance is slipping, and that the CEO is at fault, they will gravitate to additional signs that performance is going to get even worse and that the CEO is even more inept than initially believed. For instance, journalists can selectively listen to, and then pass onto their constituencies, opinions from the most negative financial analysts or investors.
In sum, the performance problem in a turnaround situation will not only trigger concerns among investors and the board, but will also arouse social arbiters’ interest and enthusiasm to render judgments about the troubled firm and its top management. In attributing meaning to information, social arbiters are guided not only by professional standards and rational analyses,
18 but also by their own human biases and anticipation of their constituents’ biases (Wiesenfeld, et
al., in press). These biases generally steer social arbiters in the direction of asserting that the
CEO deserves blame for the unsatisfactory performance and should be replaced.
2.1.4. Institutional Investors
Institutional investors (e.g., pension funds, mutual funds, and hedge funds) own well over
half the shares of the major listed companies in the United States, and their proportion of
holdings continues to increase (Davis & Kim, 2006; Useem, 1996). Although institutional
investors differ in their willingness and ability to become involved in CEO dismissal debates in
the companies they are invested in, they all have one thing in common: of all the parties who
might play a role in CEO dismissals, institutional investors have a major incentive to be
objective and dispassionate about whether a CEO should be fired or not. For the most part,
institutional investors cannot easily sell their shares in a company without depressing the price of
those shares (Shleifer & Vishny, 1997). Therefore, when a company encounters performance
problems in a turnaround situation, these investors continue to hold most or all of their shares
(Parrino, Sias, & Starks, 2003; Shleifer & Vishny, 1997). Therefore, institutional investors stand to lose if a capable CEO is forced out or if an inadequate CEO is retained. This is not to say that institutional investors are immune to the decision-making biases that affect others (e.g., the romance of leadership), but compared to others – especially the incumbent CEO and social arbiters – institutional investors comprise an attentive audience, seeking and interpreting information from both sides of the debate, staying alert to new facts and opinions, and continuously assessing whether they should take any action – which can include buying or selling shares in the company or becoming involved directly in the CEO dismissal process.
19 Institutional investors differ greatly in their willingness to enter into CEO dismissal debates at all, as well as in their thresholds for becoming involved. For instance, mutual funds are known to be least inclined toward any activist stance in the companies they hold – both because their holdings are spread across so many companies as to make their substantive involvement infeasible, and because the mutual fund companies often serve as investment managers for the very firms they are invested in (Davis & Kim, 2006; Gillan & Starks, 2007). At the other extreme, hedge funds often take very visible stances in CEO dismissal fights; indeed, some hedge funds specifically invest in companies in which they believe they can bring about a change of leadership regime (Gillan & Starks; Jaeger, 2002).
For institutional investors who choose to become involved in a dismissal debate, several mechanisms are available. Large investors may communicate directly with the board, voicing either support for or opposition to the incumbent CEO. These communications can include veiled
(or explicit) promises or threats regarding the investor’s continued holdings in the company, intentions to publicly support or oppose the board, or intentions to communicate with social arbiters. Large investors may then communicate their preferences to social arbiters, such as journalists or watchdog groups, who in turn can selectively decide whether to pass these opinions on to their audiences. Inasmuch as social arbiters have an overwhelming inclination to frame for a CEO’s dismissal, we can reasonably anticipate that investors’ opinions in favor of CEO retention will tend to lie fallow if communicated to social arbiters, whereas investors’ opinions in favor of dismissal will be featured prominently in social arbiters’ renderings. Indeed, it is very common for journalists to quote (often by name) investors who have lost patience with a CEO, but it is rare to see investors’ quotes in favor of CEO retention when firm performance declines.
20 2.1.5. Directors
Boards of directors hold ultimate responsibility for hiring and firing CEOs of publicly- held companies (Fama & Jensen, 1983; Mizruchi, 1983). Although boards almost always report, or imply, that their actions are unanimous, the reality is that individual directors vary in their stances on many complex issues – including decisions about retaining or dismissing a CEO
(Stiles & Taylor, 2001). Arriving at unanimity, or even a strong majority vote in favor of dismissing a CEO, then, is typically a protracted, multi-round process.
There are several factors that might cause a director to favor CEO dismissal. Most obvious, of course, is when company performance has dropped so much, on so many fronts, that there is simply no ambiguity remaining in the situation. Similarly, if social arbiters and institutional investors are loudly and persistently calling for dismissal, directors will conclude that they must go along. In these cases, social and normative ambiguity has been greatly reduced, and the required course of action, even for the most reluctant director, is clear. Not firing the
CEO under these conditions would open the board (and individual directors) to public scorn and possibly legal exposure – particularly in the post-2002 era of Sarbanes-Oxley (Romano, 2005).
Although essentially any director will be willing to vote for dismissal when conditions are extreme, I anticipate that a typical director will react to initial indicators of performance problems in turnaround situations with an attitude of support for the CEO. That is, most directors favor CEO retention – so long as equivocal stimuli provide them the social leeway to do so.
There are several conditions that cause directors to avoid or delay CEO dismissal, only some of which have been noted in prior literature. A given director may be a friend of, or otherwise socially co-opted by, the CEO (Heidrick & Ogden, 2006; Mace, 1971). It is well known that CEOs have substantial influence in director selection and tend to appoint individuals
21 who are congenial to them (Westphal & Zajac, 1995). Indeed, researchers commonly use the percentage of directors who have been appointed during a CEO’s tenure as an indicator of CEO co-optation of the board (McDonald & Westphal, 2003; Wade, O’Reilly, & Chandratat, 1990;
Westphal & Zajac, 2001). In a related vein, directors who spearhead tough anti-CEO actions can find themselves marginalized in the director labor market. For example, Westphal and Khanna
(2003) found that directors who participate in governance initiatives that threaten managerial interests tend to experience informal sanctioning, or social distancing, on other boards.
Directors also may prefer CEO retention because the process of searching for and recruiting a new CEO is onerous and very time-consuming, especially when the predecessor has been fired. Most outside directors are fully employed in other, often demanding, capacities apart from the focal firm (Khurana, 2002). By the standards of their external income and net worth, directors receive modest compensation for being on a board; they accept these terms, however, because the typical workload as a director is minimal (Stiles & Taylor, 2001). Having to search for a CEO would expand the director’s workload well beyond what he or she had anticipated, and perhaps even beyond the amount of time the director has available.
It is not surprising that Khurana (2002) found that the directors who comprise CEO search committees rarely include currently-employed top executives of other firms, but instead are populated largely by retired executives or individuals from not-for-profit settings – who may have more time on their hands. (This finding also aligns with the widespread belief that directors who are retired CEOs are most likely to initiate and propel CEO dismissal campaigns within boards; presumably, they have the time, and they may even hope for the job themselves.)
Finally, directors may be reluctant to dismiss their CEO because it would reflect badly on their prior decision to appoint the person. Like other individuals, directors are subject to
22 commitment escalation biases (Brockner, 1992; Staw, 1981), which are particularly pronounced when an initial action (and its potential reversal) is widely-known. Namely, in the face of ambiguous performance cues, directors who were involved in hiring the incumbent CEO may
find multiple reasons for rationalizing that he or she was, and still is, the right person for the job.
In sum, as long as there is ambiguity in turnaround situations (in terms of severity, causes,
and likelihood of improvement), directors may vary in their stances regarding whether the CEO
should go or stay. Many, and perhaps most, directors will favor retention for as long as they
reasonably can. Their support for the CEO may be communicated to social arbiters and investors; moreover, supportive directors may put pressure on neutral or antagonistic directors. However, if poor performance persists, or if social arbiters and investors turn up the heat, the number of antagonistic directors will grow.
2.2. A Case Example
To illustrate the elements of the framing contest model, I now describe the events and rhetoric that preceded the dismissal of Jill Barad, CEO of Mattel, Inc., the major toy and children’s products company. Barad became CEO of Mattel in January 1997 and was dismissed in February 2000. The center of Figures 2a and 2b shows the stock performance of Mattel, relative to the Standard and Poor 500 index, during Barad’s tenure. Direct quotations from the press (including the press’ self-standpoints, as well as comments and responses of other parties
conveyed, and filtered, by the press)3 are displaced surrounding the figure.
------Insert Figures 2a and 2b here ------
3 I searched the Factiva Database with the key words Mattel and Barad from Jan 1, 1997 to Feb 3, 2000, and obtained a total of 300 news reports.
23
2.2.1. A Longitudinal Examination of Social Arbiters’ Assessments of Barad
In Barad’s first year as Mattel’s CEO, its stock price went from underperforming to
outperforming the S&P 500 index, and later reached its historical high in March 1998. During
this period, Barad was credited with being an exceptionally talented leader who did a great job
and played a crucial role in Mattel’s growth. As one of the first women to take the reins of a
Fortune 500 company, Barad was acclaimed a model of the motto “We Girls Can Do Anything.”
Many news reports and analysts spoke highly of Barad, her marketing talents, work style, and
strategies (The New York Times, Oct 20, 1997; The Wall Street Journal, Mar 5, 1997; Feb 11,
1998)4.
After March 1998, we observed three major performance declines for Mattel, as
numbered and highlighted by ovals in Figures 2a and 2b. The first decline occurred from late
August to October of 1998, during which the Mattel share price consistently underperformed the
S&P 500 index. Although some financial analysts raised their concern, they were in general optimistic for a long time. The reason for their confidence was that “the 46-year-old Barad . . . has some of the sharpest marketing skills out there, and a great product sense” (Journal of
Business Strategy, Sep 19, 1998). Meanwhile, the social arbiters highly valued a series of
Barad’s strategic moves, including the acquisition of Pleasant Company and overseas expansion.
“Mattel’s overall strategy is sound and the company should return to outperforming broad stock- market indexes” (The New York Times, Oct 11, 1998).
The second distinct plummet in late December 1998 came mainly from an announcement that Mattel’s earnings might come in 35 percent below expectations because the company had ignored Toys “R” Us’ earlier plan to reduce its inventory. The press reported the
4 To save space we do not include news reports in the reference list. They are available upon request.
24 performance shock and started to question the company - but without criticizing Barad – as one
writer said “How could a $4.8 billion company get blindsided like this?” (Business Week, Dec 28,
1998). In the first two quarters of 1999, Mattel’s performance had no sign of improvement, and
the gap between Mattel and the market index did not narrow. On March 5, 1999, The New York
Post had the first article, shifting its focus from Mattel to the CEO Barad, saying that “. . . Jill
Barad is on the hot seat . . . and is facing the wrath of some shareholders who are upset at the
performance . . . .” After that, there were growing doubts about Barad as more and more arbiters
linked her specific business weaknesses to the turnaround situation. Some analysts portrayed her
as “a marketing whiz but who has not fully demonstrated that she has the financial skills and
leadership ability to turn around the $4.8 billion company” (The New York Times, Apr 06, 1999).
During this period, social arbiters had changed their evaluations of Barad: 10 of 34 media reports
covering both Mattel and Barad in the first half of 1999 rendered negative assessments of her,
and expressed their skepticism about Barad’s strategy. For instance, The Wall Street Journal
argued that the collapse in performance “reflects what is going wrong at Mattel under the
leadership of Jill Barad . . . .” and the tactics used by Barad to turn around “are now backfiring”
(The Wall Street Journal, Jun 7, 1999). Later on, Business Week also issued a cover article
saying that Barad was “under the gun to prove she can deliver the goods this holiday season”,
and eventually set a deadline for Barad: “Come December, if they're not staring at a big
turnaround, it may not matter what kind of song and dance Barad has planned” (Business Week,
Sep 6, 1999).
In October, 1999, Barad surprised the financial market once again by announcing that
Mattel’s third-quarter profits would drop sharply due to a big loss that had occurred in the
Learning Company, a software company acquired by Mattel at the end of 1998. Mattel’s shares
25 plunged about 30 percent on the date of announcement. The following day witnessed a number
of national media, including The Wall Street Journal, The New York Times, The Associated Press,
followed by local newspapers, such as The Boston Globe and The Toronto Star, in creating a media cascade questioning the Barad’s function. Within two months, the news reports on Barad
(59 items) almost doubled compared to the first half of 1999, 73% of which (43 items) attributed the poor performance of Mattel to Barad. The news reports said, for example, “Mattel CEO lacks full knowledge of problems” (Reuters News, Oct 8, 1999) and “Mattel is suffering from Ms.
Barad’s weaknesses” (The New York Times, Nov 7, 1999). During this period, the list of Barad’s personal weaknesses blamed by the media in attributing the company’s troubles became longer and longer: she lacks financial acumen, is not disciplined herself, has severe problems delegating authority to subordinates, chronically overpromises and underdelivers, jealously guards her power. Meanwhile, the sources of these news reports expanded from the most prestigious national media, such as The Wall Street Journal, Business Week, and The New York Times, to smaller newspapers such as The Cincinnati Post and The Portland Oregonian.
At the same time, financial analysts rendered negative assessments of Barad. They said,
“We’re very upset, and we’re very critical of management at this point” (The Wall Street Journal,
Oct 5, 1999). “Conversations with analysts and with many other people draw an image of a company severely damaged by Barad’s management style” (The New York Times, Nov 7, 1999).
They also pressured Mattel’s board to investigate the issue of performance decline (The Wall
Street Journal, Oct 5, 1999). In addition, corporate governance watchdogs questioned the function of Mattel’s board: “The board is in some pretty desperate need of new blood . . . when they serve a long time, they may not see the need for change” (The New York Times, Nov 7,
26 1999). Their negative assessments of Barad, as well as their criticism of the board of Mattel, were cited and conveyed by the press, increasing the voices that urged the dismissal of Barad.
2.2.2. Barad’s Response to Each Decline
The first decline of Mattel posed a minimum threat to Ms. Barad’s position as CEO as the social arbiters either kept silent or even continued to praise her. Only after the second decline did she feel the heat of criticism and pressure. To manage this tough period, she tried to regain the market’s confidence by predicting “that the emptying of inventories would open the way for
Mattel's earnings to bounce back to $1.50 a share next year” (The Financial Times, Dec 15,
1998). She also claimed in early 1999 that “Barbie growth is expected to be in the high single digits, which will add significantly to our profitability this year” (Reuters News, Feb 2, 1999). To turn the poor performance around, she revamped a retail plan to reduce dependence on traditional outlets and boost direct sales (The Wall Street Journal, Feb 17, 1999), overhauled the executive suites by forcing two executives to resign (The New York Time, Mar 4, 1999), countered the complaints of some analysts as “minority opinions” (The New York Post, Mar 5,
1999), and cut 3000 jobs (Bloomberg News, Apr 16, 1999).
The threat to Barad’s position was overwhelming after the third decline. To fight for her job, Barad attributed the company’s disappointing profits to a range of problems beyond her control, including “. . . a canceled licensing arrangement, and termination of agreements with some distributors” (The Associated Press, Oct 5, 1999). She also said the head of the Learning
Company “hadn’t told her about the trouble” (The Wall Street Journal, Oct 8, 1999). In addition, she affirmed that Mattel’s core business remained sound, but “unfortunately, the Learning
Company performance masks the underlying vitality of our core U.S. business” (The Associated
27 Press, Oct 5, 1999). When asked whether the Learning Company would be sold to increase shareholder value, she defended her strategy and said that “once the opportunities [the] Learning
Company presents in Internet commerce and other areas come to light, you will agree that this was the right acquisition for Mattel” (The Dow Jones Business News, Oct 21, 1999). Without a doubt, the top two executives of the Learning Company were dismissed later as the scapegoats to please shareholders and cover Barad’s responsibilities.
2.2.3. Institutional Investors
Institutional investors were impressed by Ms. Barad’s flashy style and marketing savvy
for two years beginning in January 1997. They did not issue any public opinion against Ms.
Barad in the first decline. However, after the second decline, “investors who were once
enamored of Barad appear to have grown impatient waiting for her to deliver results” (The New
York Times, Apr 7, 1999). Institutional investors lost their confidence in Barad after the third
plummet in Oct 1999. They pressured the board for answers to whether Learning Company’s
financial trouble was a one-time event or part of a larger problem. One of the more outspoken
portfolio managers virtually called for her ouster by saying that “the board has to consider
bringing in a new team that can deliver . . . Somebody has to be held accountable for the loss of
shareholder value'' (The New York Post, Nov 11, 1999).
2.2.4. Mattel’s Directors
Mattel’s board of directors was clearly on the side of Barad during her early tenure, and
ascribed every success of Mattel to her. The board chairman, Mr. Amerman, said, “Through her
skilled management, sales of Mattel’s core brands have increased substantially and brand
28 recognition has been expanded on a worldwide basis” (The Wall Street Journal, Oct 9, 1997). In the first three declines, Barad had bought sufficient time from the board, and no director expressed any public concern about her management abilities. Instead, just one month before the fourth decline, when Barad was under great pressure since there was no improvement nine months after the third decline, a director stand out publicly supported Ms. Barad: “There has been zero talk of Jill leaving,” said Mr. Rollnick, a board member for 16 years, who described
Barad as “the best marketing person I have ever met in my life” (Business Week, Sep 6, 1999).
Even after the fourth decline, “Ms. Barad continue[d] to have full support of the company's board” (The New York Times, Oct 7, 1999). One month after the fourth decline, a Mattel spokesman further confirmed that “Ms. Barad has a strategic plan for the company and its future and has the full support of the board of directors” (Reuters News, Dec 2, 1999). However, the board was under increasing criticism from social arbiters and institutional investors in late 1999, as discussed above, not only because of Mattel’s poor performance, but also because of the board’s explicit support of Ms. Barad. Finally, under pressure, the board decided to hold an emergency meeting to discuss the fate of its CEO, and subsequently Ms. Barad was forced to quit in early February of 2000.
2.3. Framing Contest for a Dismissal or Retention of CEO
2.3.1. Framing Contest
The Barad example helps to illustrate that in turnaround situations CEOs and social arbiters engage in a framing contest to mobilize institutional investors and directors to accept their respective “frames” or claims so as to influence the organizational decision toward their favored outcome. We can expect the framing contest to be a dynamic and longitudinal process.
29 In the initial stage of performance declines, key players start with small battles over the
legitimacy of their views and dispositions (Benford & Snow, 2000; Ryan, 1991). As time
progresses, particularly with growing evidence that shows no performance recovery, or even
further deterioration, the contest between dismissal and the retention frame intensifies more and
more. An increasing number and types of social arbiters join the replacement framing activities.
For example, at the beginning, perhaps only a single newspaper article hints that the troubled
firm might be better off with a new CEO. Later on, more and more commentaries in different
types of newspapers and magazines start to describe the performance declines and evaluate the
troubled firm’s CEO, because other media may feel pressure to respond to audience interest in
corporate anecdotes (Wiesenfeld, et al., 2008). Meanwhile, the media coverage may further
attract other categories of social arbiters, such as financial analysts and corporate governance watchdogs, to participate in the public “whipping” of the incumbent CEO. For instance, security analysts may downgrade the declining firm’s stocks (Zuckerman, 1999). In order to establish a reputation of toughness, corporate governance watchdogs may stand out to raise their concerns about CEO entrenchment and poor governance if the incumbent cannot be replaced.
Although the sequence may not be as clear as what I describe, and many actions may actually take place simultaneously, there is a general diffusion of framing activities initiated by social arbiters: they interact with each other to influence the board and institutional investors’ attitudes on the dismissal frame. Meanwhile the CEOs respond to the commentaries of social arbiters and intensively engage in counter-framing activities, claiming that the public criticism is inaccurate or groundless, addressing their unique value to the firm, and leveraging their power to influence the boards’ disposition on the retention frame. For example, when analysts complained in 1999 that Mattel’s performance was unacceptable, Barad said Mattel’s core businesses
30 remained strong and vital; when Kraft’s profits tumbled in early 2004, its CEO blamed increased costs for the company’s key commodities, particularly dairy products, for the earnings decline.
Because of the presence of these counter-framing activities, social arbiters cannot frame the turnaround situation as just any version they like (Benford & Snow, 2000). However, in the contest, a frame that can mobilize institutional investors and directors will emerge as the one that will dominate the other, and thus can ultimately influence the outcome of CEO dismissal or retention. In this vein, I turn to the question of why a certain dismissal frame initiated by social arbiters is more likely to have a greater mobilizing power or effectiveness than others.
2.3.2. Effectiveness of Social Arbiters’ Dismissal Frame
Prior research in the social movement literature has suggested that the effectiveness of a frame depends on the creditability of the frame articulators (e.g., the status or the perceived expertise of the claimers), consistency of the framing arguments (i.e., the congruency between the prior and current description), and the value consensus (e.g., an apparent fit between the
framing claim and a cherished belief) (Aronson & Golden, 1962; Benford & Snow, 2000;
Hovland & Weiss, 1951). While these factors may also increase the functioning and mobilizing
power of the dismissal frame, in this paper I specifically discuss how social arbiters strengthen
their dismissal frame and thus achieve their influence on the board and institutional investors’
stances by personalizing performance decline and criticizing the board of directors.
Personalization of the performance decline. The personalization of the performance decline is a process of increasingly making personal attributions to the CEO in developing
judgments about the declining performance in a turnaround situation. Such a process originates
from objectively reporting unsatisfactory performance and gradually develops to subjectively
31 blanket the individual’s personal shortcomings and weaknesses. The personalization processes
can be broadly divided into three stages. At the first stage, the firm in a turnaround situation
shows an early sign of performance problems. The social arbiters, as the intermediaries, are
attracted by and also compelled to convey this information to the public (because they also
compete for their audience). During this stage, the social arbiters are relatively likely to be
guided by their professional standards and rational analyses. They will try to be neutral and
impersonal in their reports (Dyck & Zingales, 2002; Jensen, 1979; Miller, 2006), such as an unbiased description of the facts (e.g., a decrease in market share, profitability, or share price).
Their comments mainly refer to “the firm” rather than the “person”, with a minimum of sensationalism. Thus, although a report of unsatisfactory performance might be harmful for the incumbent’s career future in the troubled firm, it does not necessitate a dismissal.
At the second stage, the social arbiters develop interpretations and explanations of why the firm’s performance cannot achieve its prior level under the incumbent CEO. Influenced by
the fundamental attribution error (Meindl, et al., 1985; Ross, 1977) and their anticipation of their
constituents’ biases (Wiesenfeld, et al., 2008), the social arbiters tend to ascribe the reasons for
performance decline to corporate leadership. In the social arbiters’ analyses, they are inclined to
link the CEO’s specific business weaknesses to the ill-constructed corporate strategies or to poor
business judgment. For instance, the social arbiters may attribute a firm’s declining sales to the
CEO’s engineering background and a lack of understanding of the current market demand. In
Barad’s case, her lack of financial acumen was blamed for her poor decision in acquiring the
troubled Learning Company, which ruined Mattel’s overall performance. During this stage, the
social arbiters start to personalize the performance decline by localizing the reasons for poor
32 performance with the CEO, and by providing a narrow but grounded description of the CEO’s
specific business weaknesses.
At the third stage, the ingredients of personal attribution increase substantially. The blaming list compiled by the social arbiters expands to include a wider set of the CEO’s personal
attributes. Every aspect of the embattled CEO’s personal shortcomings surface and are publicly
criticized. For instance, in framing Barad’s dismissal, the social arbiters not only talked about her
business weaknesses (e.g., lacking financial acumen), but also about her personal faults (e.g., not
being disciplined enough). The extended list of personal defects emerges not only to justify the
social arbiters’ predisposition, but also to meet the demand of their audience to taint high-profile
personnel (Jensen, 1979; Wiesenfeld, et al., in press). While the second stage focuses on the
CEO’s faults in the turnaround situation, an overall criticism of the CEO’s shortcomings at the
third stage posits that the incumbent is not capable of leading the firm to a turnaround. To
reverse the performance downturn, the only choice is to change the corporate leadership.
Therefore, the third stage of blanketing the CEO’s personal attributes is the key part of the
process of personalizing performance decline, making it different from other arguments, such as
“romance of leadership” or internal attribution in prior studies (Bettman & Weitz, 1983; Meindl
et al., 1985). These prior arguments would predict that social arbiters tend to attribute the firm’s
poor performance to the CEO, but they will not expect the arbiters to further generate an
extended list of the CEO’s overall personal deficiencies, many of which may not have any direct
effect on the firm’s performance. For example, among Barad’s weaknesses discussed by the
social arbiters was her “dance-to-music” presentation style, which they thought was
inappropriate to investment bankers.
33 In sum, the effectiveness of dismissal frames depends on the extent that the performance decline has been personalized as a result of the CEO’s overall personal weaknesses and shortcomings. The institutional investors and boards are very likely to be persuaded to accept the social arbiters’ claim when the personalization of the performance decline has reached the third stage, because a dismissal frame which successfully blankets the CEO’s overall personal weakness suggests that the incumbent is not only responsible for the troubled situation, but also does not have the credentials to turn the declining firm around.
Proposition 1: The greater the personalization of performance problems by the social arbiters in blaming the CEO in turnaround situations, the greater the likelihood and speed of the CEO dismissal.
Criticism of the board. I argue that many directors react to initial indicators of performance problems with an attitude of support for the CEO, and would like to continue their prevailing inclination as long as equivocal stimuli provide them the social leeway to do so.
Sensing that the board is in line with the incumbent, the social arbiters may leverage their endowed legitimacy to render a negative assessment of the directors. Such a criticism of the board implies that the social arbiters’ targets of blame extend from managers to directors. While the personalization of a performance decline is aimed at the CEO’s shortcomings and defects, the criticism of the board emphasizes its malfunction in monitoring the firm’s top executives. For instance, the social arbiters questioned the Mattel board’s advising role in the over-paid acquisition of the Learning Company. An analyst questioned where the board was when the management judged that this was a fair valuation. Failure to advise the managers also leads to concern about the board’s effectiveness in monitoring managers, and the overall corporate governance. For example, the social arbiters further commented that Mattel's board was too weak and included too many of Barad’s friends. They also pointed out that an insider sitting on the
34 Mattel board’s nominations and corporate governance committees is an unacceptable practice for
a good governance system (The New York Times, Nov 7, 1999).
The criticism of the board immediately places the directors in the center of public review and scrutiny. For example, after The Wall Street Journal published an article in which all the
directors of Sears Roebuck, identified by name, were labeled as “the non-performing assets”
(The Wall Street Journal, 1992), their directors were greatly embarrassed. The social arbiters’
criticism conveyed to their audience is that the directors are also responsible for the performance
downturn, although they are not directly involved in the day-to-day operation of the firm.
Although the directors can keep quiet during the CEO-focused personalization of the
performance decline, they surely cannot when they become the targets of the social arbiters’
criticism. By serving on the board, the directors receive limited monetary compensation; instead,
they are rewarded by being in an elite network and having a higher social status (Davis, et al.,
2003; Useem & Karabel, 1986). Being criticized by social arbiters could damage their reputation
and elite identity, the worst scenario directors could conceive. Their tainted reputations might
have spillover effects, causing the directors to lose other board seats, or even threatening their
own full-time jobs. Therefore, the board-focused criticism by social arbiters will increase the
effectiveness of the CEO dismissal frame by pushing and mobilizing the board to take decisive
action to dismiss the CEO. I should note that, in some cases, the pressure on the board is
indirectly through the functioning of institutional investors, who incorporate the social arbiters’
commentaries, among others, in their decisions.
Proposition 2: The greater the criticism of the board of directors by social arbiters in blaming the board’s failure to monitor the CEO in turnaround situations, the greater the likelihood and speed of the CEO dismissal.
35 I would argue that the social arbiters’ criticizing the board and blaming the CEO’s overall weaknesses in turnaround situations are highly related, and usually work in tandem. This is because arbiters who join later to render their judgments are pressured to bring new information, such as finding new personal defects of the CEO, or including the board as the criticizing target.
Therefore, these two would mutually reinforce the effectiveness of the dismissal frame, influencing the board’s and institutional investors’ stance, thus increasing the likelihood and speed of the CEO’s dismissal.
2.3.3.Competing and Moderating Forces
The argument given above is mainly from the perspective of social arbiters, whose frame is oriented toward CEO dismissal. However, because of interests inherited in the change of corporate leadership, the framing contest in the decision of CEO retention or dismissal will inevitably involve persuasion, counter-argument, coercion, and rhetoric (Weick, 2001). Surely not every dismissal frame turns out to be the dominant one. Similar to the idea that the initial account offered to justify the identity-threatening events might be in conflict with others’ views so that the final account would be a compromised and negotiated one (Ginzel, Kramer, & Sutton,
1992), the CEO dismissal frame initiated by the social arbiters might dissolve and become ineffective due to the presence of counter-framing activities oriented to CEO retention. For instance, GM CEO Richard Wagoner, successfully worked through his career crisis, or at least
“bought some time” to turn the troubled firm around, when the press mentioned the GMS should consider hiring a new CEO in 2006 (The Wall Street Journal, 2006). In sum, while some factors might strengthen the effectiveness of the dismissal frame, others work in the opposite way. In the
36 following, I discuss the competing and moderating forces that might influence the process or outcome of the framing contest.
CEO’s counter-framing activities. Once the social arbiters launch a campaign for a
CEO’s dismissal, it may be very difficult to slow or reverse its momentum. It falls to the CEO himself or herself to make the best possible case for retention, by seizing on any available ambiguities or equivocalities in the company’s situation in the hopes of changing others’ minds or just buying time. A great deal of the CEO’s framing for retention may occur privately with the board, but some occurs in the public domain in an effort to affect the broader social framing contest.
For instance, Jill Barad’s efforts to frame for retention, particularly in October of 1999, encompassed multiple defenses. She argued that disappointing profits were partly due to the company’s intentional actions (e.g., a cancelled licensing agreement and termination of some distributors), which would soon prove to be beneficial. She argued that she had only recently learned of a major revenue shortfall at the recently-acquired the Learning Company, implying that this is a common problem when making acquisitions – and could have happened to any CEO.
She argued that the poor performance of the Learning Company was overshadowing the health and performance of the rest of Mattel, or that things were not as bad as they seemed. And she argued that, despite the problems of the Learning Company, it would soon prove to be a smart move into Internet-based educational products. Although Barad’s framing activities did not secure her job, because there was little equivocality remaining in Mattel’s situation after October
1999 as the company’s value had dropped by two thirds. Thus, we might say that Barad’s framing for retention bought her some additional time, as about four more months elapsed before
37 she was fired. Therefore, the effectiveness of social arbiters’ dismissal frame is mitigated to the
extent that the CEO’s argumentation for retention is vocal and visible.
Proposition 3: The more vocal and visible the CEO’s argumentation for retention, the less the likelihood and speed of CEO dismissal.
Prior performance. A firm’s prior performance to the turnaround situation can generally
meet the expectations of all its major constituents, but it varies in the level of its achievement.
For example, prior to the decline a firm could be a market leader, or it could just be a mediocre
player. I expect that the market leader is more likely to receive the attention of the social arbiters
once its performance shows signs of decline. This is because the audience is more interested in
the information related to a once glorious performer; so the social arbiters are pressured to report
the market leader’s performance decline once it can no longer deliver a generally satisfactory
performance. However, I also expect that arbiters are less likely to establish an effective
dismissal frame by blaming the CEO’s overall personal weaknesses (the third stage of personalization of performance decline), because the prior outstanding performance has earned credit for the incumbent. A clear example is that Mattel’s first and second performance downturns did not develop into a blanket criticism of Barad’s shortcomings, because, at least partially, Mattel’s share price achieved a historic high in early 1998. By contrast, if the declining
firm’s prior performance is only marginally good, although its performance decline is less likely
to arouse arbiters’ interest, once they start reporting the performance problems, the arbiters will
quickly link the poor performance to the CEO’s weaknesses, and further blame the CEO’s
personal shortcomings on a wider set. Therefore, for firms who have an extraordinary
performance before the decline, the CEO’s counter framing activities, such as attributing poor
performance to external factors or arguing that the current decline is only a stumble, sounds more
38 convincing to investors and directors, and thus would more likely get their support on the retention frame.
Proposition 4: The better the prior performance, the less the likelihood and speed of CEO dismissal.
Severity of turnaround situations. Besides the prior performance, the severity of the turnaround situations has moderating effects, leading one or the other frame to dominate in their influence on the CEO’s career trajectory. The severity of the situation has two essential elements, the magnitude and duration of the performance decline, both of which would affect the social arbiters and the CEO’s framing activities. The romance of the leadership argument suggests that the more severe the performance decline, the more likely the arbiters would attribute the decline to the corporate leadership (Meindl, et al., 1985). Therefore the ingredients of personal attributes are very likely to be incorporated into the social arbiters’ interpretation of a turnaround situation.
Meanwhile, the CEO’s personal shortcomings will be quickly extended, because the severity of the decline will attract a large number and different types of arbiters to report and analyze the performance decline. Each arbiter may feel pressure to offer new information, gradually contributing a longer list of the CEO’s shortcomings (Wiesenfeld, et al., 2008). Thus, the severity of the performance decline would prompt the social arbiters to quickly establish an effective dismissal frame. On the other hand, any counter argument proposed by the CEO becomes very weak in the context of a severe situation.
Proposition 5: The more severe the performance problems, the more the likelihood and speed of CEO dismissal.
CEO’s prior public image. The CEOs of public firms are usually highly visible because newspapers, magazines, and other social arbiters use their names in their articles and headlines.
Therefore, a number of CEOs have a prior public image before the turnaround situation. In a
39 content analysis of Donald Burr and People Express, Chen and Meindl (1991) found that the press reconstructed the leadership image to account for the dramatic performance failure of the company, but in a way it also maintained consistency with previous construction. This suggests that once a positive image has been established, it is resilient to future challenges, because social arbiters are reluctant to repudiate their prior description immediately. In the case of Ms. Barad, because she was projected by social arbiters as a high-profile female CEO who had broken through the glass ceiling of corporate America, the first performance decline at the end of 1998 did not lead to her dismissal. Many news reports debriefed the performance surprise but did not proceed to the third stage of personalization. When she was finally fired in early February 2000, some claimed that the media was actually responsible for keeping Barad in the job longer than she should have been (CNN Financial News: 3 Feb 2000). Therefore, for a CEO with a prior positive image, the social arbiters are less likely to immediately render negative assessment on the CEO and generate a long list of the CEO’s overall personal shortcomings. In addition, activities initiated by the CEO oriented toward the retention frame tend to be more persuasive to the investors and directors, and thus reduce the likelihood of CEO dismissal.
Proposition 6: The better the CEO’s prior public image, the less the likelihood and speed of CEO dismissal.
Institutional investors: Institutional investors who cannot readily sell their shares may publicly register their opinions about a CEO in hopes of influencing the CEO’s fate. As noted earlier, investors have a vested interest in being objectively prudent about the dismissal of the
CEO; they stand to lose if a capable CEO is dismissed, and they stand to lose if an incapable
CEO is retained. Therefore, they might contribute their opinions to either side in the social framing contest. And we can assume that the voice of large investors in a public debate about a
CEO carry a great deal of weight. First, large investors have credibility, because – compared, say,
40 to watchdog groups, journalists, or academics – it is their money that is on the line. Second, they
have credibility because they can threaten, or even just imply, that if their voice goes unheeded, they will sell their shares or mount a legal action (Gillan & Starks, 2007).
Investors may voice their assessments privately to the board or in the public domain. We can assume that investors’ sentiments appearing in the public domain are overwhelmingly on the side of CEO dismissal, due to a two-step process: 1) investors anticipate that social arbiters will welcome opinions that reinforce their own biases in favor of dismissal, and 2) social arbiters will indeed feature pro-dismissal opinions from investors, while ignoring or submerging opinions in favor of patience. The outcome of this two-stage process is illustrated in the Barad case. Once social arbiters commenced talk about Barad’s flaws, all of the articles in the press including quotes from investors, expressed dissatisfaction and dismissal. Their public opinions represent an endorsement of the social arbiters’ dismissal frame and carry great weight in pushing directors to take action.
Proposition 7: The more vocal and visible that institutional investors are in arguing for dismissal, the more the likelihood and speed of CEO dismissal.
Directors. The previous discussion posits that, in turnaround situations, many directors would strongly prefer to maintain the status quo, and have an inclination to support the CEO as long as they reasonably can. In addition to the reasons offered by prior research (e.g., a lack of board independence, the effect of social psychological factors), I specifically argue that directors who serve on the board as side activities would not like the tremendous workload and pressure that accompany the hiring of a new CEO (Khurana, 2002). They are also reluctant to repudiate their prior decision of hiring the incumbent. In addition, guided by a motivated cognition framework, some directors will find and evaluate evidence that justifies their preferences of CEO retention, and convince themselves that retaining the CEO is the correct decision (Molden &
41 Higgins, 2004). To create a social environment in favor of CEO retention, these directors would support the incumbent either explicitly (e.g., the board of Mattel saying there had been zero talk of Barad’s leaving) or implicitly (e.g., the board spoke highly of Barad’s marketing skills, prior achievements, and strategies for Mattel’s future). These supporting activities would echo and strengthen the CEO’s framing activities toward retention.
On the other hand, if there is a minimum of equivocality in turnaround situations, or the extremely poor performance has deeply shocked the market, the more the directors would show their support for the embattled CEO, the more likely the social arbiters would think the corporate governance of the declining firm is very weak. Arbiters would then conclude that the board is not independent enough, and not act in the interest of the shareholders. Social arbiters, particularly governance watchdog groups, would think they have responsibilities to discipline the board. The launch of intensive criticism of the board would alter the institutional investors to pressure the supportive directors to change their stance, and thus increase the likelihood and speed to CEO dismissal.
Proposition 8a: The more vocal and visible the board’s argumentation for retention, the less the likelihood and speed of CEO dismissal.
Proposition 8b: Under conditions of extremely poor, or unequivocally poor performance, the more vocal and visible the board’s argumentation for retention, the more the likelihood that social arbiters and institutional investors will criticize the board, and thus the more the likelihood and speed of CEO dismissal.
2.4. Conclusion
Because ambiguity and equivocality are seen as prominent accompaniments of firms in turnaround situations, interpretation, sensemaking, and framing are often invoked in the decisions that have an enduring influence on the organization, such as the decision to retain or to change the corporate leadership. The lack of a clear pattern between CEO succession and post-
42 succession performance further provides room for key players to frame the situation in different ways to support their claims, and thus influence the decision toward their preferences. This paper
argues that the organizational decision is situated in a broad social context, and develops a model
of CEO dismissal as a social framing contest in which the incumbent CEO and the social arbiters
try to mobilize institutional investors and directors to accept their claims. In the framing contest,
to strengthen the mobilizing power of the dismissal frame, the social arbiters personalize the
performance decline by attributing the performance troubles to the CEO’s overall personal
weaknesses, and criticize the board’s malfunction in monitoring the incumbent. I also discuss the
competing and moderating forces that might either strengthen or weaken the effectiveness of the dismissal frame, and thus increase or reduce the likelihood and speed of the CEO dismissal.
2.4.1. Research Implications
The decision of the retention or dismissal of a top executive is an important topic in organization studies (Finkelstein & Hambrick, 1996). This paper contributes to the CEO succession literature by considering the dynamic relations among multiple players, particularly pointing out the role of social arbiters in pushing the decision of CEO dismissal through a framing contest with the incumbent in persuading investors and directors to accept their frames. I argue that the party that drums up the CEO dismissal may be the one without any direct interest in the focal firm (neither gain nor loss if the CEO dismissal does happen). By situating the CEO dismissal in a social context, my framing contest model has acknowledged the institutional richness of the current-day CEO dismissal process.
The important role of social arbiters highlighted in this paper implies that public firms and their upper echelons are increasingly pressured by an institutional environment they had not
43 faced before (Dyck & Zingales, 2002). First, it suggests that how to manage the external
constituent’s expectations has become an important skill for CEOs today (Porter, Lorsch, &
Nohria, 2004). But it would cast doubt on the efficiency of the executive labor market. For
example, talented CEOs might be dismissed if they cannot handle the external constituents
professionally; instead, poorly performed CEOs could remain in the position if they have a strong relationship with the analysts or journalists. Pushing CEOs toward an external focus is a big drain on their time and energy, constraining their efforts to meet the internal corporate issues.
This focus may not be beneficial for a firm from a long-term perspective.
In this paper I argue that many directors are inclined to maintain the status quo, or retain
the CEO, as long as the social leeway allows them to do so. The reasons I emphasize are the
tremendous workload and pressure on the directors to select a new CEO (Khurana, 2002). Given
the minimal compensation that directors receive, and their original purpose for serving on the
board, we can expect that not every director would like to put tremendous effort into evaluating
to what extent the CEO should be accountable for the performance decline, and volunteer to
shoulder the responsibility of replacing the incumbent with a new CEO who matches the
troubled firm’s needs. Indeed many, if not most, directors would like to maintain the status quo
so that they can avoid the additional workload that accompanies a change of CEO. In sum, how
to motivate directors to fulfill their fiduciary duties has long been an essential question in the
corporate governance research. The “settling-up” process might be useful (Fama, 1980), but only
to a certain extent, particularly if the target of “settling-up” is the director, who is not responsible
for the business operations (Wiesenfeld, et al., 2008). Prior research also suggests relating the
directors’ interest to those of the shareholders by granting directors share options. But the
function of the directors’ shareholdings and options is not conclusive (Hambrick & Jackson,
44 2000; Yermack, 2004). This paper suggests that social arbiters’ assessments might be very
effective. A given director’s stance on a CEO is subject to change and very likely to take CEO-
disciplinary action under social pressures. However, such an externally-driven behavior may not
always be good for the focal firm.
A common critique of a current board is that the directors are not focused enough on
fundamentals and are too focused on Wall Street. This paper points out that the pressure to
dismiss a CEO imposed on the board mainly comes from the social arbiters, who are not only
guided by professional standards, but also by human biases and the anticipation of their
constituents’ biases. In fact, they may seek “blood” and interesting stories, and lack objectivity in
their assessments and evaluations of business elites. For better or for worse, the board is under
greater pressure to monitor the CEOs. However, the other functions of the board, such as
providing resources to the focal firm, giving advice and helping the management, have become
less salient today. The recent corporate governance reform puts the board of directors and the
CEO at two different poles, which may not be in the best interest of the shareholders (Westphal,
1999).
In addition, given that public firms and business elites are more receptive to the comments and critiques rendered by the social arbiters, it would be interesting to study the
effects of social arbiters on corporate strategy. For example, if financial analysts recommend that
the firm should divest its non-core business segment, will it increase the likelihood of divestiture
in the following months? If a firm faces higher pressure from the financial market (e.g., a lower
than expected profit predicted by the financial analysts), will it become more aggressive in its
strategy, such as aggressive price-cutting, new market penetration; or by contrast, will it become
rigid in its responses?
45
2.4.2. Limitations and Future Research
Similar to other studies, this paper also suffers a number of limitations, which provide opportunities for future research. First, I have not considered the role of other executives in the top management team in the decision-making process of CEO dismissal. As prior research has suggested, the power of the CEO is subject to competition from his or her subordinates (Ocasio,
1994; Shen & Cannella, 2002). Because these executives have inside detailed information about the firm’s operation and financial condition, and are strongly motivated to compete for privilege and power, they are not solely passive agents; by contrast, the actions of these executives may serve as a stimulant to the replacement of the incumbent CEO. For example, in the dismissal of
William Agee, the top executives of Morrison Knudsen played a critical role by sending their anonymous letters telling the directors the perilous state of the company’s balance sheet.
Besides senior executives, I also assume that other stakeholders (such as employees, suppliers, customers, and creditors) are passive in the decision process of CEO dismissal. This assumption has limitations. For example, debt holders played a critical role in the dismissal of
William Agee. While debt holders could extend the Morrison loan covenants, they said they were not going to do it under the current management; in addition, the banks said they would not provide cash in the future unless Mr. Agee was entirely removed from the board. Future studies should recognize these forces.
Third, I haven’t included small investors in my framing contest model. Historically, small investors have lacked a platform for voicing their opinions about CEO dismissal, but that appears to be changing – due primarily to the Internet. For instance, activist investor Eric Jackson, who owns just 130 shares of Motorola, embarked on a campaign to enlist other small investors in
46 support of Jackson’s “Plan B” for ousting Motorola’s CEO (The Wall Street Journal, July 9,
2007). Further research should also consider the influence from this group of investors.
Finally, I use social arbiters as a categorical term for the press, financial analysts, governance watchdogs and other entities who have a legitimate platform from which to issue
their assessments. However, these social actors do not always move in the same direction, nor
can they always be treated as a single unit. For example, in some cases, financial analysts tend to
be more optimistic than the press, especially when the analysts employed by the brokerage firms
who also have underwriting relationships with the company issue recommendations or earnings
growth forecast (Dechow, Hutton, & Sloan, 1998; Michaely & Womack, 1999). But, on the other
hand, given that the press can selectively listen to and quote opinions from the most negative
financial analysts, their effects on CEOs, directors, and institutional investors can be, in general, treated as influences from a group of external arbiters.
47 Chapter 3
DOES CEO REPLACEMENT INCREASE THE LIKELIHOOD OF SUCCESSFUL
TURNAROUND? THE IMPORTANCE OF CONTEXT-PERSON FIT
“Can anyone save HP? … now HP’s board is on the hunt for a replacement. They’re looking for a CEO who can rescue HP, much the way Louis V. Gerstner Jr. lifted a troubled IBM …” ---- Business Week, Feb 21, 2005
“If a troubled firm is to survive, then it surely needs a new CEO …” ---- Peter J. Leitner, the CEO of Numeria Management LLC
As the above quotations suggest, a replacement of leadership has long been regarded as a necessary condition for a troubled firm’s turnaround to be successful. This wisdom has been implicitly or explicitly stated in journal articles, analysts’ reports, and consultants’ suggestions.
This rule has also been adopted by many troubled firms, evidenced by Bibeault (1982)’s study in
which he documented that about three fourths of 82 firms in turnaround situations involved new
CEOs. However, does a change of CEO really improve firm performance and increase the
likelihood of a successful turnaround? It remains as an important question in the extant research.
As Finkelstein and Hambrick (1996) stated, “In fact, neither Bibeault nor other researchers, as
far as we know, have provided telling evidence of the results that come from different CEO
succession patterns in turnaround situations (page 198).”
A study of CEO replacement consequences in turnaround situations cannot ignore the
existing research which investigates the performance implications of CEO turnover in general
domains. But, despite decades of empirical studies, there is yet consensus on whether CEO
turnover helps or hurts an organization (e.g., Allen, Panian, & Lotz, 1979; Denis, Denis, & Sarin,
1997; Gamson & Scotch, 1964; Helfat & Bailey, 2005; Huson, Malatesta, & Parrino, 2004;
48 Khurana, 2002; Vancil, 1987; Weisbach, 1995; Zajac, 1990; Zhang & Rajagopalan, 2004). Some studies have found that firm performance improves after a change of CEO (e.g., Huson, et al.,
2004; Weisbach, 1995), but some show the opposite (e.g., Carroll, 1984; Haveman, 1993), while others document no effect from CEO replacement on the firm’s post-succession performance
(e.g., Brown, 1982; Lieberson & O’Connor, 1972).
The lack of consistent findings suggests that research investigating performance implications of CEO turnover should consider contextual factors surrounding the succession event (Finkelstein & Hambrick, 1996). In this vein, scholars have moved forward by considering a number of succession contexts, such as the organization’s stage of life (e.g., Carroll, 1984;
Haveman, 1993), the industry structure (e.g., Zhang & Rajagopalan, 2004), and the environmental conditions (e.g., Virany, Tushman, & Romanelli, 1992). However, a widely observed precipitating context for CEO succession – firms in turnaround situations – has received less research attention than it should.
Firms in turnaround situations are established companies that once consistently delivered generally satisfactory results but now are performing badly (Barker & Duhaime, 1997; Hofer,
1980; Pearce & Robbins, 1994; Schendel, et al., 1976). Studying CEO replacement specifically in turnaround situations has at least three motivations. First, an exclusive focus on troubled firms helps to define a contextual boundary for the CEO succession research. Prior literature on performance consequences of CEO succession typically examined a broad cross-section of CEO succession events (Huson, et al., 2004; Shen & Cannella, 2002; Zhang & Rajagopalan, 2004).
Such a sample framework has certain benefits, however, pooling all succession events in a single study is expected to muddy the waters and cause the inconsistent or non-findings of the effects of
CEO turnover. It is reasonable to expect that a change of CEO in a turnaround situation is very
49 likely different from that in other situations (e.g., CEO succession because of retirement) because
the precipitating context before the succession event varies to a great extent (Finkelstein &
Hambrick, 1996). Therefore, focusing on just turnaround situations allows the researchers to
tighten the investigation boundary so that a variety of noises due to different succession contexts can be attenuated.
Second, turnaround situations are usually accompanied with complexities and means-end ambiguities (Hambrick, 1985; Pearce & Robbins, 1994), the scenarios where the corporate leaders tend to have greater influence on firm strategy and performance (Hambrick & Finkelstein,
1987; Shen & Cho, 2005). Thus replacing CEO in turnaround situations represents an important event for the troubled companies with both symbolical and substantive implications. And it is more interesting for scholars to investigate the role and function of corporate leaders in such extreme situations.
Third, the incumbent CEOs of firms in turnaround situations are usually under great pressure, not only from internal challenges from other senior executives (Ocasio, 1994; Shen &
Cannella, 2002), questions from the board of directors (Fama & Jensen, 1983; Huson, Parrino, &
Starks, 2001), but also criticisms from institutional investors (Parrino, Sias, & Starks, 2003) and external social arbiters such as the press, financial analysts and governance watchdogs (Miller,
2006; Wiesenfeld, et al., 2008; Zuckerman, 1999). Since CEO replacement has long been thought to be a prerequisite to successfully turning the troubled firms around (Hofer, 1980), CEO replacement rates for firms in turnaround situations are higher than those in normal situations
(Bibeault, 1982; Hotchkiss, 1995; Schwartz & Menon, 1985). However, whether a change of
CEO is beneficial to firms in turnaround situations has not been systematically studied
(Finkelstein & Hambrick, 1996).
50 Thus the first overarching research question of this paper is “does CEO replacement help or hurt firms in turnaround situations?” Prior research has discussed the potential advantages of
CEO turnover, such as solving the incumbent’s entrenchment issue (Jensen & Meckling, 1976;
Walsh & Ellwood, 1991), and bringing in new resources and human capital (Castanias & Helfat,
1991). Existing studies have also suggested the potential disadvantages of CEO turnover, such as resulting in organizational discontinuity and disruption (Allen, et al., 1979; Cannella &
Hambrick, 1993). These pros and cons of a change of leadership also apply to firms in
turnaround situations. Because of these opposing arguments, as well as the prior inconsistent
findings of performance consequences of CEO turnover in general domains, I do not have a
strong theoretical framework to predict the potential effects of CEO replacement in turnaround
situations. As such I put the first question as an open-ended research question in the paper.
The second research question is this: Under what conditions is a change of CEO more
positively (or less negatively) related to firm performance in turnaround situations? To address
this question, I draw the idea of “fit-drift/shift-refit” first introduced by Finkelstein and
Hambrick (1996: 199), and push this line of thought further by developing different types of
“context-person fit”, suggesting the cases when corporate leaders’ competences and skills align
(or misalign) with the contextual requirements. I argue that this context-person fit is crucial in
understanding the performance consequences of CEO replacement. Specifically, the presence of
a predecessor’s misfit with contextual requirements will make a change of CEO particularly
beneficial to a troubled firm. In addition, a new CEO’s fit with contextual requirements is more
likely to directly address the troubled firm’s problems, and thus will be well-received by the
stock market, and bring subsequent performance improvements.
51 With 140 CEO replacements in 223 turnaround situations for Standard and Poor’s 1500
index companies from 1992 to 2003, I find that CEO replacement announcement in turnaround
situations tends to receive positive immediate market reaction; however, CEO replacement per
se does not have any effect on subsequent performance. In addition, I find considerable support for the context-person fit arguments: the presence of the predecessor’s misfit and the successor’s fit with the context has strong performance implications.
3.1. Theoretical Background and Hypotheses
3.1.1. Main Effect of CEO Replacement in Turnaround Situations
No firm is immune from performance decline, no matter how glorious its prior history
(Hofer, 1980). Slowdown in revenue growth, decline in market share, as well as increase in costs, make an established firm that once delivered generally satisfactory performance fall into a turnaround situation (Hofer, 1980; Hambrick & Schecter, 1983; Pearce & Robbins, 1994). The incumbent CEOs in troubled situations are under pressure to hold responsibilities for the declining performance (Dyck & Zingales, 2002; Ocasio, 1994; Parrino, et al., 2003; Wiesenfeld, et al., 2008). It is not surprising for prior research to document that, compared to normal situations, CEOs in troubled turnaround situations are more likely to be replaced (Bibeault, 1982;
Schwartz & Menon, 1985). The troubled firms change their leaders with an expectation to turn the situation around; however, is CEO replacement really related to performance improvement?
Although no research, to the best of my knowledge, has empirically studied the implication of CEO replacement in turnaround situations (Finkelstein & Hambrick, 1996), CEO succession and its performance consequences, in general, has attracted lots of attention in an array of academic fields. The origin of succession research could be traced back to two early
52 case studies, in which one found a negative effect of CEO succession (Goulder, 1954) and the other documented a positive effect (Guest, 1962). The following decades of research have produced more than 50 other published empirical articles on performance consequences of executive successions, however, the research findings to date are mixed (Karaveli, 2007). They have proposed different theoretical arguments to explain why CEO succession may have positive, negative or no effect on post-succession performance. I review this stream of studies and incorporate their thoughts when discussing the pros and cons of CEO replacement in turnaround situations.
Positive effects of CEO replacement in turnaround situations: Prior studies have drawn managerial human capital and corporate governance literature to argue that a change of
CEO is beneficial. For instance, Castanias and Helfat (1991) suggested that top executives represent a key resource in obtaining sustained, competitive advantages for the firm. The poor performance in a turnaround situation implies that the incumbent’s knowledge and techniques are obsolete (e.g., Hambrick & Fukutomi, 1991; Henderson, Miller, & Hambrick, 2006), that the managerial capabilities cannot meet the environmental requirements (Tushman & Rosenkopf,
1996), or that there is management entrenchment (Jensen & Meckling, 1976). Therefore, CEO replacement could be seen as an organization’s efforts to remove managerial deadwood (Walsh
& Ellwood, 1991; Virany et al., 1992). A new CEO will bring an improved management quality, the required human and social capital, and the formula for success (Becker, 1964; Castanias &
Helfat, 1991), and thus improve the subsequent firm performance and the likelihood of successful turnaround.
CEO replacement is also argued as a pre-condition for an organizational reorientation
(Hofer, 1980; Virany, et al., 1992). The emergence of a turnaround situation suggests that current
53 practices and corporate strategies have certain weaknesses, or cannot deal with environmental
conditions. Although a strategic reorientation is needed, the organization might be experiencing
inertia and be resistant to change (Hannan & Freeman, 1984). Hence, CEO dismissal would help
to clear any counterforce of organizational change (Tushman & Romanelli, 1985). In addition,
prior literature took the approaches of organizational learning and adaptation to discuss CEO
replacement’s advantages (Pfeffer & Salancik, 1978; Tushman & Rosenkopf, 1996): a change of
CEO can fundamentally alter the knowledge, skills, and interaction dynamics at the top of a
company (Zhang & Rajagoplan, 2004); a change of CEO can be a response to the prior
incumbent’s misjudgments and limitations (Kahneman, 2003; Tversky & Kahneman, 1974). All these can in turn significantly improve firm performance.
Negative effects of CEO replacement in turnaround situations: Meanwhile, prior
research has also suggested a negative effect of CEO replacement on firm performance. First, a
change in corporate leadership would result in organizational discontinuity and disruption (Allen,
et al., 1979; Cannella & Hambrick, 1993; Grusky, 1963; Helmich & Brown, 1972). CEO
replacement usually accompanies with a change of other senior executives and strategic
refocuses. Such a change tends to cause anxiety within the organization and has spill-over effects
to external stakeholders. For instance, employees in the organization will lose clear goals and
objectives; suppliers or customers may choose other business partners to avoid the uncertainties
associated with the focal troubled firm. The detrimental effects of discontinuity are particularly
fatal for organizations which have not established routines to mitigate the potential turbulence
caused by a change of leader (Carroll, 1984; Grusky, 1963; Haveman, 1993).
Even if the organizations can successfully manage through the “continuity” issues during the succession period, new CEOs face the challenge of survival in the new position or in the new
54 organization. They have to learn to deal with new job requirements (if they are promoted from
the same company), or acquire knowledge about the details of the organization and business
operation (if they are hired from outside the company). Meanwhile, they are under pressure to
prove their ability to deliver in a relatively short time horizon given the firm has been in a
troubled situation. Thus, a high proportion of new CEOs have the difficulty to continue their
services for more three years, resulting in multiple changes of corporate leaders and a vicious
cycle of performance deterioration (Finkelstein & Hambrick, 1996). These arguments lead to the
prediction that CEO replacement may further hurt firms in turnaround situations.
No effect of CEO replacement in turnaround situations: Because of the opposing
effects of CEO replacement, the costs of a new leader are very likely to cancel out the benefits,
and thus lead to no relationship between CEO replacement and firm performance. In addition,
existing studies have questioned the extent that a CEO can influence the organizational outcome
(Hannan & Freeman, 1977; Lieberson & O’Connor, 1972). They suggest that a change of CEO is
no more than a scapegoat. Specifically, managers are scapegoats, often being dismissed during performance stumbles. The improvement in post-succession performance is not because of the
new managers, but because of the regression to mean effect (e.g., Allen, et al., 1979). CEO
replacement is also considered as a symbolic action or impression management for the company
to placate its stakeholders when firm performance declines (Pfeffer, 1981). Such a symbolic
action may not have substantive effects on performance from a long-term perspective. This line
of thoughts draws the conclusion that a change of CEO does not influence firm performance.
A summary of the above arguments suggests that the positive effects of CEO replacement
in turnaround situations are interweaving with the negative effects, as well as the symbolic or
scapegoating considerations. Because the opposing theoretical frameworks lead to different
55 predictions, it is more sensible for me to state my overarching research question, rather than
propose any ex ante hypothesis on whether CEO replacement helps or hurts firms in turnaround
situations. Since I am interested in both immediate and long-term influences of CEO replacement,
my question is as follows:-
Research Question: In the context of turnaround situations, does an announcement of CEO replacement bring about a positive initial market reaction? Is CEO replacement positively associated with subsequent performance?
3.1.2. Importance of Context-Person Fit
If we cannot propose a general hypothesis on the main effect of CEO replacement in turnaround situations, can we instead suggest the conditions under which a change of CEO is more beneficial (or less harmful) to troubled firms? The work of Finkelstein and Hambrick (1996) provides an insightful framework. They suggested that CEO replacement represents an opportunity for a firm to realign its corporate leader with the contextual environments, and they further developed a “fit-drift/shift-refit” model (Finkelstein & Hambrick, 1996: 199). They argued that the board, when selecting a corporate leader, strives to hire a person whose competencies fit the environmental requirements. The new executive may not fit perfectly, as organizational inertia or political factors may make the selection deviate from the normative ideal. In general, however, the new leader is typically more appropriate than a randomly selected person.
However, the executive who initially fits the contextual requirements may fit less well as time passes. This change is due to the gradual drift (or radical shift) in the environment that may require capabilities and skills different from those of the incumbent; it will be the rare executive who can transform his or her mindset, aptitudes, and skills to match such environmental changes
56 (Miller, 1991). When the incumbent is replaced, the board has another opportunity to refit the executive competencies to the new requirements of the environment.
This “fit-drift/shift-refit” model addresses the importance of “fit” and provides a normative framework to understand the potential effects of CEO succession. However, scholars have yet to explore what it means for a leader to “fit with the context”. In the paper I further develop this “fit-drift/shift-refit” model by proposing a concept of “context-person fit”, suggesting the conditions where executives have competencies and skills aligning (misaligning) with the contextual requirements in turnaround situations. The executives whose competencies and skills match the contextual requirements are relatively likely (compared to those without such alignments) to overcome the challenges posed by the environment, and thus bring performance improvement (Virany, et al., 1992).
Given that the CEO replacement involves both a departure of predecessor (incumbent) and a succession of new CEO (successor), the concept of context-person fit has two-headed implications in predicting the potential effects of CEO replacement. On the one hand, the worse the context-person fit for the predecessor (or, the greater the misfit), the more likely that CEO replacement will be helpful in turning the situation around; on the other hand, the better the context-person fit for the successor, the more likely that the new CEO will increase the firm performance. Thus, both the successor’s “fit with the context” and the predecessor’s “misfit with the context” would make the effects of replacing an incumbent with a new CEO more positive
(or less negative). Next, I analyze the contexts of firms in turnaround situations and the characteristics of CEOs to develop different types of context-person fit for both predecessors and successors, and then further hypothesize their potential influences on firm performance.
57 Since I exclusively focus on troubled firms in my study, there is an implied preface in each of my hypotheses: “In the context of turnaround situations …”
3.1.2.1. Predecessor’s Misfit
Environmental turbulence and incumbent’s tenure: Among CEO characteristics, CEO tenure has received the most attention in the previous studies (e.g., Finkelstein & Hambrick,
1990; Hambrick & Fukutomi, 1991; Shen & Cannella, 2002). On the one hand, a longer tenure suggests that CEOs have accumulated more firm-specific knowledge and thus have a positive influence on firm performance (Castanias & Helfat, 1991; Harris & Helfat, 1997). On the other hand, the longer the tenure of the CEOs, the more entrenched they are likely to become (Hill &
Phan, 1991). Long-tenured CEOs are also very likely to increase their commitments to their strategic paradigms and earlier success formulas (Hambrick, Geletkanycz, & Fredrickson, 1993), and therefore refuse to initiate change and cause organizational inertia (Hannan & Freeman,
1984; Miller, 1991). Given these potential benefits and costs, prior studies have suggested that whether a long-tenured CEO helps or hurts firm performance depends on the dynamism of the external environment.
If the external environment is stable enough so that knowledge accumulated today remains useful tomorrow, firms with longer-tenured executives will have less concern about their
CEO’s misfit with the external environment. Indeed, in stable environments the informational and decision-making requirements are more standardized and routine, and problem solving is more systematic (Kotter, 1982). The incumbent’s established capabilities or accumulated firm- specific knowledge are actually more valued and less likely to be outdated (March, 1991).
However, if the external environment is turbulent so that customer preferences, technologies, and
58 competitive dynamics change quickly, a misfit between the CEO’s paradigms and external
conditions accrues rapidly (Henderson, et al., 2006). The executive’s competencies and skills
developed in the focal firm are very likely to become obsolete or unsuitable to the new
contextual requirements. According to this line of logic, Henderson and his associates found that
in the stable foods industry, firm performance improved steadily with CEO tenure, with downturns occurring, on average, only among those few CEOs who served more than 10 to 15 years. However, in the dynamic computer industry, the CEOs were at their best when they started their jobs, but firm performance declined steadily across their tenures (Henderson, et al.,
2006). Therefore, I argue that a long-tenured CEO in a turbulent environment is a case of a context-person misfit. In a scenario of a greater predecessor’s misfit, CEO replacement will be particularly helpful for firms in turnaround efforts.
Hypothesis 1: CEO replacement will improve the (a) immediate market reaction to the CEO replacement announcement and (b) subsequent performance to the extent that the current environment is turbulent and the incumbent’s tenure has been long.
Performance severity and incumbent’s tenure: Firms in turnaround situations differ not only in the environmental turbulence, but also in the performance severity (Barker &
Duhaime, 1997; Hofer, 1980). If a firm is experiencing minor losses, continuation of the current strategy and avoiding organizational disruption may be sensible responses. However, if the
troubled firm’s performance is extremely poor, commitment to the status quo (CSQ) is very
likely to exacerbate the performance decline (D’Aveni, 1989; Tushman & Rosenkopf, 1996).
Firms in deep trouble need substantial change and strategic reorientations (Virany, et al., 1992).
However, some top executives are more committed to the status quo than are others. One
significant determinant of executive’s CSQ is tenure. As CEOs have a longer stay in the same
position, they tend to choose the way they feel more confident to operate the business, resulting
59 in reinforcement of prior practices and less likelihood to make changes in strategy and leadership profiles (Hambrick & Fukutomi, 1991; Hambrick, et al., 1993). Thus I expect that a long-tenured incumbent will misfit with the contextual requirements if the performance situation is severe.
Under such a misfit scenario, replacing the predecessor with a new CEO will be beneficial to firms in turnaround situations.
Hypothesis 2: CEO replacement will improve the (a) immediate market reaction to the CEO replacement announcement and (b) subsequent performance to the extent that the company’s performance situation is severe and the incumbent’s tenure has been long.
Performance severity and incumbent’s functional background: The performance severity also has implications for the type of turnaround strategy needed (Hambrick, 1985; Hofer,
1980). Prior research has conceptualized a link between the severity of the performance decline and the degree of cost or asset reductions that a firm should include in its recovery responses
(Hofer, 1980). Cost cutting and asset reduction, or retrenchment strategies, are recommended for firms in more severe turnaround situations (Hofer, 1980; Pearce & Robbins, 1994). The underlying logic is that if a troubled firm is far below the break-even point, it is very difficult, if not impossible, for the firm to increase total revenue enough to achieve a profit position. Instead, reducing costs or assets becomes the first essential step for turning the situation around
(Hambrick, 1985). In contrast, firms in less severe situations, or slightly below the break-even point, are more flexible in choosing either revenue-generating or cost-cutting strategies to achieve their turnaround. Given that firms in deep troubles are in a greater need of cost or asset reduction, top executives with competencies in these domains, as opposed to competencies in, say, increasing revenues, would represent a better context-person fit. In this vein, I highlight the importance of an executive’s functional experiences.
60 Prior research suggested that executive’s functional background provides a lens through
which he or she sees business problems and solutions in general (Dearborn & Simon, 1958;
Fligstein, 1990). This stream of research argues that functional experiences will influence an
executive’s cognitive frameworks, perceptions, and interpretations, all of which will in turn
affect his or her decision making and strategic choices (Carpenter, et al., 2004; Hambrick &
Mason, 1984). A correspondence between functional background and individual competencies
could be explained by at least two reasons. First, individuals may be attracted to the functional
areas that suit their strengths and personalities (Schein, 1968; Schneider, 1987). In addition, with
the passage of time and particularly the accumulation of career successes in a functional area,
executives are immersed in that professional area and tend to develop a mode of thinking and
acting that is typical for that specific area (Blau & McKinley, 1979). Thus, at the time when a
manager has climbed to the apex position, his or her functional background usually represents
the area in which he or she has expertise.
For example, an executive with a throughput-oriented background (e.g., operations,
finance, and accounting) tends to address the value of cost cutting, asset rationalization, and operating efficiency, and is very likely to use the approaches that he or she feels comfortable with to turn the performance around. By contrast, another executive with an output-oriented background (e.g., marketing and sales) tends to emphasize sales growth and market expansion as recovery strategies, which are less appropriate for firms in deep trouble. Given that a retrenchment strategy is more beneficial to firms in very severe situations, an incumbent with a non-throughput function represents another type of misfit with the context. Thus CEO replacement would be in general related to better performance in the presence of such a predecessor’s misfit.
61 Hypothesis 3: CEO replacement will improve the (a) immediate market reaction to the CEO replacement announcement and (b) subsequent performance to the extent that the company’s performance situation is severe and the incumbent’s primary functional experience is not in throughput functions.
Sources of performance problem and incumbent’s functional background: Firms in turnaround situations also vary in the sources of performance problems (Hofer, 1980; Schendel, et al., 1976). While the severity of the problems refers to the magnitude of poor performance, the sources of the problems refer to the underlying origin or cause of performance troubles. Early turnaround studies have suggested that performance declines can be caused by either operating problems (e.g., production bottle-necks, labor strife) or strategic factors (e.g., intense price competition). A match between the causes of decline and turnaround strategies was proposed, such that operating turnarounds were argued to be appropriate for poor-operation-induced declines, whereas strategic turnarounds were seen as suitable for poor-strategy-induced declines
(Hofer, 1980; Schedel, et al., 1976). In this paper, I argue that, although various reasons for turnaround situations can be considered (e.g., global competition, technological turbulence, or labor strike), poor performance can be directly attributable to, or manifested by, either 1) a serious decrease in sales or 2) a substantial increase in costs or asset problems. Following the earlier idea of match (Hofer, 1980), and the previously discussed context-person fit argument, a leader with competencies and paradigms directly addressing the declining firm’s sources of problems is deemed to fit the context.
To assess executives’ competencies and paradigms, their functional experiences are considered once again. Specifically, a CEO with a throughput background who has risen and thrived with efficiency-driven skills is very likely a talented cost cutter, and has a relatively fixed paradigm of operating efficiency. By contrast, another CEO with output background who has successfully climbed the corporate ladder with an outstanding sales or marketing track record is
62 very likely a market wizard, and has established a paradigm of revenue expansion. Depending on the sources of turnaround problems, troubled firms need executives with different competencies and capabilities. For example, if the sources of the problem are sales stagnation or market share erosion, but not cost control, an incumbent CEO who is good at cost cutting and operating efficiency will be relatively inappropriate. Even if the incumbent recognizes the contextual requirements of revenue expansion, he or she will have great difficulty organizing all the elements necessary to execute a strategy consistent with expansion, because such needed actions differ from his or her prior experiences and undermine the executive’s core skills (Porter, 1996;
Siggelkow, 2002). Thus, when the company’s problems are due to revenue declines, an incumbent with non-output expertise is likely to misfit the context. Again, such a case of predecessor’s misfit will make a change of CEO more valuable for firms in turnaround situations.
Hypothesis 4: CEO replacement will improve the (a) immediate market reaction to the CEO replacement announcement, and (b) subsequent performance to the extent that the company is experiencing sales problems and the incumbent’s primary functional experience is not in output functions.
3.1.2.2. Successor’s Fit
The above discussion on predecessor’s misfit only represents one side of the context- person fit argument, while the other is the new CEO’s fit with contextual requirements. It is eventually the successor who operates the company once he or she gets the baton from the predecessor. Thus I expect that the better the new CEO is suited to the context, the more positive the performance implications. Following the earlier development of predecessor's misfit, I consider three types of context-person fit for the successor.
Performance severity and CEO outsiderness: As discussed above, troubled firms vary in the degree of performance severity. If the firm’s performance is extremely poor, incremental
63 changes to existing strategy and procedures will probably not be sufficient, or even lead to
further decline into bankruptcy situation (D’Aveni, 1989; Tushman & Rosenkopf, 1996). Indeed,
firms with a more severe situation need a substantial and discontinuous change, and I argue that
such firms will benefit from a new successor with a greater extent of “outsiderness.”
CEO outsiderness is a concept developed by Finkelstein and Hambrick (1996) in addressing the limitations of prior research on CEO origin. Extant studies investigating the
effects of CEO origin have developed the idea of insider versus outsider (i.e., whether the new
CEO is hired from inside or outside the firm) (Boeker, 1997; Beatty & Zajac, 1987; Cannella &
Lubatkin, 1993). However, such a strictly binary term is at odds with the reality that there are
degrees of “outsiderness.” For instance, compared to a new CEO hired directly from outside the
company, a new CEO who has three years’ tenure in the focal company is an insider. However,
that new CEO with three years’ tenure is very much an outsider compared to one who has 25 years’ tenure (Finkelstein & Hambrick, 1996). Similarly, compared to a new CEO hired from
outside the industry, a new CEO from the same industry is an insider.
The deeper theoretical implications of CEO outsiderness are that the greater the extent of outsiderness, the greater the likelihood that the new CEO will be cognitively, socially, and interpersonally open to change, and the stronger will be the signals to internal and external parties that the company is committed to change (Finkelstein & Hambrick, 1996; Karaveli, 2007).
Nevertheless, prior research has also pointed out the potential negative effects of outside CEOs.
Since extreme outsiders do not have any experience in the focal firm and industry, they may have very limited understanding on the firm’s business and operations (Karaveli, 2007). Their strategic change or reorientation might be based on little knowledge about the firm, and thus lead the troubled company to a wrong direction. However, I argue that if firms are in very severe
64 situations, routine change might be insufficient. Instead, these firms may need non-traditional or innovative change. An extreme outsider without historical embededness with the focal firm or emotional attachment to the prior strategy is more likely to provide fresh perspectives on strategic formulation and implementation, to initiate substantial change to turn the performance around. Therefore, in a more severe situation, a more extreme outside successor has a better fit with the context, and thus has better performance implications.
Hypothesis 5: When the company’s performance situation is more severe, a successor with a greater extent of outsiderness will be positively related to (a) initial market reaction to the CEO replacement announcement, and (b) subsequent performance.
Performance severity and successor’s functional background: Drawing prior studies on business turnaround (Hofer, 1980; Hambrick, 1985; Pearce & Robbins, 1994), I have developed an argument that firms in a more severe situation need top executives with throughput functional background. This is because throughput-oriented CEOs are more likely to have competences in developing and implementing retrenchment strategies, and such turnaround strategies are more suitable for firms in deep troubles. Thus, a new CEO with a throughput background would represent a good fit with the context if the performance situation is more severe. CEO replacement will be particularly beneficial (or less harmful) if a deep troubled firm is succeeded by a throughput-oriented CEO.
Hypothesis 6: When the company’s performance situation is severe, a successor with throughput-oriented expertise will be positively related to (a) initial market reaction to the CEO replacement announcement, and (b) subsequent performance.
Sources of performance problem and successor’s functional background: In the above development of predecessor’s misfit, I suggest that sales-problem firms are in a greater need of executives with outstanding sales growth or market explanation expertise. Thus, a new
CEO with an output background would have a better fit with a firm whose problem is a serious
65 decrease in sales. An interaction between sources of performance problem and successor’s
functional background would have positive performance implications.
Hypothesis 7: When the company’s problems are due to revenue declines, a new CEO with output-oriented expertise will be positively related to (a) initial market reaction to the CEO replacement announcement, and (b) subsequent performance.
3.2. Data and Methods
3.2.1. Sample Selection
I used the following three steps to identify firms in turnaround situations. First, all sample
companies are domestic, non-diversified (at least 70 percent of sales from the primary “SIC
three-digit” industry), and non-financial firms which are or were members of Standard and
Poor’s 1500 index members. Second, they have annual sales greater than $100 millions, have
positive equity values, and have their shares publicly traded for more than three years. These
criteria are used to ensure that they are well-established companies before they fall into
turnaround situations. Third, their net return (income before extraordinary items) on equity (ROE)
is higher than the cost of equity (COE) in any two consecutive years from 1990 to 2002, which
are immediately followed by net losses (negative profits) in any year from 1992 to 2003. Two
consecutive years of net ROE greater than COE suggest that declining firms once deliver
satisfactory results5, and the net losses in the following year indicate that they start to have
significant performance problems. I should note that this is a specific type of turnaround situation: such a sample selection process is designed to identify firms with abrupt and distinct performance decline, but not firms suffering ongoing performance decline for a long period of time.
5 Although there is no widely-recognized criterion to define a company of satisfactory performance, the one I used here is relatively stringent. For instance, only about half (262) of Standard and Poor’s 500 Index Members have two consecutive years of ROE greater than COE in the 2005-2006 period.
66 For the data sources, net income and ROE were collected from COMPUSTAT database.
Cost of equity was calculated based on the following equation: COEit = Riskft + βit * Riskp, where Riskft is the risk-free rate proxied by the return rate for 1-year U.S. government treasury
bills at yeart; βit is the beta for the firmi at yeart estimated with its prior five-year monthly return
data provided by CRSP database; and Riskp is the market risk premium, usually at a rate of 5 to 7
percent (Stewart, 1991; Welch, 2000). I used the 7 percent as a more conservative way to
identify once-healthy firms in turnaround situations (Brealey & Myers, 2000; Stewart, 1991).
Applying the above criteria to the universal companies in the COMPUSTAT database, I identified a total of 223 turnaround situations which occurred in the 1992-2003 period. I defined the year of making losses as Year 0 when firms enter turnaround situations, and traced each firm from two its pre-decline years (Year -2 and Year -1) to its three post-decline years (Year +1, +2, and +3).
Next I used ExecuComp and Factiva Database to identify whether and when CEO replacement occurred in each turnaround situation. Out of 223 turnaround situations, a total of
140 replacement events took place during the period from Year 0 to Year +2 (I excluded 21 replacements events involving interim CEOs). I examined CEO replacement events from Year 0 to Year +2 because firms in turnaround situations may vary in their responses to the troubles, including whether and when the incumbent are replaced.
3.2.2. Dependent Variables
Initial market reaction: The market’s initial reaction was measured by abnormal return.
A firm’s daily abnormal return is the difference between the firm’s actual daily return and the return predicted by the market model using the estimated parameters. Following the argument of
67 market efficiency (Bromiley, Govekar, & Marcus, 1988), I chose a three-day event window
(from day -1 to day +1, assuming day 0 is the announcement date) to calculate the initial market reaction to the CEO replacement announcement. The sum of three days’ abnormal return was the
cumulative abnormal return (CAR). These data were collected from CRSP database.
In the events where the new CEO’s succession date is different from the predecessor’s
departure date, I used the departure date, except for the hypotheses testing successor’s context-
person fit (e.g., Hypotheses 5, 6 and 7) where the succession date was used. To control for
confounding events such as mergers and acquisition, earning announcements, or declarations of
dividends (McWilliams & Siegel, 1997), I checked for these events in the Factiva database
during a 5-day window (from day -2 to day 2) around the announcement date and excluded any
announcements with these confounding events. My final sample to test initial market reaction
consisted of 99 departure announcements, and 101 succession announcements.
Subsequent performance: I used net ROE6, market-to-book ratio, and a dummy
variable indicating a successful turnaround at Year +3 to measure a troubled firm’s subsequent
performance7. Net ROE represents an accounting-based indicator; market-to-book ratio captures
a market-based performance; and a successful turnaround, coded as “1” if a troubled firm’s net
ROE in Year +3 is greater than its COE, suggests that the troubled firm has recovered from its
performance problem. The use of multiple measures has the advantage to investigate the
subsequent performance from different but related perspectives, and is generally been considered
as more desirable (e.g., Karaveli, 2007; Shen & Cannella, 2002; Zhang & Rajagoplan, 2004).
6 I also used net ROA as alternative accounting-based measures of post-decline performance. The results of these models are very similar to what I report here. 7 I applied a three-year time frame to measure subsequent performance. Such a time frame is consistent with other research on the performance consequences of executive succession. I also tried the average of performance indicators in Year +3 and Year +4. All the significant findings I report here remain.
68 3.2.3. Independent and Context-person Fit Variables
CEO replacement: It was a dummy variable, coded as “1” if a firm in a turnaround situation has replaced its CEO during the period from Year 0 to Year +2. As will be described later, I added year of replacement to control for the potential effects of how quickly the CEO has been replaced.
I have several context-related (i.e., environmental turbulence, performance severity, and
sales-problem firms) and person-related variables (i.e., tenure, outsiderness, throughput and
output function), an interaction of which constitutes the measurement of predecessor’s misfit and
successor’s fit. In the following I discuss how I measure each of these context-person fit
components.
Environmental turbulence: To measure environmental turbulence, I began by summing
the sales of all sampled firms in a given industry (classified with three-digit SIC codes). A prior
five-year average volatility measure reflects turbulence (for example, sales from Year -5 to Year
-1 were used to obtain environmental turbulence in Year 0) (Keats & Hitt, 1988). I extracted
sales data in each industry from COMPUSTAT dataset. And then regressed net sales on time
over the five years as follows: Industry Net Sales j = β0 j +β1 j (year) + e j , Where β0 j is the
intercept coefficient of the regression modeling industry net sales, year is the discrete time period
for each firm-year observation weighted by the slope coefficient and indexed by year = 1, 2, … 5,
β1 j is the slope coefficient for year, and e j represents the error term for the regression. Following
prior research, environmental turbulence is measured by the standard error of the regression
slope coefficient (e.g., Carpenter & Fredrickson, 2001; Palmer & Wiseman, 1999; Wiersema &
Bantel, 1993).
69 Performance severity: It was measured by the reverse coding of firm performance at
Year 08. The worse the net ROE (or market-to-book ratio, to correspond different measures of
subsequent performance I used in different models), the greater the performance severity.
Sales-problem firm: Firms in turnaround situations could be largely attributed to either
sales-problem firms or cost-problem firms. I defined a troubled company as a sales-problem firm
if its sales dropped more than five percent from Year -1 to Year 0, and there was no asset
reduction or major divestiture in the corresponding period to rule out the possibility that the sales
decline was because of reduced business scope. 9
Incumbent’s tenure: It was the number of years an incumbent CEO held the top position
in the focal firm at Year 0 (including CEOs who were eventually replaced, and those who
continued their services, in turnaround situation). I generated an interaction term between the
environmental turbulence and the incumbent’s tenure to test Hypothesis 1, and between the
performance severity and the incumbent’s tenure to test Hypothesis 2. To reduce non-essential
collinearity, all variables used in the interactions were mean-centered (Cohen, Cohen, West, &
Aiken, 2003).
CEO functional background: To operationalize a CEO’s functional background
(including both predecessor and successor), I coded his or her primary functional area from
proxy statements, Dun & Bradstreet’s reference Book of Corporate Management, or Standard &
Poor’s Register of Corporations, Directors, and Executives. CEO’s functional background was
8 Severity of turnaround situation was also measured by the difference between firm performance in Year -1 and Y0. The results are qualitatively the same. 9 It is less clear to identify a cost-problem firm because an increase in cost (e.g., a decrease in gross margin) could be due to either a decrease in sale or an increase in cost. In addition, it is sensible to argue that all non-sales-problem troubled firms are cost-problem firms. In analysis I didn’t report here, I tried to define a troubled company as a sales-problem firm if the sales growth rate is lower than the industry median, and as a cost-problem firm if the operating cost increases at a higher rate than the industry median. The correlation between the sales-problem firm and cost-problem firm was -0.76. Therefore, I only focused on sales-problem firm and its interaction with a CEO’ output background.
70 the functional area in which he or she had the longest employment history. Following prior
research, CEO’s primary background is categorized by either output (marketing, sales, and product development), throughput (operations, engineering, finance or accounting), or other (law,
consultant, general management) function (Hambrick & Mason, 1984). Based on this
categorization, I created a dummy variable named Non-throughput incumbent, and coded as “1”
if the incumbent CEO’s primary background was not throughput function; and “0” otherwise. I
also created a dummy variable named non-output incumbent, and coded as “1” if the
incumbent’s primary function was not output-oriented; and “0” otherwise. I generated an
interaction between performance severity and non-throughput incumbent to test Hypothesis 3,
and between sales-problem firm and non-output incumbent to test Hypothesis 4.
Similarly, I created a dummy variable named throughput-oriented successor, and coded
as “1” if the successor’s primary function was throughput related; and another dummy variable
name output-oriented successor, and coded as “1” if successor’s primary function was output
related. To test Hypothesis 6, I created an interaction between performance severity and
throughput-oriented successor; and to test Hypothesis 7, I created another interaction between
sales-problem firm and output-oriented successor. Positive effects of these interactions would
support my hypotheses.
Successor’s outsiderness: Prior research only used an insider versus outsider dichotomy
to categorize CEO origin (Kesner & Sebora, 1994; Shen & Cannella, 2002; Zajac & Westphal,
1996). Finkelstein and Hambrick (1996) argued that viewing CEO successions in binary terms is
a very limited approach since there are degrees of “insiderness” and “outsiderness”, and “… the
biggest breakthroughs in the study of insider versus outsider succession will come from a new
conception of “outsiderness” (p.183). Following their line of logic, successor’s outsiderness was
71 measured as a continuum, ranging from extreme insiders to extreme outsiders. A 7-point ordinal
scale was used as follow: New CEOs with more than 15 years in focal firms were categorized as
extreme insiders (with an outsiderness score of “1”), followed by those with medium tenure (6 to
15 years, with a score of “2”), and with short tenure (1 to 5 years, with a score of “3”) in the focal firms. Then the outsiderness of new CEOs increased if they were outside directors of the focal firms (with an outsiderness score of “4”), further increased if they were hired from the same industry (with a score of “5”), and then from the related industry (with a score of “6”).
Finally, the extreme outsiderness occurred if new CEOs were hired from unrelated industry (with a score of “7”). Such a 7-point continuum measure of new CEO outsiderness was intended to
capture the underlying construct of the insider versus outsider CEO more adequately, with a
more fine-grained measure10.
I generated an interaction term for the severity of a situation and successor’s outsiderness
to test Hypothesis 5.
3.2.4. Control Variables
I also included a number of control variables, depending on the model specifications.
Prior performance at Year -2 and Year -1: Prior performance at Year -2 and Year -1
indicates a company’s healthiness before the performance troubles, and thus is expected to have
a positive effect on subsequent performance, given that a healthier company will tend to perform
better. It was measured by the average firm performance of Year -2 and Year -1.
10 I have also tried to measure CEO outsiderness as an index variable by summing the inversed standardized (Z- score) firm and industry tenure of the new CEO (Karaveli, 2007). For instance, a new CEO who has a 5-year tenure in the focal firm’s industry, but has no focal firm’s tenure, is twice as much an outsider as another new CEO who has a 5-year firm tenure, and has no additional tenure in the same industry (because in the latter case the new CEO is regarded as having a 5-year industry tenure as well). The results of this outsiderness measure are consistent with those I report here.
72 Firm performance at Year 0: To control for the potential effect of regression to mean
(Allen, et al., 1979; Shen & Cannella, 2002), I also included firm performance at Year 0 as an
additional control.
Performance change in the industry: I controlled for the change of performance in a given industry (again, classified with three-digit SIC codes) because the troubled firm’s
performance at Year +3 is very likely to correlate with its industry’s performance change
between Year 0 and Year +311.
Firm age: It was measured by the number of years that a firm has been publicly listed at
Year 0. Data were collected from CRSP.
Firm size: It was measured by the logarithm transformed sales at Year 0.
Strategy change: It captures the extent to which a firm’s strategy has changed from
Year 0 to Year 3. The measurement I used is a variation of Finkelstein & Hambrick (1990)’s
strategic persistence measure. First, I collected six strategy indicators from COMPUSTAT.
These indictors included advertising intensity (advertising/sales), research and development
intensity (R&D/sales),12 plant and equipment newness (net P&E/gross P&E), nonproduction
overhead (SGA expenses/sales), inventory levels (inventories/sales), and financial leverage
(debt/equity) (for a detailed explanation of the justification behind using these six indicators,
please see Finkelstein & Hambrick, 1990: 491). Then I calculated the absolute difference for
each indicator from Year 0 to Year +3, implying the change of each strategy dimension over the
three year period. Finally, I standardized the absolute difference and sum the z-scores of each
indicator to get the index of strategy change for each troubled firm from Year 0 to Year +3.
11 For the above three performance-related control variables, I used ROE measure if the dependent variable was initial market return, net ROE or the likelihood of successful turnaround at Year +3; and used market-to-book measure if the model had market-to-book at Year +3 as its dependent variable. 12 For those companies which didn’t report their advertising or R&D expenses, I used industry median values (classified with three-digit SIC codes) to replace the missing data.
73 Top management team (TMT) change: It suggests the extent of change in senior
executives from Year 0 to Year +3. It is the sum of executives exiting the focal firm and those
entering the focal firm over the three year period, divided by the total number of executives at
Year 0.
Replacement year dummy: CEO replacement may occur in any time from Year 0 to
Year +2. To control for the potential effect of how quickly the CEO has been replaced, I created
two dummies: replacement in Year 0 (coded as “1” if the replacement happened during the Year
0, and “0” otherwise), and replacement in Year +1 (coded as “1” if the replacement happened
during the Year +1, and “0” otherwise). Replacement in Year +2 was the omitted variable.
Multiple replacement dummy: Firms in turnaround situation may have multiple CEO replacements during my investigation period from Year 0 to Year +2. Prior research suggested that multiple changes are negatively related to post-succession performance (e.g., Allen, et al.,
1979), thus, I included a dummy variable to control for its potential effect.
Prone to CEO replacement: Since CEO replacement does not occur randomly, it is necessary to correct for any “selection” bias in analyzing the effects of replacement and context- person fit on the post-decline performance. Following the procedure used in prior research
(Stuart et al., 1999; Zajac & Westpha, 1996), I used the Heckman two-staged model (Heckman,
1976, 1979). In the first stage, I used firm performance (measured by net ROE at Year 0), CEO
characteristics (measured by CEO age), agency factors (measured by outside director ratios, and
CEO ownership) to predict whether CEO replacement occurs when firms fall into turnaround
situations. Each of these predicting variables was significant. An inversed Mill’s ratio was
generated in the first-stage model, and then was included in the second-stage analysis as an
74 instrumental variable to correct for any selection bias (Heckman, 1979; Van de Ven & van Praag,
1981).
3.3. Results
Table 1 presents the descriptive statistics and correlations for all variables I used to address my first research question and test hypotheses on the context-person fit arguments.
------Insert Table 1 here ------
3.3.1. Main Effect of CEO Replacement in Turnaround Situations
Because of the opposing theoretical arguments on the effect of CEO succession, I didn’t
propose any specific hypothesis on the main effect of CEO replacement in turnaround situations.
Instead I used empirical data to explore its immediate and long-term performance consequences.
To study the stock market’s initial reaction to CEO replacement announcement in turnaround situations, I applied the event study methods (McWilliams & Siegel, 1997). I calculated the firm’s market-adjusted daily abnormal return on the day prior to the announcement (day -1), the day of the announcement (day 0), and one day after the announcement (day +1) respectively. I also calculated the three-day cumulative abnormal returns (CAR) from day -1 to day +1. Results are presented in Table 2. They show that average daily abnormal returns on day -1 are 0.36% with a marginal significance (p < 0.10), and on day +1 are positive and significant (0.59%, p <
0.05). In addition, the three-day cumulative abnormal returns are highly significant (1.04%, p <
0.01). In sum my data suggest that the market in general responds favorably to CEO replacement announcement when firms have fallen into turnaround situations
75 ------Insert Table 2 here ------
Table 3 reports the main effect of CEO replacement in turnaround situations on subsequent performance. I have three separate models because subsequent performance is measured by net ROE, market-to-book (MTB) and successful turnaround (ST) at Year +3.
Columns starting with 1 (i.e., 1, 1’ and 1’’) include all control variables, and Columns starting with 2 include our interested variable - CEO replacement. Results show that CEO replacement is not significant across ROE, MTB and ST models. To test whether an early replacement of CEO differs from a late replacement, I further substituted the variable of CEO replacement with three time-related dummies - CEO replacement during Year 0, during Year +1, and during Year +2 - in Columns starting with 3. Again, there is no significant result. Therefore, I did not find any evidence suggesting that CEO replacement will increase subsequent performance.
------Insert Table 3 here ------
3.3.2. Predecessor’s Misfit
Table 4 reports the effects of predecessor’s misfit. Columns starting with 1 (i.e., 1, 1’, 1’’ and 1’’’) include all control variables; Columns starting from 2 to 5 include each type of predecessor’s misfit; and Columns starting with 6 are the final models. For the CAR Model testing initial market reaction, I dropped the control variables of performance change in the industry, strategy change, TMT change, and multiple replacement of CEO, because these factors do not surface at the timing of CEO replacement announcement. In addition, CEO replacement in CAR model by default equals to one, because I cannot collect market reaction if there is no
76 such an event. Thus the CEO replacement and interactions involved CEO replacement were
dropped.
------Insert Table 4 here ------
Results in Column 2 of CAR Model show that the interaction between environmental turbulence and incumbent’s tenure is positive (β=0.04, p < 0.05). Columns 2’ of ROE, 2’’ of
MTB and 2’’’ of ST Models show that the three-way interactions between CEO replacement, environmental turbulence and incumbent’s tenure are all positively significant (β=0.08, p < 0.01 in ROE model; β=0.45, p < 0.05 in MTB model; and β=0.38, p < 0.05 in ST model). These significant results remain in the full models - Columns starting with 6. Therefore, CEO replacement has a positive effect on both immediate and subsequent performance to the extent that the environment is turbulent and the incumbent has a long tenure. My hypothesis 1 is supported.
Next, I investigated the effects of another type of predecessor’s misfit – performance severity coupled with long-tenured incumbent. Results in Column 3 of CAR Model show that the interaction between performance severity and incumbent’s tenure is positive (β=0.03, p < 0.05), but such significance does not sustain in full model of Column 6. The three-way interaction between CEO replacement, performance severity, and incumbent’s tenure is positively significant in Columns 3’ of ROE Model (β=0.07, p < 0.05) and 3’’’ of ST Models (β=2.52, p <
0.01). Such significance remains in the full models (Columns 6’ and 6’’’). The only case that I did not find any significant result is MTB Model. Therefore, my hypothesis 2 is largely supported.
77 The following Columns starting with 4 test another predecessor’s misfit - an interaction
between performance severity and non-throughput incumbent. First, I did not find significant
results in the immediate market reaction (i.e., CAR model). Second, although I found significant
results for the three-way interaction in Columns 4’ of ROE (β=0.49, p < 0.05), 4’’ of MTB
(β=0.22, p < 0.10), and 4’’’ of ST Models (β=1.24, p < 0.10), these results do not remain in the
full models (Columns starting with 6). Therefore, my hypothesis 3 is marginally supported.
Finally, Columns starting with 5 test the predecessor’s misfit between a sales-problem firm and a non-output incumbent. The only significant results I found across immediate and
subsequent performance models is the three-way interaction between CEO replacement, sales- problem firm and non-output incumbent in MTB model (β=1.03, p < 0.05), and its significance remains in the full model of Column 6’’ with β=1.31 (p < 0.05). Therefore, I only found very weak support for my hypothesis 4.
3.3.3. Successor’s Fit
Table 5 reports the effects of successor’s fit on initial market reaction and subsequent performance. It has a similar layout with Table 4. Columns starting with 1 include all control variables; Columns from 2 to 4 include each type of successor’s fit variables; and Columns starting with 5 are the final models. Similar to the predecessor’s misfit analysis, the CAR model dropped the controls of performance change in the industry, strategy change, TMT change, and multiple replacement of CEO. But different from predecessor’s misfit analyses which use the incumbent’s departure date, initial market reactions in successor’s fit models are calculated based on the new CEO’s succession date. In addition, in the subsequent performance analyses
(ROE, MTB and ST models), I can only include firms which eventually replaced their CEOs in
78 turnaround situations (because if there is no CEO replacement, I can not measure the new CEOs’ outsiderness and their functional background). Thus, the sample size dropped from 223 to 140.
------Insert Table 5 here ------
First, Columns starting with 2 add the interaction between performance severity and successor’s outsiderness. They are significant across four models (β =0.02, p < 0.05 in CAR model; β = 0.17, p < 0.01 in ROE model; β = 0.74, p < 0.05 in MTB model; and β =0.71, p <
0.01 in ST model), and their significance remains in the full models (Columns starting with 5).
Therefore, the stock market tends to respond positively to the interaction between the performance severity and a new CEO’s outsiderness; such an interaction is also positively related to subsequent performance. Therefore, Hypothesis 5 is supported.
Columns starting with 3 include the interaction between performance severity and a throughput-oriented successor. Surprisingly, I found the effect of the interaction is negative in
CAR model (β = -0.24, p < 0.05), positive in ROE model (β = 1.03, p < 0.01) and ST mode (β =
2.41, p < 0.01), and not significant in MTB model. Therefore, I found mixed evidence in testing
Hypothesis 6.
Columns starting with 4 add the interaction between a sales-problem firm and an output- oriented successor. They are significant across all models (β = 0.06, p < 0.05 in CAR model; β =
0.15, p <0.05 in ROE model; β = 0.66, p < 0.10 in MTB model; and β = 1.91, p < 0.01 in ST model), and their significance stays in the full models (Columns starting with 5). Therefore,
Hypothesis 7 is fully supported.
Comparisons of the adjusted (or pseudo) R-squared in Columns 1 and Columns 6 in
Table 4, and the change of R-squared from Columns 1 to Columns 5 in Table 5, imply that both
79 predecessor’s misfit and successor’s fit with context substantially improves the explanation
power of the regression models. For instance, Table 5 shows that the adjusted R-squared
increased from 0.03 to 0.12 in predicting CAR, from 0.02 to 0.15 in predicting net ROE, from
0.34 to 0.37 in predicting MTB, and 0.13 to 0.31 in predicting the likelihood of successful turnaround. These results suggest the critical role of context-person fit in understanding the
effects of CEO replacement in turnaround situations.
3.4. Discussion
Scholars in the fields of economics, sociology, finance and management have devoted
substantial attention on the performance consequences of CEO successions (e.g., Allen, et al.,
1979; Carroll, 1984; Gamson & Scotch, 1964; Huson, et al., 2004; Khurana, 2002; Vancil, 1987;
Weisbach, 1985; Zhang & Rajagopalan, 2004), but have derived little consensus on whether
CEO replacement helps or hurts an organization (Finkelstein & Hambrick, 1996; Gamson &
Scotch, 1964; Karaveli, 2007). Nevertheless, conventional wisdom suggests that a change of corporate leader is needed for a turnaround effort to be successful (Bibeault, 1982; Hofer, 1980), although no research has provided telling evidence supporting this statement. This paper tends to answer two related questions: 1) once a firm has fallen into turnaround situation, is CEO replacement beneficial or harmful? and 2) under what conditions has CEO replacement more positive (or less negative) performance implications?
In developing my theoretical arguments, I emphasized two levels of context. The first level is an overall context (i.e., the boundary of my research) – exclusively focusing on firms which have experienced an abrupt and substantial performance decline. This is because turnaround situations represent extreme cases in which a change of corporate leader tends to
80 have stronger implications, and it is more likely for researchers to find the effects of CEO
replacement, if any. However, for the main effect of CEO replacement in turnaround situations, I
did not propose any specific hypothesis because of the opposing arguments on the potential
positive, negative or no effect of CEO replacement.
The second level of context I highlighted is the “context-person fit”, a concept developed
from the “fit-drift/shift-refit” idea (Finkelstein & Hambrick, 1996). In the second level of context,
I argued that troubled firms differ in their contextual requirements, and an alignment between leaders’ competencies and contextual needs would have positive (or less negative) implications.
The context-person fit argument would have two-headed implications: in cases of predecessors whose competencies are badly suited to contextual requirements, or successors whose skills are well suited contextual requirements, a change of CEO has more positive performance implications. By analyzing the environmental turbulence, performance severity, and sources of performance problem in turnaround situations, as well as tenure, origin and functional
background of predecessors and successors, I hypothesized and empirically tested the influence
of predecessor’s misfit and successor’s fit on firm performance.
With a total of 140 CEO replacements in 223 turnaround situations from 1992 to 2003, I
documented that the stock market does in general respond positively to the announcement of
CEO replacement in turnaround situations. However, even in such an extreme situation I did not
find evidence supporting the notion that simply changing a CEO will improve subsequent
performance or increase the likelihood of successful turnaround. This is consistent with
Finkelstein and Hambrick (1996)’s statement that there can be no general answer to the question of whether executive succession helps or hurts an organization’s performance. Instead, the consequences of CEO replacement are contingent on a match (or mismatch) between the context
81 and person. In the article I found consideration supports for the context-person fit argument: in general, the greater the predecessor’s misfit with contextual requirements, the greater the value of CEO replacement; and the greater the successor’s fit with contextual requirements, the greater the market initial reaction, and the better the subsequent performance.
In the following Figure 3 where I illustrated the effect of “context-person fit” variables, I chose to use the influence of successor’s fit on subsequent performance. Specifically, my figures are based on Column 5’ of Table 5 (net ROE at Year +3) with a hypothetical firm that has net
ROE of -0.06 at Year 0 (approximately the median for my sample).
------Insert Figure 3 here ------
Figure 3a shows that an extreme outsider successor (outsiderness score equals to seven) performs worse than an extreme insider (outsiderness score equals to one) if the decline in the turnaround situation is not severe. However, if the poor-performing firm is in deep trouble (e.g., one standard deviation above the average of severity in my sample), an extreme outsider successor will outperform an extreme insider by about 8 percent in net ROE at Year +3.
Figure 3b shows the interaction effect between the severity of turnaround situation and a successor’s throughput background. Two lines start from the same point implying that if the performance trouble is only minor, it does not make any difference whether the successor is throughput-oriented or not. However, the line indicating that the successor has a throughput function background has a steep slope and increases substantially if the performance situation is very severe. When the troubled firm is one standard deviation above the average of performance severity in my sample, a successor with a throughput background will be able to outperform his or her peers with an output background by about 26 percent in net ROE, on average.
82 Figure 3c has a similar pattern as Figure 3b. When the troubled company is not a sales- problem firm (the score of sales-problem firm equals to zero), a successor with an output background has similar performance consequence with another new CEO without such a background. However, if a firm’s turnaround situation is mainly caused by a major decline in sales (i.e., sales-problem firm equals to one), an output-oriented successor will be very helpful in turning the situation around. Figure 3c illustrates that such a fit tends to increase net ROE by about 9 percent.
A comparison of the initial market reaction and subsequent performance of CEO replacement produces some interesting findings. First, it seems that the market tends to over- positively react to CEO replacement events, because CEO replacement per se does not have any subsequent performance implication, but the market reacts overwhelmingly positive. The reason could be due to the strong symbolic effects of CEO replacement: in turnaround situations: a change of CEO, even if it is scapegoating, will placate investors, creditors and other social arbiters (Boeker, 1992). Thus the market will applaud the news that the top person is replaced.
I also found that initial market reaction generally responds to the context-person fit as the subsequent performance does. In some cases, initial market reaction has positive reaction to a certain type of context-person fit (such as the interaction between performance severity and successor’s outsiderness), and such a fit also positively influences the subsequent performance.
In other cases where the effect on subsequent performance is not strong, stock market does not have significant reaction (e.g., the effects of the interaction between CEO replacement, performance severity and non-throughput incumbent shown in Columns 6 and 6’ of CAR and
ROE models). A more interesting finding is the contradictory effects of the interaction between performance severity and a throughput-oriented successor on immediate and subsequent
83 performance. While a throughput-oriented successor in a more severe situation tends to improve subsequent performance (in net ROE and TS models of Table 5), the stock market reacts negatively to such an interaction condition. One conjecture I provide is that the stock market generally devaluates cost and asset reduction as turnaround strategies. This conjecture may also explain why such an interaction is not significant in the MTB subsequent performance model: market-to-book mainly captures a firm’s growth potential, and a throughput-oriented successor might be good at cost and assets reduction, but less capable in building a high-growth company.
3.4.1. Theoretical Implications
First, my study directly extends CEO succession literature. Prior studies on CEO succession have emphasized the importance of incorporating precipitating context (Haveman,
1993; Shen & Cannella, 2002; Zhang & Rajagopalan, 2004) and the characteristics of new CEO
(Beatty & Zajac, 1984; Karaveli, 2007; Zajac, 1990) in understanding the effects of CEO replacement. However, they tend to treat them in a parallel or ceteris paribas form, but miss the interaction, or fit, between contextual requirements and personal characteristics. Such a fit argument is well developed in several streams of management research, such as population ecology (Hannan & Freeman, 1977), contingency theory (Lawrence & Lorsch, 1986), organizational configurations (Porter, 1996; Siggelkow, 2002), a match between person and organization (Chatman, 1989), and an alignment between organization and external environment
(Miller, 1991). Following this line of logic, and the idea of “fit-drift/shift-refit” proposed by
Finkelstein and Hambrick (1996), I further develop the fit argument in the CEO succession research. The concept of context-person fit proposed in the paper could also help to solve the contradictory findings in the prior research.
84 My study also contributes to turnaround literature. Early research on turnaround
situations suggests that a change of CEO is essential for a turnaround to be successful (Hofer,
1980). However, I found that although the stock market’s initial reaction is positive, simply changing a CEO does not bring about better subsequent performance. If the board is desperate in
hiring a new CEO to save the sinking company, not every new leader will deliver good
performance. The recent trend to search for a “corporate savior” might be an inappropriate
solution for the troubled firm (Khurana, 2002). Charismatic leaders from outside may be valued
by the stock market when they first sign on. However, if there is a misfit between the new
leader’s competencies and the contextual requirements, the troubled firm may not be able to
benefit from such a savior; instead, it may bear direct costs, for instance, in higher compensation
or a compromised and weakened governance system (Khurana, 2002). The concept of context-
person fit developed in this paper suggests that, instead of searching for a corporate savior, the
troubled firm should search for the right CEO – someone whose competencies align with the specific business conditions at hand.
My paper is also one of few studies which link the initial market return with subsequent
actual performance. The consistencies and differences between the immediate and long-term
performance have implications on the study of “romance of leadership” (Meindl, Ehrlich, &
Dukerich, 1985) and the symbolic vs. substantive research (Westphal & Zajac, 1998, 2001). For
instance, is a prestigious CEO more likely to receive immediate market reaction no matter what
the following performance is, or even the actual performance is worse off (Wade, Porac, Pollock,
& Graffin, 2006)? To what extent does the symbolic effect decouple with the substantive effect
in the CEO succession event?
85 3.4.2. Limitations, Supplementary Analyses and Future Research
Like all studies, the paper has limitations that create opportunities for future research.
First, one of the key findings of this study is that predecessor’s misfit and successor’s fit with the
context will make the CEO replacement more valuable for troubled firms. One limitation of my study is that I only investigated the effects of predecessor’s misfit and successor’s fit separately.
A natural following question is whether the positive effect of successor’s fit is further strengthened by the presence of predecessor’s misfit. To address this question, I did supplementary analyses with results reported in Table 6. Because I can only study the cases where CEO replacement does occur, the sample size is 140. In the regressions I have included all control variables, independent and interaction variables. For the sake of clarity, Table 6 only reports the coefficients and standard errors of interaction terms that we are interested in. The
control model starts with a baseline R-squared of 0.13. The following Model 1 reports that the
effect of successor’s fit on the likelihood of successful turnaround. Model 2 adds the moderating
effect of predecessor’s misfit. Results show that the three-way interaction between performance
severity, successor’s outsiderness and incumbent’s tenure is positively significant. It suggests
that an extreme outsider in a more severe situation has a stronger effect if the replaced incumbent
has a longer tenure. However, I did not find evidence to support the notion that a throughput-
oriented successor in a more severe situation has a more positive effect in case that the replaced
predecessor’s is not throughput-oriented (although it is marginally significant based on one-
tailed test with p<0.07). Neither did I find a result showing that that an output-oriented successor
in a sales-problem firm has a stronger effect if the predecessor is not out-put oriented. Future
research can further investigate the relative suitability of the predecessor vs. successor and its
performance implications.
86 ------Insert Table 6 here ------
Second, since the right type of successor (i.e., the new CEO with competences and skills
aligning with contextual requirements) substantially improve firm performance in troubled companies’ turnaround efforts, is an early replacement with the right successor especially helpful?
I had another preliminary investigation on this question. I created a dummy variable of early replacement, coded as “1” if CEO replacement occurs during Year 0, and “0” otherwise. In
analyses I didn’t report here, I found some support. The three-way interaction between early
replacement, successor outsiderness, and performance severity is significant (although I didn’t
find other three-way interactions significant). It suggests that if the company is in deep trouble,
the early replacement with an extreme outsider is particularly beneficial. Future research can
further explore the timing effects in a more fine-tuned way, for instance, does a quick
replacement lead to timely adjustment in corporate strategy? Or is a quick replacement of CEO
more likely to cause organizational disruption?
This paper suggests that replacement of a predecessor who is badly suited to, or
succession of a new CEO who is well suited to, contextual requirements will increase the
likelihood of successful turnaround. One limitation is that I did not further explore what kind of
company or board is more likely to identify the predecessor who has a worse context-person fit,
or find the right successor who has a better context-person fit. Is the board just doing something
(e.g., replacing the CEO), or doing the right thing (e.g., bringing in the right person)? Future
studies that can answer these questions can contribute substantially to the corporate governance
research.
87 The fourth limitation, posing opportunities for further inquiry, is that I only investigated
four type of predecessor’s misfit and three types of successor’s fit. There are many types of misfits/fits that might arise, and I only examined a subset that can be readily operationalized.
Indeed the concept of context-person fit could be applied in various scenarios. Two dimensions of context (firm-specific and industry/environment-specific) and another two dimensions of person (predecessor and new CEO) would create a two-by-two matrix as Figure 4 illustrates.
Items with a tick of “√” have been empirically investigated in the paper. Nevertheless, a number of other context-person fit considerations could be explored in future studies. For instance, an incumbent whose is less aggressive in setting industry standards may present a bad fit to a firm whose industry is still in an early stage of lifecycle; a successor with extensive international experience would represent a good fit to the context if the focal firm’s performance problem is
mainly due to its failure in international expansion; similarly, if customers of a focal firm’s
industry have very strong bargaining power and appropriate the economic rents, a new CEO with
solid connection with the customers is more likely to fit the industry-specific requirements.
------Insert Figure 4 here ------
88 Chapter 4
DO YOU GET WHAT YOU PAY FOR?
COMPENSATION OF NEW CEOS HIRED IN TURNAROUND SITUATIONS
Few topics in organization studies have received the same degree of attention from a wide array of scholars in different fields as CEO compensation (e.g., Beatty & Zajac, 1994;
Bebchuk & Fried, 2003; Core, Holthausen, & Larcker, 1999; Gilson & Vetsuypens, 1993;
Hambrick & Finkelstein, 1995; Jensen & Murphy, 1990; Lazear & Rosen, 1981; Porac, Wade, &
Pollock, 1999; Wade, O’Reilly, & Pollock, 2006; Wasserman, 2006). Academic studies have
tried to answer two primary questions: (1) What are the determinants of CEO pay (e.g., Eriksson,
1999; Henderson & Fredrickson, 1996; O’Reilly, Main, & Crystal, 1988); and (2) what are the potential consequences of CEO pay (e.g., Mehran, 1995; Sanders & Hambrick, 2007)? Despite a considerable volume of research on this topic, few studies have addressed the initial compensation of new CEOs, particularly those hired in turnaround situations.
Firms in turnaround situations provide a unique research context to investigate how they
design the new CEO’s compensation. On the one hand, to attract talented CEOs to manage
organizations under tough situations, troubled firms must pay a premium to compensate these
successors because of the high job demand, the task complexities, and the career risks that
accompany the position. On the other hand, troubled firms face financial and political constraints
as to how much they can pay new CEOs because greater pay will further drain the distressed
firms’ financial resources. In addition, higher compensation could raise concerns from
shareholders, creditors, and other stakeholders who are already quite unsatisfied with poor firm
performance. These two competing needs make the study of the new CEO’s initial pay package
89 in turnaround situations particularly interesting and valuable. Such a tension has generated the following research questions that my third essay will address: Does a troubled firm have to pay
“combat duty pay” – or a higher compensation – to its new CEO hired in a turnaround situation?
And how does it structure the new CEO’s initial compensation?
The importance of studying a new CEO’s initial pay also lies in its potential influence on
the consequences of CEO succession. Finkelstein and Hambrick (1996) suggest that an
examination of the organizational effects of CEO succession should consider factors surrounding
the succession event, such as the agency conditions before the succession, the succession process,
and the successor characteristics (e.g., Shen & Cannella, 2002; Virany, et al., 1992; Zhang &
Rajagopalan, 2004). However, the new CEO’s compensation has not yet been theorized as an
important factor, although human capital and agency theories have established that executive
compensation is related to CEO capabilities and has strong implications for managers’ behavior
(Barkema & Gomez-Mejia, 1998; Chidambaram & Prabhala, 2003; Core, Guay, & Larcker,
2003; Jensen & Murphy, 1990; Murphy, 1986). In the context of turnaround situations, the research question becomes “Does a higher total pay improve post-succession firm performance and increase the likelihood of a successful turnaround?”
With a focus on the compensation of new CEOs hired in turnaround situations, my third essay is a logical extension of my second essay. Since CEO replacement will eventually require a successor, how the troubled firms pay their new CEO and the performance consequences are questions that naturally follow. In general, the third essay has a similar empirical approach to the second essay, although I will discuss differences as they arise.
90 4.1. Theory and Hypotheses
4.1.1. Initial Compensation of New CEOs in Turnaround Situations
Firms in turnaround situations strive to turn the firm’s performance around (Barker, et al.,
2001; Hofer, 1980). It is arguable that the troubled firm needs new leadership for a successful
turnaround, because the incumbent management has had a difficult time making the required
changes and has lost too much credibility with key stakeholders (Bibeault, 1982; Finkelstein &
Hambrick, 1996; Hofer, 1980). Therefore, the new CEO is expected to solve the leadership
legitimacy crisis, bring a new perspective, energy, resources, and credibility to the top of a troubled firm (Becker, 1964; Castanias & Helfat, 1991; Huson, et al., 2004); the new CEO will also change the knowledge, skills, and interaction dynamics of the senior management team, and thus improve the organization’s ability to recognize and act on changing environmental conditions (Tushman & Rosenkopf, 1996; Wagner, Pfeffer, & O’Reilly, 1984; Zhang &
Rajagoplan, 2004). In addition, replacing the incumbent CEO would please disgruntled
shareholders and placate social arbiters (Wiesenfeld, et al., 2008). Given these potential symbolic
and substantive benefits of a new corporate leader, the board of directors is under pressure to
bring a new CEO to the troubled company. However, firms in turnaround situations have hiring
challenges.
First, managing a troubled firm is a tough job for any executive. The new CEO often
lacks the information to make strategic decisions and thus first has to learn about the business.
On the other hand, he or she is under great pressure to demonstrate worthiness of the job, and
needs to initiate some quick actions to reverse the firm’s performance decline (Babarro, 1987;
Finkelstein & Hambrick, 1996; Vancil, 1987). Abundant information and cues in an ambiguous
environment have to be filtered and interpreted quickly by the new hire. In addition, the new
91 CEO has to be extremely careful in every turnaround effort because of the limited organizational
resources left. Due to the task complexity and the higher job demand in a turnaround situation, the successor will have greater personal stress in operating the troubled firm.
Second, the new CEO accepting a troubled firm’s offer has a higher career risk. If the firm cannot reverse the downward spiral and eventually fails during the new CEO’s tenure, he or she is very likely to be stigmatized by the market, and find it hard to find a comparable job
(Cannella, Fraser, & Lee, 1995; Semadeni, Cannella, Fraser, & Lee, 2008), even though the troubles the successor inherited might be due to some fundamental issues or mistakes made by his or her predecessor (e.g., an unsuccessful large-scale acquisition) (Wiesenfeld, et al., 2008).
In sum, being a new CEO in a turnaround situation is a challenging job because of the task difficulties and the embedded career risks. Prior research has suggested that the CEO be rewarded to the extent to which they are required to process complex information (Henderson &
Fredrickson, 1996; Sanders & Carpenter, 1998). In addition, when a CEO is asked to bear more risk, he will ask for higher pay (Gray & Cannella, 1997). Therefore, I argue that troubled firms must reward their new successor with “combat duty pay” if they expect their CEO candidate to join a tough situation. Thus, I propose the following:
Hypothesis 1: Firms in turnaround situations pay their new CEOs more than do comparable firms that are not in turnaround situations.
The previous discussion suggests that new CEOs hired in turnaround situations will require higher pay as compensation for the risk of stigmatization as well as for the personal stress that comes with managing a firm in a difficult situation (Henderson & Fredrickson, 1996;
Wiesenfeld, et al., 2008). However, firms in turnaround situations may have financial or political constraints on the amount they can pay their new CEO (Altman, 1984; Hambrick & D’Aveni,
1988). Troubled firms generally face a scarcity of cash and may not have enough financial
92 resources to pay such a high price for a successor (Hambrick & D’Aveni, 1992; Hayes,
Hillegeist, & Keating, 2005). Politically, troubled firms’ directors, who are at risk of being sued
in corporate failure if they offer higher pay to their managers, may feel pressure to be more
parsimonious in paying their new managers (Gilson & Vetsuypens, 1993). Under this
circumstance, firms in turnaround situations are very likely to design compensation with a higher
percentage of stock-based pay (i.e., options and restricted stock). Stock-based components offer
companies a method for economizing cash and are considered inexpensive from a short-term
perspective, because they don’t have upfront cash outflow13 (Murphy, 2002). In addition, stock- based pay is viewed as an incentive that provides a direct link between executive pay and company performance. It has a risk-sharing feature that binds the risks and uncertainty to the managers. Directors who grant a higher proportion of stock-based pay to managers are also less likely to be scrutinized or criticized by shareholders.
On the other hand, compared to a fixed salary, the stock-based pay would carry considerable uncertainty for the new CEO. Given the unclear future of a troubled firm and the uncertainties of financial return, the new CEO might prefer a fixed salary (Harris & Helfat,
1997). However, it is also possible that the successor would accept a compensation package with a higher degree of stock-based components, because stock options are a way in which mangers can reap a huge fortune (Sanders & Hambrick, 2007). Besides, since a stock option price granted in a turnaround situation is usually comparatively low, a successful turnaround would bring tremendous monetary reward to a CEO. Thus, both the troubled firm and the new successor could potentially benefit from a higher percentage of stock-based compensation. Thus, I would
propose that:
13 Stock options had another benefit during my sample period because they were not treated as expenses in the income statement when they were granted (Murphy, 2002).
93 Hypothesis 2: Firms that are in turnaround situations use a higher percentage of stock- based pay (options and restricted stock) to pay new CEOs than do comparable firms that are not in turnaround situations.
New CEOs differ in their origins. Depending on whether the successor is appointed from
within or from outside the firm, prior studies suggest the binary term of “insider versus outsider”
(e.g., Beatty & Zajac, 1987; Boeker, 1997; Cannella & Lubatkin, 1993; Kesner & Sebora, 1994).
Troubled firms face a different kind of pressure to pay their new CEOs, depending on whether they are externally or internally appointed. In general, the pressure to provide higher compensation would be attenuated if the new CEOs were internally appointed. First, these insiders will be seen as partially responsible for the current performance decline. The boards of directors may think to curb the insider CEOs’ compensation, or ask insiders to share the pain with troubled companies (Gilson & Vetsuypens, 1993). Second, the CEO position itself is a reward to insiders. Insiders who get the organization structural power derived from the CEO position may be required to lower their compensation (Finkelstein, 1992). Finally, insiders’ bargaining power in the executive labor market is much lower than that of their outsider peers.
Because insiders’ creditability and capabilities are very likely to be tainted by the firms’ recent situations, insiders have fewer external upward opportunities (Semadeni, Cannnella, Fraser, &
Lee, 2008; Wiesenfeld, et al., 2008). Thus, internally-appointed CEOs in turnaround situations are less likely to demand and get a higher pay than their externally-appointed peers.
A higher pay for outsider CEOs is also consistent with the argument for the CEOs’ human capital (Becker, 1975; Castanias & Helfat, 1991). This stream of research suggests that managers have three types of skills: firm specific, industry specific, and generic (Harris & Helfat,
1997). Firm-specific skills are most valuable in that specific firm, but they are the least transferable across different firms. Outsider candidates must be compensated for the previous
94 employer-specific human capital they give up to make the move. Compared to insider CEOs, outsider successors have to learn more and build up their new firm-specific knowledge repertoire in a new environment fairly quickly. Such newly acquired firm-specific skills might become useless or unable to achieve their best value in the event of a firm failure and a forced departure.
Therefore, externally appointed successors may demand an additional risk premium for taking the job.
Similar to my prior argument, firms in turnaround situations would feel the constraints of paying high compensation to new outsider CEOs. The potential benefits for firms to design a higher percentage of stock-based pay as well as the potentially huge payoff to new successors in
case of a successful turnaround suggest that outsider CEOs would have a greater stock-based pay
than insider peers. In sum, I propose the following:
Hypothesis 3: The associations predicted in H1and H2 will be stronger in cases of externally-appointed new CEOs than internally-appointed CEOs.
4.1.2. Implications of New CEOs’ Compensation in Turnaround Situations
If firms in turnaround situations tend to pay higher compensation to their new CEOs, as I
argue above, the natural question that follows is whether higher pay leads to better results for the
company. Compensation has long been argued as an incentive mechanism (Ross, 1973). While
firms can attract and keep talented people in a number of ways, such as providing greater career
opportunities and creating a friendly working environment (Hiltrop, 1999), compensation
remains a basic and effective solution (Chambers, Foulon, et al., 1998; Rosenzweig & Nohria,
1994). Chief executives, like the rest of us, are motivated by monetary rewards. A greater
amount of compensation helps to sign on more talented executives (Core, et al., 2003; Hubbard
95 & Palia, 1995; Murphy, 1986)14. While various qualities of a talented CEO could be considered, my discussion focuses on the three observable ones: greater prestigious credentials, more industry experiences, and externally appointed executives.
CEOs are expected to exact a toll to compensate their early investments in building their human and social capital (Becker, 1975; Harris & Helfat, 1997). Without a higher pay, firms would feel challenged to convince an executive with prestigious credentials to join their firm.
CEOs build their prestigious credentials through work or educational affiliations with the most prominent institutions, credentials that could help them improve the firm’s performance. For instance, their prior work experience in leading firms provides the successor an understanding of major industry trends (Geletkanycz & Hambrick, 1997), relevant formulas to success (Florin,
Lubatkin, & Schulze, 2003), and connections with knowledgeable parties (Davis & Useem,
2002). Similarly, an outstanding educational background suggests that the new CEO is very capable (via the selectivity and educational offerings of elite schools) and has valuable alumni networks that could help secure critical resources (D’Aveni & Kesner, 1993).
Firms that are willing to grant higher compensation have an advantage in hiring experienced executives. New CEOs could have accumulated their industry experience either through their work experience in the focal firm (before they are appointed as chief executive) or through their prior employment outside the company but within the same industry (Karaveli,
2007). The longer their company tenure, the greater their understanding of the company operations, organizational structure, and sources of performance problems. A new CEO’s
14 Alternatively, one can argue that a CEO’s caliber will determine his or her pay. Nevertheless, a higher compensation a CEO can receive in the executive labor market implies that this executive is more talented. The link between executive compensation and CEO talents should be stronger for firms in troubled situation, because boards are expected to be more vigilant in paying their new CEOs appropriately (Gilson & Vetsuypens, 1993; Wiesenfeld, et al., 2008). An unjustifiable high pay will be criticized by shareholder, whereas an unreasonable lower pay would make candidates feel underpaid and then they would turn down the job offer.
96 industry tenure beyond the focal firm would facilitate the executive’s understanding of the lines
of business, and exploration of different approaches of doing business, for instance, with
different suppliers and customers. Thus, a seasoned CEO in the focal industry of the troubled
firm would help the company achieve a successful turnaround.
Higher compensation would also assist a company in selecting a new CEO from a
broader executive labor market - searching for capable executives from outside the company
(Harris & Helfat, 1997). Candidates in the open market who can catch the employing firm’s
attention are usually talented individuals with outstanding track records. In addition, an
externally appointed CEO may bring in new social connections and a fresh perspective to operate
the troubled company. An outside CEO is also more likely to break inertia and initiate
organizational change because the outsider is cognitively and emotionally detached from the
firm’s prior strategy (Karaveli, 2007; Beatty & Zajac, 1994). These benefits will translate into
better post-succession performance once a troubled firm signs on an outsider CEO.
In sum, a higher initial compensation helps attract talented executives, as reflected by
their prestigious credentials, rich industry experiences, and stance as outsiders in executive labor
market15. These attributes would, in turn, help troubled firms to achieve a better performance and
a greater likelihood of a successful turnaround thereafter. I also expect that the positive
relationship between initial compensation and the subsequent business upturn is only partially,
though not fully, mediated by prestigious credentials, industry experiences, and outsider stances,
because (1) there are other unobservable qualities of CEO talents not captured by these three
15 The direction of effect - from a higher pay to CEO talents - is from the firm’s perspective. One may argue from the CEO’s perspective, and suggests that the direction of the effect is from the CEO talents to a higher pay (as what I discussed in footnote 14). It is difficult to disentangle which direction of the effect works, but two arguments both suggest that the compensation a new CEO can receive will in general reflect his or her talents. In addition, the question of which direction works does not matter empirically in my test, because I am interested in whether the CEO’s initial compensation has an additional effects on the post-succession performance, beyond the effects of the CEO talents.
97 qualities; and (2) compensation may have other effects in addition to attracting talented CEOs,
for instance, the symbolic effect that the troubled company is committed to hire capable
executives to prevent a deterioration of the whole top management team. Thus, I propose the
following:
Hypothesis 4a: In turnaround situations, the magnitude of a new CEO’s total pay will be positively related to post-succession performance and the likelihood of a successful turnaround.
Hypothesis 4b: The positive effect of a new CEO’s initial compensation on post- succession performance is partially mediated by the CEO talents, as reflected in prestigious credentials, industry experiences, and being an outsider executive.
Figure 5 illustrates my theoretical models.
------Insert Figure 5 Here ------
The following sections present my methods and results in testing a new CEO’s initial compensation (Hypotheses 1 to 3) and its performance implications (Hypotheses 4a and 4b).
Since they involve different model specifications, sampling strategies and estimation methods, I present the antecedents and consequences of the CEO’s initial pay separately. The major data source was ExecuComp. To construct the variables for the hypotheses testing, I also consulted several other databases, to be discussed when they arise.
4.2. Initial Compensation of New CEOs in Turnaround Situations: Methods and Results
4.2.1. Data and Sample
I used the same method described in my second essay to identify firms in turnaround situations. Please refer to the sample selection process in the second essay. Among these troubled companies, 94 involved new CEOs either during the year they had losses or one year after the losses.
98 Hypotheses 1 to 3 predicted the new CEO’s initial pay package, and compared the magnitude and structure of compensation for the CEOs hired in turnaround situations and those hired in non-turnaround situation. Thus, in addition to 94 new CEOs hired in turnaround situations, I also needed to identify matching new CEOs from the ExecuComp database. New
CEOs were included in the matching sample if (1) their succession year was during the period from 1993 to 2003; (2) their employers belonged to one of the 24 industry sectors; and (3) their employers were not in turnaround situations one year before and after the succession year. This matching process resulted in 431 matching new CEOs. A total of 525 new CEOs were included in the testing of Hypotheses 1 to 3.
4.2.2. Dependent Variables
New CEO’s Initial Pay (total pay and stock-based pay): The new CEO’s initial total pay is his or her first year’s total compensation – including all forms of compensation that a new
CEO can receive in the succession year (Year 0)16. It represents all the monetary conditions that induce a new CEO to accept the employment agreement. Initial total pay includes some normal items (such as fixed salary, performance bonus, life insurance, options, and restricted stocks), and some special items only applicable to new CEOs, such as signing bonuses, relocation subsidies, options, or deferrable restricted stocks granted to compensate the forfeited benefits in their prior employers (if they are outsider CEOs). I checked ExecuComp’s database and the new
16 Please note that this Year 0 is different from Year 0 that I defined in the second essay (the year when the firms fell into turnaround situations)
99 CEO’s initial employment agreement disclosed in proxy statements to correct any
discrepancies17.
The percentage of stock-based pay is the proportion of total compensation derived from options and restricted stocks. It is important to note that the valuation of options, based on Black and Scholes’ (1973) option-pricing model, is an ex ante valuation calculated in the succession year when options are granted to the new CEO.
4.2.3. Independent Variables
Firms in turnaround situations: I created a dummy variable which equals 1 if new
CEOs were hired in turnaround situations (94 cases), and 0 if they were hired in non-turnaround situations (431 matching cases).
Outsider CEO: This is a dummy variable, coded “1” if the new CEO has zero tenure before he or she is hired as the CEO in the focal firm. Such a new CEO is expected to have a greater bargaining power before he or she agrees to join the firm.18
4.2.4. Control Variables
Predecessor’s last annual pay (total pay and stock-based pay): I expected the firms to
have a certain compensation policy and that the predecessor’s pay would be highly correlated
with the new CEO’s pay. Therefore, I included the predecessor’s last annual pay in the models
17 For instance, Allegheny Energy agreed to issue 1,500,000 options to its new CEO, Mr. Paul J. Evanson, in an employment agreement in June 2003. Although the options were actually granted in February 2004, the valuation of these options was treated as part of Mr. Evanson’s initial pay in 2003.
18 I also measured a new CEO as an outsider if he or she had less than one year’s tenure in the focal firm. The results are qualitatively the same as I reported here, but with a slightly smaller prediction power (R-squared).
100 predicting the new CEO’s pay. I used the same method of measuring the new CEO’s pay to measure the predecessor’s last annual pay in the firm.
Firm characteristics: A number of firm characteristics would affect the magnitude and structure of the new CEO’s initial pay (e.g., Baumol, 1967; Ciscel & Carroll, 1980; Core, et al.,
2007; Finkelstein & Boyd, 1998; Williamson, 1985). I included the firm size (measured by the logarithm-transformed total assets at Year -1), firm growth (measured by the sales growth rate at
Year -1), and the firm performance (measured by the net ROE at Year 0 to capture the ability that a firm has to pay its new CEO).
Agency factors: Prior research also suggests the influences of corporate governance in setting CEO compensation (e.g., Anderson & Reeb, 2003, 2004; Hambrick & Finkelstein, 1995;
Werner, Tsoi, & Gomez-Mejia, 2005). In this vein, I included CEO duality (the dummy variable equals 1 if the newly appointed CEO also holds the position of chair of the board at Year 0), outside director ratio (the percentage of independent directors on the board at Year -1), independent directors’ ownership (the cumulative percentage of shares held by independent directors at Year -1), institutional shareholder’s ownership (the cumulative percentage of shares held by institutional shareholders at Year -1), CEO ownership (percentage of shares, excluding options, held by the newly appointed CEO at Year 0). The variables on agency factors were drawn from IRRC, Disclosure, or proxy statements.
CEO Talents: CEO talents will determine the tolls that an executive will charge (Chen, et al., in press). Thus I controlled for its effect on the level of compensation that a new CEO can get. As I discussed in the hypotheses development section, I used three observables qualities to capture an executive’s talents. To measure prestigious credentials, I investigated a new CEO’s work experience and educational background (D’Aveni, 1990; Hogan & McPheters, 1980; Palia,
101 2001). A new CEO is regarded as possessing S&P prestige (dummy) if he or she has been
employed by a most prominent firm at the level of vice president or higher, or has sat or is
currently sitting on the most prominent firm’s board. I considered a firm to be prominent if it is a
member of the S&P 100 index because that index represents the most visible and stable companies in the U.S. economy. A new CEO is coded as possessing educational prestige
(dummy), if he or she has acquired a degree (undergraduate or graduate) from an elite institution.
The list provided by Finkelstein (1992) is used to identify the elite institutions.
Industry experience was measured by two indicators: company tenure and industry tenure
beyond the focal firm. Company tenure was the number of years that a new CEO had been
employed in the focal company before he or she was promoted to the chief executive position
(company tenure equals to zero if the new CEO was appointed externally). Industry tenure
beyond the focal firm was the number of years that a new CEO was employed outside the
company but within the same industry as the focal firm. Above I have discussed how I measured
the outsider CEOs.
CEO age: I also controlled for the effect of the CEO’s age. It is expected that CEO age
will be highly correlated with their industry experiences.
Industry and year dummies: To control for the industry and year effects on CEO pay, I
included 23 industry dummies (industry sector SIC 80 is the omitted sector) and 10 year
dummies (1993 is the omitted year) into the regression.
4.2.5. Estimation Methods
To predict the new CEO’s initial pay I used the OLS regression. My empirical setup only
allowed me to observe cases where the CEO succession occurred. To control for the sample
102 “selection” bias, I followed the procedure used in prior research (Stuart et al., 1999; Zajac &
Westphal, 1996) and used Heckman’s two-staged model (Heckman, 1976, 1979). First, I drew a total of 572 firm-years from the ExecuComp database. These firms belong to one of the 24 industry sectors and had not replaced their CEO in a specific year from 1993 to 2003. Second, I used firm characteristics (including firm size measured by total assets, and firm performance measured by ROE), CEO characteristics (including CEO age and CEO tenure in the focal firm), agency factors (including outside director ratio) to predict whether they would change their
CEOs. Each of these predicting variables was significant. An inversed Mill’s ratio was generated in the first-stage model, and then included in the second-stage analysis as an instrumental variable, named prone to CEO succession, to correct for any selection bias (Van de Ven & van
Praag, 1981).
4.2.6. Results
Table 7 reports descriptive statistics and correlations for variables used in testing
Hypotheses 1 to 3. It includes 525 observations (94 CEOs hired in turnaround situations and 431 matching new CEOs hired in non-turnaround situations).
------Insert Table 7 here ------
Table 8 reports the results of regressions that predicted a newly hired CEO’s total pay
(Models 1-3) and percentage of stock-based pay (Models 1’-3’). Models 1 and 1’ include control variables. A number of them are highly significant, cumulatively explaining about 49 percent of the variances of the new CEOs’ total pay, and about 18 percent of their stock-based pay. Models
2 and 2’ add the dummy variable indicating whether firms are in turnaround situations or not. It
103 is positively significant (β = 0.25 and p < 0.05 in Model 2; β = 0.08 and p < 0.05 in Model 2’), suggesting that firms in turnaround situations have to pay a higher total compensation to their new CEOs compared to those in non-turnaround situations. Troubled firms use a higher percentage of stock-based pay19. Thus, my Hypotheses 1 and 2 are supported.
Models 3 and 3’ include the interaction effect between outsider CEOs and firms in
turnarounds situations to test whether an externally appointed CEO in a turnaround situation gets
an even higher pay and stock-based pay. Results show that it is highly significant (β = 0.66 and p
< 0.01 in Model 3; β = 0.16 and p < 0.05 in Model 3’). Thus, my Hypothesis 3 is also supported.
------Insert Table 8 here ------
4.3. Implications of New CEOs’ Initial Compensation in Turnaround Situations: Methods
and Results
4.3.1. Data and Sample
My Hypotheses 4a and 4b target performance implications of a CEO’s initial pay and
address whether a higher pay would increase the likelihood of a successful turnaround. Thus, I
only needed 94 CEOs hired in turnaround situations in my hypothesis testing.
4.3.2. Dependent Variable
Post-succession performance: I measured post-succession performance by net ROE, net
ROA, and the likelihood of successful turnaround two and three years after the CEO succession
year. The likelihood of a successful turnaround equaled 1 if the firm’s net ROE was greater than
the cost of the equity as I discussed in the second essay.
19 In analyses I did not report here, I ran the regressions with non-stock-based pay as dependent variables. I did not find a significant effect of the dummy variable of “firms in turnaround situations”.
104
4.3.3. Independent and Mediating Variables
Independent and mediating variables in testing Hypotheses 4a and 4b included the new
CEO’s initial pay and the CEO’s talents measured by S&P prestige, educational prestige, company tenure, industry tenure beyond the focal firm, and being an outsider CEO. I used the same measures as discussed above.
4.3.4. Control Variables
In addition to using firm size, firm age, firm performance, prone to CEO succession,
CEO age, industry, and year dummies as control variables in testing Hypotheses 1 to 3, I also included the following controls in testing the consequences of the CEO’s initial pay.
Prior performance: Prior performance at Year -2 and Year -1 indicates a company’s healthiness before the performance troubles. This was measured by the average firm performance of Year -2 and Year -1. I used the ROE measure if the dependent variable was post- succession ROE or the likelihood of a successful turnaround, and used ROA if the model had a post-succession ROA as its dependent variable.
Prone to CEO succession: A proportion of newly hired CEOs cannot survive the early mandate, and are replaced within three years after their appointment (Henderson, et al., 2006).
Since my post-succession performance was measured at two and three years after the succession year, I also needed to correct the “survival” biases. Similarly I used the Heckman two-stage model (Heckman, 1976). In the first stage, I used firm performance (measured by average ROE at Year +1 and +2), CEO characteristics (including CEO age and a dummy indicating whether the new CEO was externally or internally appointed), agency factors (including outside director
105 ratio and CEO ownership at Year +2) to predict whether the newly appointed CEO was still in
that position three years after the succession. Again, an inversed Mill’s ratio was generated in the
first-stage model, and was included in the second-stage analysis as an instrumental variable, named prone to continue service (Heckman, 1979; Van de Ven & van Praag, 1981).
4.3.5. Estimation Methods
In models predicting post-succession performance, researchers first encountered the issue of an appropriate timeframe to measure performance. Prior studies typically used two (Year +2) or three (Year +3) years after the succession year as the measuring timeframe (e.g., Shen &
Cannella, 2002; Zhang & Rajagoplan, 2004), because such an investigation period was long enough for the new CEO’s strategic decision to become effective, but not too long to question the effect of CEO compensation as too far-reaching. However, scholars cannot tell ex ante which year represents a better gauge when choosing Year +2 or Year +3. To address this issue, I measured firm performance with both Year +2 and Year +3, and then used generalized estimating equations (GEE) to accommodate the issue of multiple observations for each firm
(Liang & Zeger, 1986). To define my model, I needed to specify the distribution of the dependent variable and a link function. In predicting the likelihood of a turnaround situation, I
specified a binomial distribution with a logit link function. In predicting the performance
measured by ROE and ROA, I specified a normal distribution with an identity link function.
4.3.6. Results
Table 9 reports descriptive statistics and correlations for variables used in testing
Hypotheses 4a and 4b. It focuses on 94 firms in turnaround situations and presents 188
106 observations (each firm in a turnaround situation had two observation-years for measuring post-
succession performance).
------Insert Table 9 here ------
Table 10 presents the results of models predicting post-succession performance, or “Do
the troubled firms get what they pay for in their new CEO?” Models 1 to 4 predict a post-
succession ROE; Models 1’ to 4’ present results of a post-succession ROA; and Models 1’’ to
4’’ report the likelihood of a successful turnaround.
------Insert Table 10 here ------
Models 1, 1’ and 1’’ first include control variables. Models 2, 2’ and 2’’ add our interested variable – the new CEO’s initial total pay. The results suggest that it is significant across all models (β = 0.03 and p < 0.05 in Model 2; β = 0.02 and p < 0.05 in Model 2’; and β =
0.06 and p < 0.05 in Model 2’’).
Models 3, 3’ and 3’’ include variables measuring CEO talents: S&P prestige, education
prestige, company tenure, industry tenure beyond the focal firm, and outsider CEO. The results
show that the effects of S&P prestige, company tenure, outsider CEO are positive; the effect of
industry tenure beyond the focal firm is not significant; and the effect of educational prestige is
negatively significant.
Models 4, 4’ and 4’’ are full models including all variables. First, the effect of the CEO’s
initial pay remains significant across the three models (its effect in Model 4’’ becomes
marginally significant). In addition, the effects of talent-related variables, such as outsider CEO
(in three models) and company tenure (in Model 4’) become non-significant. Considered
107 together, these results suggest that the CEO’s initial pay has a rather strong effect on post-
succession performance, not mediated by the CEO talents. Therefore, my Hypothesis 4a and 4b
are supported.
4.4. Discussion
Prior research has devoted considerable effort to studying CEO succession and CEO
compensation (e.g., Beatty & Zajac, 1994; Bebchuk & Fried, 2003; Jensen & Murphy, 1990;
Lazear & Rosen, 1981; O’Reilly, et al., 1988; Sanders & Hambrick, 2007; Shen & Cannella,
2002; Virany, et al., 1992; Wade, et al., 2006; Zhang & Rajagopalan, 2004). However, the linkage of these two, or the new CEO’s initial compensation after succession, has been limited.
Far less attention has been devoted to understanding the compensation of new successors who
just get the “baton” from troubled firms. My third essay thus represents an attempt to fill this gap
by comparing the initial pay of new CEOs hired in turnaround situations with their peers hired in
non-turnaround situations, and further investigating the implications of compensation on post-
succession performance.
4.4.1. Initial Compensations of New CEOs in Turnaround Situations
The proposition that new CEOs in turnaround situations will get higher pay represents
my consolidation of prior arguments that the CEO’s compensation should be linked to their job
demands, task complexities, risk and stress in the top position––all of which tend to be higher for
the new CEOs who agree to run a troubled firm (Hambrick, Finkelstein, & Mooney, 2005;
Henderson & Fredrickson, 1996). In addition, because troubled firms have limited resources and their boards are under pressure to be parsimonious in paying their managers, they tend to use a
108 higher percentage of stock-based pay. I further argue that externally-appointed CEOs have
greater bargaining power and thus will get an even higher total pay and stock-based pay. In my
analysis of 94 new CEOs hired in turnaround situations and 431 peers hired in non-turnaround
situations, I found considerable support for my propositions.
Based on the regression models in Table 8, I use a hypothetical example to illustrate the
additional cost that a troubled firm has to pay in order to sign on a new CEO in a turnaround
situation. For instance, a firm will pay a new CEO a total of $2.5 million (approximately the
median value of our sample observations) as a hiring package after considering the hiring year,
industry sector, firm size, predecessor’s pay, agency conditions, and the new CEO’s credentials
and experiences. However, this new CEO will request, on average, an additional $0.8 million if he or she is hired in a turnaround situation. Particularly, if the executive is hired externally, the
troubled firm has to pay, on average, an additional $1.3 million to get the new CEO signed on.
The additional hiring cost is sizeable economically, especially considering the limited resources
that the troubled firm possesses. This is why I also found that firms in turnaround situations used a higher percentage of stock-based pay in attracting their new CEO.
These results have a couple of implications in the CEO compensation literature. First, it suggests that the context, such as a turnaround situation, matters in influencing a new CEO’s compensation. Prior studies on the determinants of CEO pay have provided explanations from economic (e.g., Jensen & Murphy, 1990; Lazear & Rosen, 1981), social (e.g., Hicks, 1963; Staw
& Epstein, 2000), and political (e.g., Finkelstein & Hambrick, 1988; Zajac & Westphal, 1995) perspectives. Empirically, they investigate the effects of industry, firm characteristics, CEO characteristics, board-CEO dynamics and agency factors on the magnitude and structure of pay that a CEO can receive. However, they rarely consider the logic behind the CEO’s pay from a
109 context perspective. An abrupt performance decline, such as the turnaround situations described
in this essay, will increase the new CEO’s pay.
Second, neoclassical or agency theorists propose that executive pay will be positively related to firm profitability (Ciscel & Carroll, 1980; Jensen & Murphy, 1990), such that the CEO
should be rewarded if performance is good and punished if performance is poor. But this
argument should be based on the premise that performance is attributable to the CEO. In cases of
CEO succession where the new CEO should not account for the bad prior performance, the
performance-pay relationship could be the reverse. Bearing in mind that firms in turnaround
situations are in general poor-performing companies, my results imply that a bad performing
firm tends to reward its new CEO more. This pattern is contradictory to the positive performance-pay relationship suggested by neoclassical or agency theorists. Evidence from prior studies has not shown a strong relationship between firm profitability and CEO compensation
(e.g., Baumol, 1967; Ciscel & Carroll, 1980). Part of the reason is that researchers have not differentiated new CEOs from continuously-serving CEOs, but the prior performance could have an opposite effect on CEO compensation.
Third, a much higher pay for new CEOs in turnaround situations, especially for externally appointed executives, may have spillover effects and lead to an overall increase in
CEO compensation in the same industry sector. The mandatory requirements of the SEC to disclose executive compensation make these sensitive data publicly available. The social comparison process would guide other boards/CEOs to use the higher pay of turnaround CEOs as a benchmark to set compensation for their own firms’ top executives (O’Reilly, et al., 1988;
Porac, et al., 1999), while ignoring the fact that the premium pay received by turnaround CEOs
are because of “combat duty.”
110
4.1.2. Performance Implications of CEO’s Initial Pay in Turnaround Situations
In addition to studying the pay packages for the new CEOs in turnaround situations, I investigated the potential influence of their initial pay on post-succession performance. I argue that a higher CEO pay helps attract talented executives, as reflected in prestigious credentials, industry experiences, and outsiders hired in an open executive labor market. These qualities will improve post-succession performance to the extent that these CEOs would help troubled firms access critical information and resources required for a successful turnaround. Thus, I assert that initial compensation will be positively related to post-succession performance through the partial mediating effect of the CEO’s talents. With a sample of 94 CEOs hired in turnaround situations,
I found that the positive effect of the CEO’s initial pay was rather strong, even after I included talent-related variables. By contrast, the effects of talent-related variables, such as being an outsider CEO, became non-significant after I included CEO pay.
With these results, my study first contributes to the literature of corporate turnarounds.
Hambrick and D’Aveni (1988, 1992) have documented that troubled firms experience downward spirals – shrinking slack, declining performance, and deteriorating top team – even ten years before their eventual bankruptcy. Such a downward trend seems fairly salient and persistent. The question faced by a troubled firm is how to reverse the downward spiral. The managerial implication derived from my study is to use high pay to attract talented executives, and to keep a high-quality top management team. In other words, troubled firms striving to have a successful turnaround should not be too stingy about paying their new CEOs. Although the directors of troubled firms may be under pressure to be thrifty in setting executive compensation, lower pay
111 cannot attract and keep talented people, which will eventually further hurt the troubled firms
(Hambrick & D’Aveni, 1992).
My study also contributes to the literature on CEO succession. Finkelstein and Hambrick
(1996) suggest that studies on the performance consequences of CEO succession should not
simply answer whether CEO replacement helps or hurts; instead, scholars should investigate the
boundary conditions or factors surrounding the succession event to explore under what
circumstances a change of corporate leadership is helpful. Research in this stream has studied the
effects of precipitating contexts before succession, the process of succession, and agency factors
that may influence the performance consequences of CEO succession (e.g., Karaevli, 2007;
Virany, et al., 1992; Zhang & Rajagopalan, 2004). The current study has theorized CEO compensation as an important factor, and found that higher pay has a positive effect on post- succession performance.
As I indicated before, the new CEO hired in a turnaround situation would receive combat-duty premium pay. If this CEO does deliver good results and turn the performance around, he or she is very likely to receive much media praise, public attention, and be depicted as a corporate savior. This may pose two issues for the turnaround company. First, the board will face the challenge of retaining such a “legendary” CEO. It is very likely that the board cannot offer other terms than an even higher pay and more stock options. The tremendous rewards to such a turnaround CEO may cause another wave of spillover effects on the pay increase in the same industry due to the social comparison process (e.g., Porac, et al., 1999). Second, the credentials developed from the “proven” track record of a successful turnaround could lead the
CEO to dominate the board and the company, and to build an empire but with the cost of weakening corporate governance.
112 Finally, it is worthwhile to take a detailed look at CEO talents in both the antecedents
(Table 8) and consequences (Table 10) models, because CEO talents, on the one hand, will determine the level of compensation a new CEO can request, and on the other hand, supposedly have positive performance implications. For prestigious credentials, I found that firms have to pay a “prestige” premium to new CEOs possessing S&P prestige, and this type of prestige does deliver a positive effect on post-succession performance. However, although firms have not incurred additional cost to hire new CEOs with an elite educational background, it is surprising to know that such prestige has a negative effect on firm performance.
For industry experiences, first, firms do not pay additional for new CEOs with long company tenure, but it helps to improve firm performance (except for the full model of ROA in
Table 10). Since inside CEOs usually come with long company tenure, these results suggest the positive side of internally promoted leaders. Second, I also found non-significant effect of industry tenure beyond the focal firm in both antecedents and consequences models. Firms do not pay new CEOs for their industry experience beyond the focal firm, and such experiences are not helpful.
For outsider CEOs, Table 8 suggests that firms pay a premium to recruit leaders externally. The outsiders would improve performance (Model 3, 3’ and 3’’ of Table 10); however, these effects went away once I included the CEO’s compensation (Model 4, 4’ and 4’’ of Table 10). This implies that, although an outsider CEO is beneficial to a troubled company, the positive effect is largely cancelled out by the higher cost of getting them.
113 4.1.3. Case Examples
The effects of CEO compensation on performance are positively significant, but an inclusion of CEO pay only marginally contributes the explained variances. For instance, the pseudo R2 increased from 0.31 in Model 1’’ to 0.32 in Model 2’’ after I added new CEO’s total pay in Table 10. In addition to a normative prediction that a higher pay attracts talented people and then leads to better performance, there are firms which pay their CEOs a substantial amount of compensation, but do not get desired performance outcome (“surprising losers”), and others whose leaders actually deliver better performance with low compensation (“surprising winners”).
Figure 6 illustrates four scenarios, each represented by one company in my sample.
------Insert Figure 6 here ------
Quadrant I and III report cases conforming to my theory and hypotheses. For instance,
GAP, an apparel retailer (Quadrant I), paid a substantial amount of compensation, $36.9 million, to attract Mr. Paul Pressler to join the company. This compensation is $12.6 million (or 52%) higher than what he could receive in normal situations, controlling for year, industry, firm and individual effects. Mr. Pressler has proved himself a talented leader at Walt Disney, his prior employer before accepting GAP’s offer. Although he lacked experience in the apparel industry,
Pressler proved that he was worthy of the high pay. He used open management styles and innovative ideas based on market research and the expertise of his employees to turn the company around three years after the succession. By contrast, AVX Corporation, an electronic equipment manufacturer (Quadrant III), only paid $0.7 million for its new CEO, Mr. John S.
Gilbertson (representing $1.6 million, or 69%, below his market value). Mr. Gilbertson has been employed by AVX for about 20 years, serving several positions in the company before he was
114 promoted to chief executive in turnaround situations. He did not have glorious track records and
the succession did not help the firm achieve better performance.
While it is useful to document the positive effect of CEO compensation on firm
performance, it may be more intriguing to study the reverse cases –“surprising winner” or
“surprising losers”. Quadrant II presents a “surprising loser” – Informix, a software company
which fell into turnaround situation in 1996. One year after the troubled situation, Mr. Robert
Finocchio, a senior executive at 3Com Corp, succeeded Mr. Phil White as the new CEO. The
incumbent remained on the board as Chairman. Finocchio received an initial compensation of
$10.7 million (about $4.6 million higher than what he would expect in normal situations). After
Finocchio took over the position, he reshuffled the top management team, regrouped the product
lines, closed offices, and laid off employees. While he was capable to initiate all these turnaround efforts, Informix lacked a clear strategy: Finocchio emphasized his priority in improving Informix's internal operations and accountability, while sales and marketing were thought to be the key problem; Finocchio believed in the strength of Informix’s products and technology, but analysts said Informix had to develop new products compatible with Windows
NT immediately; Informix, on the one hand, slashed the price of its main product, and on the other hand, positioned itself as the high-end niche server. After three years of CEO succession, the market did not witness a successful turnaround.
“Surprising winner” – Rockwell International - is located in Quadrant IV, where CEO had a low pay ($3.5 million) but actually led to great performance. When signals of decline emerged, Rockwell named its president and COO, Mr. Don Davis Jr., as the new CEO. The incumbent, Mr. Donald Beall, announced that he will relinquish the Chairman role four months later. The new CEO had strong background in automation, which facilitated the company to
115 restructure itself from a conglomerate in multi businesses to a sharply focused automation
company. During Davis’s tenure, he sold the aerospace and defense operations, spin off the
automotive-parts and semiconductor business, and put the company well on the road to enlarge
its already major interest in the automation. Under the leadership of Davis, Rockwell achieved
net ROEs greater than 20 percent in the following years.
Among other things, three points stand out after a comparison of cases in Quadrant II
and IV. First, the “surprising winner” had a consistent strategy with staged goals. Actions
initiated by the new CEO represented the implementation and reinforcement of its strategy. By
contrast, although the new CEO in the “surprising loser” had undertaken many changes, these
actions were vacillating and swinging, raising stakeholders’ doubts on the next step the troubled
firm would pursue. Second, the “surprising winner” had a clear leadership, with CEO and
chairman consolidated into one individual. However, the departing incumbent of the “surprising
loser” was reluctant to give up all his power immediately, and held the chairman position on the
board. The new CEO could be handicapped or overshadowed by the incumbent chairman
(Fahlenbrach, Minton, & Pan, 2008). Finally, the “surprising winner” responded more quickly in changing its leader once it fell into turnaround situations. Although these three points are solely
based on two anecdotal evidences and should not be conclusive, they have provided some initial
ideas to understand why the surprising results on the pay-performance relationship would occur.
4.1.4. Limitations and Future Research
My third essay has a number of limitations. First, I could only observe specific
individuals who were appointed as the CEO. In other words, I could not study the recruiting
process in the firm’s search for a new CEO. A lower compensation to the new CEO could have
116 been due to the fact that the firm could not find a better CEO (assuming that talented individuals tend to get higher pay), not because the company is not in a turnaround situation. Similarly, the reason the company does not use a higher proportion of stock-based pay is that the potential candidates it approaches have a lower risk propensity, not because the company is not in a turnaround situation. This concern could be minimized because it is reasonable to expect that firms in turnaround situations have greater difficulty hiring a high-quality CEO and convincing the potential candidates to take a greater stock-based pay. Nevertheless, I cannot completely rule out these alternative explanations, which actually raise awareness about careful interpretation of the managerial implications discussed above. That the company gives a lower total pay or stock- based pay to its new CEO could be due to the fact that it cannot find a talented candidate or an executive who is willing to take the necessary risks, not because the board has a lower pay policy or has not considered the benefits of greater stock-based pay.
Second, although I found evidence that supported the positive effective of a CEO’s initial compensation on post-succession performance, I did not further study which form, stock-based pay or non-stock-based pay, played a greater role. In analysis that I did not report here, I found significant effect of stock-based pay across ROE, ROA and Successful Turnaround models. By contrast, non-stock-based pay is significant only in ROA model. These findings provide initial evidence suggesting the stronger effects of variable pay.
Third, my second essay suggests that new CEOs with a greater fit with the context tend to improve subsequent performance. Therefore, would a company pay additional compensation to a
CEO who better fits the context? In other words, can a CEO request higher pay because his or her capabilities align with contextual requirements? Prior research on the determinants of CEO compensation has not considered such a “fit” perspective.
117 Finally, I have proposed that a CEO’s prestigious credentials, measured by affiliations with prestigious entities, have positive performance implications. While I did find a positive effect of S&P prestige, a CEO’s educational prestige consistently showed the opposite. Future research could explore other indicators of a CEO’s prestigious credentials, and study why different types of prestigious affiliations may have opposing effects on performance for firms in turnaround situations.
118 Chapter 5
CONCLUSION
My dissertation consists of three essays investigating CEO replacement in turnaround
situations. It is driven by three major research questions. The first asks why some CEOs are more
likely to be dismissed in turnaround situations. Chapter 2 (my first essay) suggests that the
organizational decision on CEO dismissal is essentially situated in a broader social context,
where social arbiters can play a critical role through their calling for a change of corporate
leadership. Different parties with strong biases engaged in a social framing contest to mobilize
and convince others to accept their wisdom and claims for replacing or retaining the incumbent.
While it is obvious that the worse the company’s problems, the louder the calls for a CEO’s
dismissal, the insight and novelty of the social framing contest model is that it addresses how
calls for dismissal (or retention) can be louder (or softer) than objective performance indicators
might predict; and explains why some frames of CEO dismissal are more effective than others in
influencing the board’s decision. Attention to these framing efforts enhances our ability to
explain the likelihood and speed of a CEO’s dismissal.
The second question asks whether and when CEO replacement is helpful for firms in
turnaround situations. To answer this question, Chapter 3 (my second essay) reviews the pros
and cons of CEO replacement, and theorizes a “context-person fit” argument in explaining the
conditions where a change of CEO is beneficial. By analyzing the environmental turbulence,
severity and sources of performance problems, as well as the CEO tenure, outsiderness and functional background, I propose several types of predecessors’ misfit and successors’ fit.
Results based on 140 CEO replacements in 223 turnaround situations suggest that CEO
119 replacement per se does not have any effect on subsequent performance, although the stock market responds positively to the replacement announcement. I also present considerable evidence to suggest that the presence of a context-person fit (misfit) has strong performance implications.
The third question asks how firms in turnaround situations pay their new CEOs and whether CEO compensation will improve post-succession performance. In Chapter 4 (my third essay) I theorize the determinants of CEO compensation (both the magnitude and the structure) from the perspective of an overall context of turnaround situations, and further argue that compensation is an important factor that would influence post-succession performance. Using data on 94 new CEOs hired in turnaround situations and 431 new peers hired in non-turnaround situations, I document that firms in turnaround situations reward their new CEOs with higher total pay, particularly a higher stock-based pay, than firms that are not in turnaround situations.
Firms have to pay an even higher compensation if the new CEOs are appointed externally.
Finally a higher compensation helps attract talented executives, which, in turn, would improve post-succession performance.
These three essays together present a coherent view of executive leadership in turnaround situations. They are built on, and contribute to, the literature on corporate turnaround, CEO succession, and CEO compensation. Although I have discussed each essay’s implications and limitations at the end of each chapter, I would also like to offer perspectives from the whole dissertation.
120 5.1. Research Implications
In several places across this dissertation, I highlight the importance of understanding the
effect of “context” on executive behaviors and strategic outcomes. That context could include external social factors (e.g., social arbiters in the first essay), industrial environment (e.g.,
environmental turbulence in the second essay), internal organizational factors (e.g., severity of
the situation in the second essay), or turnaround situations themselves (as a context explaining
the logic of CEO pay in the third essay). Research in management could benefit from a wider
concept of context, considering its role in setting a boundary for research and its main and
moderating effects in organizational studies.
My dissertation has implications for managerial discretion research as well. The question
of whether a CEO matters has seen decades of debate (e.g., Barnard, 1938; Hannan & Freeman,
1977). To reconcile competing perspectives, Hambrick and Finkelstein (1987) introduce
managerial discretion, defined as the latitude of managerial action, as a way to understand
whether, and when, executives have a strategic choice (Child, 1972). They further suggest
individual, organizational, or industrial factors that affect the degree of discretion a CEO has. My
dissertation contributes to this stream of research by suggesting determinants of managerial
discretion from situational and social perspectives. For instance, I expect that new CEOs in
turnaround situations have a higher degree of discretion because of mean-end ambiguity, and
incumbents in firms being criticized by social arbiters have less discretion due to the reasons in
the following discussion of governance mechanisms.
Prior research on corporate governance has addressed both the internal mechanism, such
as boards of directors and ownership structures (Baysinger & Butler, 1985; Fama & Jensen,
1983), and the external mechanism, such as market for corporate control (Jensen & Ruback,
121 1983; Manne, 1965). My first essay provides some evidence that the media or financial analysts may act as an external control mechanism (Miller, 2006; Wiersema & Zhang, 2008). Comments and critiques from social arbiters may exert pressure on managers and directors, and trigger the functioning of the internal mechanism. My dissertation also has implications for corporate governance research in several other places, for instance in selecting new CEOs and setting executive compensations as I discussed in my second and third essays.
5.2. Limitations and Future Research Directions
First, my dissertation focuses on the CEO as the unit of analysis (e.g., CEO succession,
CEO compensation). However, upper-echelons research suggests that the top management team, rather than an individual, represents a stronger predictor of strategic choices and organizational outcomes (Hambrick & Mason, 1984). In the current study, I have not considered the dynamics of the top management team, which doubtlessly affects the antecedents and consequences of
CEO replacement (Cannella & Shen, 2001; Ocasio, 1994; Zhang, 2006). But it raises these questions: How might a CEO’s lieutenants (or other employees) enter into the framing contest for a CEO’s dismissal? How do the capability complementarities between executives and CEOs affect the performance consequences of a successor’s context-person fit? Does a higher initial pay to a new CEO in a turnaround situation increase or decrease the average compensation of other executives? Is the pay disparity in the top team harmful to the turnaround efforts? Future studies that examine the whole team, instead of an individual, as the research focus might provide new insights on these issues.
Second, my dissertation did not consider the psychological differences among CEOs, such as locus of control, risk attitude, hubris, and narcissism (Chatterjee & Hambrick, 2007;
122 Miller, Kets de Vries, & Toulouse, 1982; Malmendier & Tate, 2005). Research has suggested that psychological factors influence executive behaviors. For instance, CEO hubris may
determine how vigorously an incumbent fights for his or her retention, and thus influence the
process of a social framing contest. A personal risk attitude may affect whether a candidate
accepts a job offer from a troubled firm or not. Incorporating personality differences in a study
would further increase the models’ predictive power.
Finally, my empirical sample for this study was solely based on U.S. companies, where
CEOs tend to have a greater effect, for better or worse, on organizational performance
(Crossland & Hambrick, 2007). Future research could explore whether we observe different
patterns in other national contexts with regard to my three major research questions in the
dissertation. For instance, is the social framing contest model more apt in nations where the
“romance of leadership” is strong (e.g., the U.S.) rather than in countries where it is weak
(Meindl, et al., 1985)? Are the positive effects of a predecessor’s misfit and the successor’s fit weaker in a culture which places a higher value on collectivism (e.g., Japan) (Hofstede, 2001)?
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140 APPENDIX A: FIGURES
Figure 1: A Social Framing Model of CEO Dismissal
Incumbent CEO CEO Retention Frame
Firms in Turnaround Situations Institutional CEO Dismissal/ (ambiguity, Directors Investors Retention uncertainty)
Social Arbiters CEO Dismissal Frame
141 FIGURE 2: Dismissal of Jill Barad, CEO of Mattel
Figure 2a: A Longitudinal Examination of Social Arbiters’ Assessments on Barad in Mattel (From Jan 1997 to Feb 2000)
The Press: a “The international push marks “Mattel is suffering from Barad’s weaknesses… she lacks financial the latest move by Barad to acumen, is not disciplined herself …” (NYT. 07Nov99) strengthen the company… Mattel stock has risen sharply” “Several sources question Barad’s ability to “She reinvented Barbie… (WSJ, 11Feb98) “How could a $4.8 billion company get “Mattel CEO lacks full deal with slackening overseas sales and the Barad has shot through the blindsided like this?” (BW, 28Dec98) knowledge of problems” complicated $3.5 billion purchase of software glass ceiling by virtue of her (RN, 08Oct99) maker Learning Co” (RN, 02Dec99) fiercely competitive spirit – and by outperforming all “She has broken every rivals” (WSJ, 05Mar97) stereotype about successful “Mattel’s overall strategy is “There are growing doubts on “She is not a good strategist and she corporate women…” (BW, sound, and the company Barad whether she can turn the doesn’t have the kind of financial 250 25May98) should return to outperforming company around…Mattel sophistication … good marketers don’t Return broad stock-market indexes” need to reduce its reliance on necessarily make good CEOs (CNN (NYT, 11Oct98) Barbie…” (NYT, 07Apr99) Financial News, 03Feb00) 200
150
MATEL S&P 500 100 1 2
3 50 4
0 Month/Year Jan-97 Feb-97 Mar-97 Apr-97 May-97 Jun-97 Jul-97 Aug-97 Sep-97 Oct-97 Nov-97 Dec-97 Jan-98 Feb-98 Mar-98 Apr-98 May-98 Jun-98 Jul-98 Aug-98 Sep-98 Oct-98 Nov-98 Dec-98 Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99 Jul-99 Aug-99 Sep-99 Oct-99 Nov-99 Dec-99 Jan-00 Feb-00
Financial a “To me the true measure of “Barad revamps retail “We’re very upset, “Conversations with “…The analyst cited Analysts: management is stock strategy to boost its and we’re very analysts and with poor results, missed performance, and based on direct sales…Some critical of many other people expectations and the that she is doing a great analysts are skeptical management at this draw an image of a inability to managing in job.” (NYT, 20Oct97) of this strategy.” point… It was way company severely a difficult environment (WSJ, 17Feb99) worse than we had damaged by Barad's as strikes against Barad.” ever anticipated.” management style.” (DJBN, 03Feb00) “Wall Street analysts, who were (WSJ, 05Oct99) (NYT, 07Nov99) also briefed on the plans this week, generally applaud the new strategy.” (WSJ, 11Feb98)
"The board is in some pretty desperate need of new blood … when “The problem was that Mattel has a pretty weak board, Governance they serve a long time, they may not see the need for change… It a lot of Jill’s friends are on the board … they just stuck a Watchdogs: is not good governance, period." (NYT, 07Nov99) by her…” (CNN Financial News, 03Feb00) Figure 2b: CEO’s Response, Board of Directors and Institutional Investors’ Disposition (From Jan 1997 to Feb 2000)
“She had only been informed last week about a revenue shortfall at the software division … division heads hadn't told her about CEO “Barad blamed the disappointing profits on a range of the trouble.” (WSJ, 08Oct99) (Jill Barad): a problems, including returns of merchandise, a canceled licensing arrangement, and termination of agreements with “Asked if Mattel would sell Learning Co., Barad said no. She some distributors …” (AP, 04Oct99) added that once the opportunities Learning Co. presents in Internet commerce and other areas come to light, ‘you will agree that this was the right acquisition for Mattel.’” (DJBN, 21Oct99) “Barad predicts that the emptying of “Unfortunately, The inventories would open the way for Learning Company Mattel's earnings to bounce back to $1.50 performance masks the “Barad said the toy maker didn't uncover any a share next year.” (FT, 15Dec98) irregularities and remains ‘very satisfied’ with the 250 underlying vitality of our core U.S. business”. acquisition.” “Top two executives of its troubled Return (AP, 05Oct99) Learning Co. have left the company.” (DJBN, 10Nov99)
200
150
MATEL S&P 500 100 1 2
3 50 4
0 Month/Year Jan-97 Feb-97 Mar-97 Apr-97 May-97 Jun-97 Jul-97 Aug-97 Sep-97 Oct-97 Nov-97 Dec-97 Jan-98 Feb-98 Mar-98 Apr-98 May-98 Jun-98 Jul-98 Aug-98 Sep-98 Oct-98 Nov-98 Dec-98 Jan-99 Feb-99 Mar-99 Apr-99 May-99 Jun-99 Jul-99 Aug-99 Sep-99 Oct-99 Nov-99 Dec-99 Jan-00 Feb-00
“Through her skilled ``There has been zero talk of Jill leaving,'' says management, sales of William D. Rollnick, a board member for 16 years “Mattel’s board will Board of Mattel’s core brands who describes Barad as ``the best marketing meet in an emergency Directors have increased person I've ever met in my life.'' (BW, 06Sep99) session to discuss the substantially and brand future of Jill Barad” recognition has been (WSJ, 03Feb00) expanded on a “Ms. Barad continues to have full support of the worldwide basis (WSJ, company's board.” (NYT, 07Oct99) 09Oct97)
“Ms. Barad has a strategic plan for the company and its Notes: future and has the full support of the board of directors.” a: Comments and responses of CEO, board, (NYT, 07Nov99) financial analysts and governance watchdogs are conveyed by the press Institutional Investor: a “investors who were once enamored of Barad appear to “The board has to consider bringing in a new AP: Associated Press; BW: Business Week; have grown impatient waiting for her to deliver results; team that can deliver … Somebody has to be DJBN: Dow Jones Business News; FT: Since she took over as chief executive, company’s stock held accountable for the loss of shareholder Financial Times; NYT: New York Times; RN: has fallen 10 percent” (NYT, 07Apr99) value…” (New York Post, 11Nov99) Reuters News; WSJ: Wall Street Journal; Figure 3 The Effects of New CEO’s Context-Person Fit on Subsequent Performance
Figure 3a Figure 3b
0.3 0.3
0.25 0.25
0.2 0.2
0.15 3 0.15 3
0.1 0.1
0.05 0.05 0 0 Throughput function=0 Net ROE at Year + at Year ROE Net
Net ROE at Year + atYear ROE Net -0.05 -0.05 Extreme insider Throughput function=1 (Outsiderness=1) -0.1 -0.1 Extreme outsider -0.15 -0.15 (Outsiderness=7) -0.2 -0.2 1 S.D. below the 1 S.D. above the 1 S.D. below the 1 S.D. above the average of STS average of STS average of STS average of STS Severity of Turnaround Situation (STS) Severity of Turnaround Situation (STS)
Figure 3c
0.3
0.25
0.2
0.15 3
0.1
0.05 Output function=0 0 Output function=1 Net ROE atYear + -0.05
-0.1
-0.15
-0.2 01 Sales-problem firm
Figure 4 Two-by-two Matrix of Context-person Fit Considerations
Firm-specific Industry/Environment-specific
Predecessors (misfit) • Severity of the situation * Long- √ • Turbulent environment * Long-tenure √ tenured incumbent incumbent
• Severity of the situation * Non- √ • Industry in an early stage of life cycle * throughput incumbent predecessor lacking aggressiveness in setting industry standards • Sale-problem company * Non-output √ incumbent
• Lack of information flow from the grass-root employees * big-strategist incumbent
Successors (fit) • Severity of the situation * Successor’s √ • Overall industry decline * Successor outsiderness from outside the industry
• Severity of the situation * Successor √ • Industry in an early stage life cycle * with throughput background Successor who is innovative and doesn’t like to commit to status quo • Sale-problem company * Successor √ with output background • Extremely powerful suppliers/customers in an industry * Successor who has • Cost-problem company * Successor strong social networks with with throughput background suppliers/customers
• Fail in global expansion * Successor with international background
145 Figure 5 Initial Compensation of New CEOs in Turnaround Situations
5a: Antecedents of New CEOs’ Initial Compensation
H1: High pay for new CEOs Turnaround Situation H2: High percentage of stock- based pay for new CEOs
H3: Externally-appointed CEOs (+)
5b: Consequences of New CEOs’ Initial Compensation
H4a
CEO Talents Post-succession New CEO’s (Prestigious credentials, performance / initial Pay industry experiences, Likelihood of and outsiders) successful turnaround
H4b
146 Figure 6 Case Illustration of new CEOs’ Initial Compensation and Post-succession Performance Quadrant IV: “Surprising Winner” Quadrant I “Successful Turnaround” Company: Rockwell International Company: GAP New CEO: Don H Davis Jr. New CEO: Paul S. Pressler Succession Year: 1997 Succession Year: 2002 Experience: Employed by Rockwell Intl in 1963 Experience: Joined GAP in 2002. Prior to that, Mr. Pressler worked in the Walt Disney Company, served as president of Disneyland, Initial Compensation (total): $ 3.5 million president of Disney Stores etc. Pay Discount (compared to predicted pay): $1.3 million Initial Compensation (total): $ 36.9 million Post-succession Performance (Net ROE at Year +2 and Year +3): Pay Premium (compared to predicted pay): $12.7 million 22.1% & 23.8% Post-succession Performance (Net ROE at Year +2 and Year +3): 23.2% & 20.5%
Quadrant III Quadrant II: “Surprising Loser”
“Not Turnaround” Company: AVX Corp Company: Informix New CEO: John S. Gilbertson New CEO: Robert J. Finocchio, Jr. Succession Year:: 2001 Succession Year: 1997 Experience: Employed by AVX since 1981 Experience: Joined Informix in 1997. Prior to that, Mr. Finocchio was employed as a president in 3Com systems. Initial Compensation (total): $0.7 million Initial Compensation (total): $ 10.7 million Pay Discount (compared to predicted pay): $1.6 million Pay Premium (compared to predicted pay): $4.6 million Post-succession Performance (Net ROE at Year +2 and Year +3): -7.7% & 3.8% Post-succession Performance (Net ROE at Year +2 and Year +3):-3.5% & -30.9%
“Low Pay” “High Pay”
Note: To determine whether the initial pay is high or low, I considered the absolute value of CEO compensation, as well as the pay residuals (i.e., whether the compensation is greater or less than the predicted pay. The predicted pay is constructed based on Model 1 of Table 8 ).
147 APPENDIX B: TABLES
Table 1 Descriptive Analysis and Correlations a Mean S.D. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Prior performance (Average of net 1 0.19 0.06 ROE in Y-2 and Y-1) Prior Performance (Average of 2 1.71 1.61 0.52 MTB in Y -2 and Y -1) 3 Performance at Year 0 (net ROE) b -0.14 0.17 0.030.14 4 Performance at Year 0 (MTB) b 1.09 0.96 0.45 0.59 0.15 Performance change in the industry 5 0.02 0.06 0.01 0.03 -0.02 0.01 (net ROE) Performance change in the industry 6 0.12 0.31 -0.07 0.05 0.03 0.01 0.35 (MTB) 7 Firm size c 7.21 1.28 -0.03 -0.13 0.06 -0.03 0.01 0.00 8 Firm age c 3.12 0.70 -0.10 -0.29 -0.04 -0.18 -0.03 -0.01 0.34 9 Strategy change -0.01 2.31 0.25 0.18 -0.24 0.02 -0.11 -0.01 -0.23 -0.16 10 Top management team change 0.49 0.37 0.07 0.10 -0.13 0.03 0.08 0.00 0.02 0.01 0.13 11 Multiple replacement of CEO 0.19 0.40 0.13 0.15 0.02 0.04 -0.10 0.00 0.12 0.08 0.17 0.05 12 Prone to CEO replacement 0.65 0.32 0.02 -0.01 0.01 0.05 -0.01 -0.10 -0.16 -0.23 -0.05 -0.13 -0.18 13 CEO replacement 0.59 0.49 0.00 -0.02 0.02 -0.02 -0.05 -0.05 0.19 0.11 0.01 0.18 0.40 -0.36 14 CEO replacement during Year 0 0.25 0.43 -0.06 -0.11 -0.07 -0.09 -0.08 -0.11 0.06 0.07 0.01 0.11 0.04 -0.22 0.44 15 CEO replacement during Year +1 0.19 0.38 0.10 0.14 0.01 0.11 0.05 0.02 0.10 0.05 0.01 0.03 0.22 -0.14 0.37 -0.27 16 CEO replacement during Year +2 0.18 0.38 -0.02 -0.05 0.09 -0.03 -0.02 0.03 0.07 0.02 0.00 0.08 0.23 -0.07 0.38 -0.28 -0.23 17 Environmental turbulence 0.20 0.11 -0.04 -0.12 0.00 -0.20 -0.07 -0.13 -0.19 -0.07 0.07 0.07 0.02 -0.01 0.07 0.04 -0.01 18 Sales-problem firm 0.38 0.49 0.18 0.09 -0.15 -0.09 0.23 0.20 -0.20 -0.08 -0.05 0.03 0.02 -0.14 0.03 0.12 -0.05 19 Incumbent’s tenure 9.01 6.81 -0.01 0.09 0.03 0.07 -0.03 -0.07 -0.09 0.01 0.08 -0.01 0.01 -0.03 0.06 -0.03 0.03 20 Non-throughput incumbent 0.63 0.27 0.11 0.08 0.00 0.05 -0.15 -0.10 0.03 0.09 0.00 -0.01 0.11 0.13 0.03 0.08 -0.02 21 Non-output incumbent 0.76 0.35 0.01 -0.10 -0.14 -0.16 0.02 0.03 -0.03 0.04 0.11 0.00 -0.02 -0.09 0.05 0.05 -0.02 22 Successor’s outsiderness 3.18 2.15 -0.01 0.08 -0.04 -0.01 0.31 0.14 -0.05 -0.21 0.00 0.27 0.10 -0.02 - -0.10 0.01 23 Throughput-oriented successor 0.41 0.29 0.12 0.00 -0.04 0.06 -0.09 -0.17 0.29 0.17 -0.01 0.10 -0.12 -0.01 - 0.10 -0.18 24 Output-oriented successor 0.20 0.40 0.06 0.13 -0.01 0.23 0.07 0.07 0.07 0.03 -0.03 -0.23 0.02 0.16 - -0.16 0.20 25 Initial market reaction (CAR) 0.01 0.03 -0.06 0.10 -0.06 0.09 0.02 0.09 0.02 0.00 0.02 0.10 0.22 -0.16 - -0.10 0.13 Subsequent performance at Year +3 26 0.09 0.19 0.11 -0.18 -0.04 0.02 0.07 -0.05 0.19 0.16 -0.19 -0.15 -0.19 0.05 -0.09 -0.03 -0.01 (net ROE) Subsequent performance at Year +3 27 1.21 0.94 0.39 0.56 0.09 0.50 -0.03 0.15 -0.01 -0.11 0.05 0.04 -0.03 0.08 -0.14 -0.07 -0.01 (MTB) Subsequent performance at Year +3 28 0.19 0.06 0.02 -0.16 -0.01 -0.02 0.15 0.02 0.18 0.20 -0.11 -0.05 -0.11 0.04 0.02 -0.06 0.06 (successful turnaround)
148 Table 1: Descriptive Analysis and Correlations (Continued) a
16 17 18 19 20 21 22 23 24 25 26 27 17 Environmental turbulence 0.06 18 Sales-problem firm -0.05 -0.01 19 Incumbent’s tenure 0.08 0.02 0.07 20 Non-throughput incumbent -0.04 0.05 -0.05 0.14 21 Non-output incumbent 0.03 0.10 0.01 0.05 -0.19 22 Successor’s outsiderness 0.10 0.02 0.11 -0.02 -0.29 0.09 23 Throughput-oriented successor 0.07 -0.07 -0.08 0.07 0.04 -0.02 0.03 24 Output-oriented successor -0.03 -0.07 -0.11 0.13 -0.04 0.21 -0.12 -0.18 25 Initial market reaction (CAR) -0.03 -0.14 -0.04 0.19 -0.02 -0.03 0.27 -0.06 0.02 Subsequent performance at Year +3 26 -0.06 -0.12 -0.10 -0.04 -0.02 -0.01 -0.03 0.18 0.20 -0.16 (net ROE) Subsequent performance at Year +3 27 -0.09 -0.21 0.03 0.01 -0.01 -0.20 0.05 0.07 0.24 0.03 0.30 (MTB) Subsequent performance at Year +3 28 0.03 -0.13 -0.07 -0.09 -0.08 0.02 0.05 0.10 0.20 -0.10 0.65 0.21 (successful turnaround)
Correlations above |.12| are significant at .05 level; a N=223 for variables 1~21 and 26~28; N = 140 for variables 22~24; N = 101 for variable 25; b Performance severity is a reverse coding of performance at Year 0; c Logarithm transformed;
149 Table 2
Initial Market Reaction to the Announcement of CEO Replacement in Turnaround Situations
Event Window Mean abnormal returns
Day -1 0.36%† (1.42)
Day 0 0.09% (0.19)
Day +1 0.59%* (1.95)
Cumulative Abnormal Returns 1.04%** (from Day -1 to Day +1) (2.82)
N=99 t- values are in parentheses †:p < 0.10; *: p < 0.05; **: p < 0.01
150 Table 3 Predicting the Effects of CEO Replacement on Subsequent Performance
ROE MTB ST 1 2 3 1’ 2’ 3’ 1’’ 2’’ 3’’ Prior performance (average of 0.42* 0.42* 0.42* 0.20** 0.20** 0.20** -0.11 -0.11 -0.19 performance at Y-2 and Y-1) (0.20) (0.20) (0.20) (0.04) (0.04) (0.04) (1.43) (1.43) (1.45) Performance at Year 0 -0.06 -0.06 -0.07 0.40** 0.41** 0.40** 0.06 0.07 -0.01 (0.07) (0.07) (0.07) (0.08) (0.08) (0.08) (0.50) (0.51) (0.51) Performance change in the 0.22 0.22 0.20 0.31* 0.29* 0.30* 2.20+ 2.22+ 1.84 industry (from Y0 to Y+3) (0.17) (0.17) (0.17) (0.13) (0.13) (0.13) (1.21) (1.21) (1.22) Firm size a 0.02* 0.02* 0.02* 0.05 0.05 0.04 0.07 0.06 0.07 (0.01) (0.01) (0.01) (0.05) (0.05) (0.05) (0.07) (0.07) (0.07) Firm age a 0.03 0.03 0.03 0.08 0.08 0.08 0.30* 0.31* 0.31* (0.02) (0.02) (0.02) (0.08) (0.08) (0.08) (0.13) (0.13) (0.13) Strategy change -0.01 -0.01 -0.01 0.03 0.03 0.03 -0.02 -0.02 -0.02 (from Y0 to Y+3) (0.01) (0.01) (0.01) (0.02) (0.02) (0.02) (0.04) (0.04) (0.04) Top management team change -0.07+ -0.07+ -0.07+ 0.03 0.07 0.05 -0.09 -0.12 -0.08 (from Y0 to Y+3) (0.04) (0.04) (0.04) (0.15) (0.15) (0.15) (0.23) (0.24) (0.24) Multiple replacement of CEO -0.08* -0.07* -0.08* -0.18 -0.09 -0.15 -0.39+ -0.44+ -0.44+ (0.03) (0.03) (0.03) (0.13) (0.14) (0.14) (0.22) (0.24) (0.24) Prone to CEO replacement 0.03 0.02 0.03 0.26 0.18 0.21 0.32 0.36 0.38 (0.04) (0.04) (0.04) (0.16) (0.17) (0.17) (0.27) (0.29) (0.29) CEO replacement -0.01 -0.20 0.11 (0.03) (0.13) (0.20) CEO replacement during Year 0 -0.01 -0.05 -0.10 (0.03) (0.14) (0.24) CEO replacement during Year +1 -0.00 -0.09 0.13 (0.04) (0.17) (0.27) CEO replacement during Year +2 0.01 -0.24 0.41 (0.04) (0.17) (0.28) Constant -0.23* -0.22* -0.23* 0.05 0.18 0.14 -1.54* -1.59* -1.71* (0.10) (0.10) (0.10) (0.43) (0.44) (0.44) (0.70) (0.71) (0.72) Sample (N) 223 223 223 223 223 223 223 223 223 Adj/Pseudo R-squared 0.07 0.07 0.07 0.40 0.41 0.40 0.05 0.05 0.05
a Logarithm transformed †:p < 0.10; *: p < 0.05; **: p < 0.01
151 Table 4 Predicting the Effects of Predecessor’s Misfit on Initial Market Reaction and Subsequent Performance
CAR ROE 1 2 3 4 5 6 1’ 2’ 3’ 4’ 5’ 6’ Prior Performance (average of 0.19 0.22 0.15 0.19 0.16 0.17 0.30+ 0.55** 0.61** 0.41* 0.33+ 0.60** performance at Y-2 and Y-1) (0.19) (0.19) (0.19) (0.19) (0.19) (0.20) (0.19) (0.19) (0.19) (0.18) (0.19) (0.20) Performance at Year 0 0.06 0.07 0.31 0.21 0.07 0.39 -0.04 -0.04 -0.04 -0.08 -0.05 -0.12 (0.15) (0.15) (0.21) (0.31) (0.15) (0.33) (0.07) (0.07) (0.13) (0.24) (0.07) (0.18) Performance change in the industry ------0.18 0.14 0.07 0.15 0.25 0.14 ------(0.18) (0.18) (0.17) (0.17) (0.18) (0.19) Firm size a -0.00 -0.00 -0.00 -0.00 -0.00 -0.00 0.02* 0.02 0.02 0.02 0.02+ 0.01 (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) Firm age a 0.01 0.01 0.01 0.01 0.01 0.01 0.03 0.03+ 0.02 0.02 0.02 0.01 (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.02) (0.02) (0.02) (0.02) (0.02) (0.02) Strategy change ------0.01 -0.01+ -0.02* -0.01* -0.01+ -0.02* (from Y0 to Year3) ------(0.01) (0.01) (0.01) (0.01) (0.01) (0.01) Top management team change ------0.01 -0.01 -0.01 -0.01 -0.01 -0.01 (from Y0 to Year3) ------(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Multiple replacement of CEO ------0.07* -0.07* -0.07* -0.05 -0.07* -0.05 ------(0.03) (0.04) (0.03) (0.03) (0.03) (0.04) Prone to CEO replacement -0.02 -0.02 -0.02 -0.02 -0.02 -0.02 0.03 0.04 0.00 0.01 0.01 0.01 (0.03) (0.03) (0.03) (0.03) (0.03) (0.03) (0.04) (0.05) (0.04) (0.04) (0.04) (0.05) CEO replacement ------0.02 0.00 0.00 0.01 0.12 0.18 ------(0.03) (0.06) (0.05) (0.06) (0.07) (0.11) Incumbent’s tenure 0.00+ -0.00 -0.00 0.00+ 0.00+ -0.08 0.00 -0.00 0.00 0.00 0.00 -0.00 (0.00) (0.00) (0.00) (0.00) (0.00) (0.07) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Environmental turbulence -0.06 -0.09 -0.07 -0.06 -0.06 -0.00 -0.10 -0.03 -0.11 -0.08 -0.08 -0.01 (0.07) (0.07) (0.07) (0.07) (0.07) (0.00) (0.11) (0.12) (0.10) (0.11) (0.11) (0.12) Non-throughput incumbent -0.03 -0.03 -0.03 -0.04 -0.03 -0.04 -0.02 -0.02 -0.04 -0.01 -0.01 -0.01 (0.02) (0.02) (0.02) (0.03) (0.02) (0.03) (0.03) (0.04) (0.03) (0.06) (0.03) (0.06) Non-output incumbent b -0.03 -0.02 -0.02 -0.03 -0.03 -0.02 -0.01 -0.01 -0.02 -0.02 0.07 0.08 (0.03) (0.03) (0.03) (0.03) (0.03) (0.03) (0.04) (0.04) (0.03) (0.03) (0.06) (0.05) CEO replacement * - - - - 0.01* 0.00 0.01 Incumbent’s tenure - - - - (0.01) (0.00) (0.01) CEO replacement * - - - -0.36 -0.33 Environmental turbulence - - - (0.37) (0.36) Environmental turbulence * 0.04* 0.03+ 0.00 0.01 Incumbent’s tenure (0.02) (0.02) (0.02) (0.02) CEO replacement * Incumb. tenure - - - 0.08** 0.07+ * Environmental turbulence - - - (0.04) (0.04) CEO replacement * - - - 1.24* 1.36** 1.53* Performance severity - - - (0.55) (0.32) (0.61) Performance severity * 0.03* 0.02 -0.06 -0.06 Incumbent’s tenure (0.01) (0.02) (0.04) (0.04) CEO replacement * Incumb. tenure - - 0.07* 0.04* * Performance severity - - (0.03) (0.02) CEO replacement * - - 0.01 0.04 Non-throughput incumbent - - (0.07) (0.08) Performance severity * 0.20 0.21 -0.67* -0.34 Non-throughput incumbent (0.35) (0.37) (0.27) (0.36) CEO replacement * severity of situ. - - 0.49* 0.06 * Non-throughput incumbent - - (0.20) (0.32) CEO replacement * - - -0.15+ -0.09 Sales-problem firm - - (0.08) (0.10) CEO replacement * - - -0.06 -0.18* Non-output incumbent - - (0.10) (0.08) Sales-problem firm * 0.02 0.01 -0.01 0.01 Non-output incumbent (0.02) (0.02) (0.04) (0.05) CEO replacement * Sales-prob firm - - 0.12 0.05 * Non-output incumbent - - (0.11) (0.11) Constant 0.04 0.03 0.07 0.05 0.03 0.06 -0.18 -0.22+ -0.16 -0.15 -0.21+ -0.18 (0.08) (0.08) (0.09) (0.09) (0.09) (0.09) (0.11) (0.12) (0.11) (0.11) (0.12) (0.13) Sample (N) 99 99 99 99 99 99 223 223 223 223 223 223 Adj. R-squared 0.01 0.03 0.02 0.01 0.01 0.02 0.06 0.10 0.13 0.13 0.07 0.17 a Logarithm transformed b Other function (e.g., general counsel) is the omitted dummy variable †:p < 0.10; *: p < 0.05; **: p < 0.01
152 Table 4 Predicting the Effects of Predecessor’s Misfit on Initial Market Reaction and Subsequent Performance (Continued)
MTB ST 1’’ 2’’ 3’’ 4’’ 5’’ 6’’ 1’’’ 2’’’ 3’’’ 4’’’ 5’’’ 6’’’ Prior Performance (average of 0.14** 0.14** 0.12** 0.11** 0.13** 0.11* 1.41 1.14 2.13 2.26 1.46 2.83 performance at Y-2 and Y-1) (0.04) (0.04) (0.04) (0.04) (0.04) (0.04) (1.47) (1.58) (1.59) (1.52) (1.51) (1.77) Performance at Year 0 0.42** 0.41** 0.36** 0.37** 0.44** 0.37** 0.14 0.34 -0.34 -0.43 0.03 -1.13 (0.08) (0.09) (0.09) (0.09) (0.08) (0.09) (0.56) (0.62) (0.43) (0.57) (0.57) (1.17) Performance change in the industry 0.27* 0.30* 0.29* 0.29* 0.38** 0.45** 2.40+ 2.84+ 2.45 2.23 2.87* 3.06+ (0.13) (0.14) (0.13) (0.13) (0.14) (0.15) (1.38) (1.46) (1.50) (1.47) (1.45) (1.76) Firm size a 0.05 0.04 0.06 0.06 0.06 0.06 0.11 0.08 0.01 0.03 0.12 -0.02 (0.05) (0.05) (0.05) (0.05) (0.05) (0.05) (0.08) (0.09) (0.09) (0.09) (0.08) (0.10) Firm age a 0.07 0.05 0.06 0.06 0.08 0.05 0.40** 0.46** 0.40** 0.36* 0.30* 0.30+ (0.09) (0.09) (0.09) (0.09) (0.09) (0.10) (0.14) (0.16) (0.15) (0.15) (0.15) (0.18) Strategy change 0.04 0.03 0.05+ 0.05+ 0.04+ 0.06+ 0.01 0.08 0.01 -0.02 0.02 0.04 (from Y0 to Year3) (0.03) (0.03) (0.03) (0.03) (0.03) (0.03) (0.04) (0.05) (0.05) (0.05) (0.05) (0.06) Top management team change -0.01 -0.02 -0.02 -0.02 -0.01 -0.01 0.00 0.01 0.02 -0.00 0.00 0.01 (from Y0 to Year3) (0.01) (0.01) (0.01) (0.01) (0.01) (0.01) (0.02) (0.02) (0.02) (0.02) (0.02) (0.03) Multiple replacement of CEO -0.04 0.06 -0.02 -0.01 -0.05 0.06 -0.47+ -0.52+ -0.49+ -0.33 -0.50+ -0.41 (0.15) (0.16) (0.15) (0.15) (0.15) (0.16) (0.26) (0.29) (0.27) (0.27) (0.26) (0.32) Prone to CEO replacement 0.14 0.17 0.14 0.11 0.19 0.25 0.49 0.84* 0.63+ 0.36 0.39 0.84+ (0.18) (0.21) (0.18) (0.18) (0.18) (0.21) (0.30) (0.39) (0.33) (0.32) (0.30) (0.45) CEO replacement -0.19 -0.51+ -0.34 -0.09 -0.22 -0.44 0.13 0.26 -0.21 -0.04 0.95 0.88 (0.13) (0.30) (0.24) (0.26) (0.31) (0.42) (0.22) (0.64) (0.42) (0.53) (0.63) (1.08) Incumbent’s tenure at Year 0 -0.00 -0.00 -0.00 -0.00 -0.00 -0.01 -0.02 -0.02 -0.01 -0.01 -0.02 0.03 (0.01) (0.02) (0.02) (0.01) (0.01) (0.02) (0.01) (0.05) (0.03) (0.01) (0.01) (0.06) Environmental turbulence at Year 0 -0.83+ -0.54 -0.78 -0.72 -0.88+ -0.52 -0.99 -0.35 -1.32 -1.15 -0.99 -0.23 (0.49) (0.55) (0.50) (0.49) (0.49) (0.55) (0.83) (0.95) (0.89) (0.86) (0.84) (1.00) Non-throughput incumbent -0.14 -0.13 -0.13 0.06 -0.14 -0.11 -0.27 -0.27 -0.34 0.14 -0.17 -0.08 (0.13) (0.14) (0.13) (0.23) (0.13) (0.34) (0.25) (0.27) (0.27) (0.43) (0.15) (0.54) Non-output incumbent b -0.18 -0.17 -0.13 -0.14 -0.02 0.10 0.16 0.13 0.08 0.07 0.60 0.76 (0.16) (0.17) (0.16) (0.16) (0.25) (0.27) (0.28) (0.30) (0.29) (0.28) (0.47) (0.55) CEO replacement * 0.08* 0.01 0.08* 0.12* 0.01 0.10+ Incumbent’s tenure (0.03) (0.02) (0.04) (0.05) (0.04) (0.06) CEO replacement * 0.71 0.21 -3.96 -3.53 Environmental turbulence (1.68) (1.73) (4.15) (4.40) Environmental turbulence * -0.12 -0.08 -0.39 -0.54 Incumbent. tenure (0.10) (0.11) (0.41) (0.42) CEO replacement * Incumb. tenure 0.45* 0.47* 0.38* 0.45* * Environmental turbulence (0.21) (0.21) (0.19) (0.21) CEO replacement * -0.06 -0.11 -0.06 1.04+ 4.23 5.56 Performance severity (0.07) (0.09) (0.11) (0.53) (2.56) (7.30) Performance severity * -0.02* -0.01 -1.52* -2.58+ Incumbent tenure (0.01) (0.02) (0.78) (1.41) CEO replacement * Incumb. tenure 0.02 0.01 2.52** 2.63+ * Performance severity (0.01) (0.02) (0.94) (1.47) CEO replacement * -0.21 0.04 -0.06 0.49 Non-throughput incumbent (0.33) (0.43) (0.60) (0.75) Performance severity * -0.19* -0.14 -1.9** -1.60 Non-throughput incumbent (0.09) (0.21) (0.60) (1.11) CEO replacement * severity of situ. 0.22+ 0.15 1.24+ 1.83 * Non-throughput incumbent (0.13) (0.23) (0.72) (1.37) CEO replacement * -1.05* -1.10* -0.64 -1.24 Sales-problem firm (0.42) (0.45) (0.68) (0.82) CEO replacement * -0.03 -0.15 -0.06 -0.13 Non-output incumbent (0.34) (0.38) (0.68) (0.77) Sales-problem firm * 0.06 0.22 0.33 0.20 Non-output incumbent (0.20) (0.23) (0.32) (0.40) CEO replacement * Sales-prob firm 1.03* 1.31* 0.57 0.32 * Non-output incumbent (0.49) (0.50) (0.79) (0.92) Constant 1.04* 1.26* 1.23* 1.11* 0.71 0.92+ -2.3** -2.40* -1.77+ -1.79+ -2.8** -2.19+ (0.50) (0.54) (0.52) (0.51) (0.52) (0.55) (0.88) (1.01) (0.97) (0.94) (0.95) (1.20) Sample (N) 223 223 223 223 223 223 223 223 223 223 223 223 Adj. R-squared 0.40 0.42 0.42 0.42 0.42 0.44 0.09 0.17 0.17 0.15 0.11 0.27 a Logarithm transformed b Other function (e.g., general counsel) is the omitted dummy variable †:p < 0.10; *: p < 0.05; **: p < 0.01
153 Table 5 Predicting the Effects of Successor’s Fit on Initial Market Reaction and Subsequent Performance
CAR ROE 1 2 3 4 5 1’ 2’ 3’ 4’ 5’ Prior Performance (average of 0.04 0.06 0.07 0.08 0.13 0.07 -0.05 -0.12 0.04 0.15 performance at Y-2 and Y-1) (0.12) (0.12) (0.12) (0.12) (0.12) (0.29) (0.28) (0.29) (0.28) (0.27) Performance at Year 0 0.06 0.04 -0.12 0.04 -0.11 -0.05 -0.04 -0.04 -0.04 -0.12 (0.05) (0.05) (0.09) (0.04) (0.09) (0.11) (0.10) (0.10) (0.11) (0.14) Performance change in - - - - - 0.18 0.12 0.17 0.14 -0.09 the industry - - - - - (0.29) (0.29) (0.28) (0.29) (0.26) Firm size a -0.01 -0.00 -0.01 -0.00 -0.00 0.01 0.01 0.01 0.00 -0.02 (0.01) (0.01) (0.01) (0.01) (0.01) (0.02) (0.02) (0.02) (0.02) (0.02) Firm age a 0.01 0.01 0.01 0.01 0.01 0.03 0.03 0.02 0.03 0.03 (0.01) (0.01) (0.01) (0.01) (0.01) (0.03) (0.03) (0.03) (0.03) (0.03) Strategy change ------0.01 -0.01 -0.01+ -0.02+ -0.02* (from Y0 to Year3) - - - - - (0.01) (0.01) (0.01) (0.01) (0.01) top management team change ------0.09+ -0.07 -0.06 -0.06 -0.06 (from Y0 to Year3) - - - - - (0.05) (0.05) (0.05) (0.05) (0.04) Multiple replacement of CEO ------0.06 -0.07 -0.05 -0.05 -0.04 - - - - - (0.04) (0.04) (0.04) (0.04) (0.04) Prone to CEO replacement -0.02 0.01 -0.01 -0.00 0.02 -0.03 -0.09 -0.08 -0.07 -0.14+ (0.03) (0.03) (0.03) (0.03) (0.03) (0.07) (0.08) (0.07) (0.08) (0.08) CEO replacement during Year 0 0.02 0.02 0.02 0.01 0.02 -0.01 -0.02 -0.00 -0.00 0.00 (0.02) (0.02) (0.02) (0.02) (0.02) (0.04) (0.04) (0.04) (0.04) (0.04) CEO replacement during Year +1 0.03+ 0.03 0.03 0.03 0.02 0.00 -0.00 -0.00 0.02 0.02 (0.02) (0.02) (0.02) (0.02) (0.02) (0.05) (0.04) (0.04) (0.05) (0.04) Sales-problem firms 0.02 0.02 0.02 0.02 0.03+ -0.03 0.00 -0.00 -0.07 -0.01 (0.02) (0.02) (0.02) (0.02) (0.02) (0.04) (0.04) (0.04) (0.04) (0.04) Successor’s outsiderness 0.01* 0.01** 0.01* 0.01+ 0.01* 0.00 -0.02 0.00 0.00 -0.02+ (0.00) (0.00) (0.00) (0.00) (0.00) (0.01) (0.01) (0.01) (0.01) (0.01) Throughput-oriented successor 0.01 0.01 0.04* 0.02 0.04+ 0.05 0.04 -0.06 0.04 0.08+ (0.02) (0.02) (0.02) (0.02) (0.02) (0.05) (0.04) (0.06) (0.04) (0.05) Output-oriented successor b 0.05+ 0.06* 0.05+ 0.07** 0.08** 0.02 -0.01 0.02 -0.04 -0.07 (0.03) (0.03) (0.03) (0.03) (0.03) (0.06) (0.06) (0.06) (0.07) (0.06)
Performance severity 0.02* 0.02* 0.17** 0.08** * Successor’s outsiderness (0.01) (0.01) (0.06) (0.02) Performance severity -0.24* -0.18+ 1.03** 1.27* *Throughput-oriented successor (0.10) (0.10) (0.37) (0.55) Sales-problem firms 0.06* 0.06* 0.15* 0.09+ * output-oriented successor (0.02) (0.02) (0.07) (0.05) Constant -0.02 -0.07 -0.05 -0.06 -0.12+ -0.08 0.02 0.01 0.03 0.17 (0.06) (0.06) (0.06) (0.06) (0.06) (0.16) (0.16) (0.16) (0.16) (0.15) Observations 101 101 101 101 101 140 140 140 140 140 Adj/(Psudo)-R-squared 0.03 0.05 0.07 0.07 0.12 0.02 0.07 0.07 0.05 0.15
a Logarithm transformed b Other function (e.g., general counsel) is the omitted dummy variable †:p < 0.10; *: p < 0.05; **: p < 0.01
154 Table 5 Predicting the Effects of Successor’s Fit on Initial Market Reaction and Subsequent Performance (Continued)
MTB ST 1’’ 2’’ 3’’ 4’’ 5’’ 1’’’ 2’’’ 3’’’ 4’’’ 5’’’ Prior Performance (average of 0.09+ 0.08 0.09+ 0.08 0.08 0.26 -0.65 -1.54 0.64 -0.65 performance at Y-2 and Y-1) (0.05) (0.05) (0.05) (0.05) (0.05) (2.04) (2.22) (2.24) (2.20) (2.46) Performance at Year 0 0.43** 0.44** 0.43** 0.43** 0.45** -1.43+ -0.75 0.07 -1.49+ -0.27 (0.11) (0.11) (0.11) (0.11) (0.11) (0.77) (0.90) (1.05) (0.84) (1.14) Performance change in 0.27+ 0.31* 0.27+ 0.27* 0.30* 0.66 0.09 -0.38 0.15 -0.70 the industry (0.15) (0.15) (0.15) (0.14) (0.14) (2.15) (2.35) (2.26) (2.21) (2.41) Firm size a 0.02 0.03 0.02 0.04 0.04 0.00 -0.12 -0.08 -0.14 -0.25+ (0.06) (0.06) (0.06) (0.06) (0.06) (0.11) (0.12) (0.12) (0.13) (0.14) Firm age a 0.06 0.01 0.06 0.02 -0.00 0.45* 0.41+ 0.28 0.46* 0.35 (0.11) (0.11) (0.11) (0.10) (0.10) (0.21) (0.22) (0.22) (0.22) (0.23) Strategy change 0.03 0.03 0.03 0.03 0.03 0.02 0.01 -0.06 -0.03 -0.07 (from Y0 to Year3) (0.03) (0.03) (0.03) (0.03) (0.03) (0.06) (0.07) (0.07) (0.07) (0.08) top management team change -0.03* -0.02+ -0.03* -0.02+ -0.02+ -0.60 -0.58 -0.37 -0.33 -0.29 (from Y0 to Year3) (0.01) (0.01) (0.01) (0.01) (0.01) (0.37) (0.41) (0.42) (0.40) (0.45) Multiple replacement of CEO 0.05 0.07 0.05 0.07 0.07 -0.57+ -0.51 -0.34 -0.48 -0.38 (0.15) (0.15) (0.16) (0.14) (0.14) (0.30) (0.32) (0.32) (0.31) (0.34) Prone to CEO replacement 0.23 0.23 0.22 0.09 0.08 0.74 0.08 0.23 0.39 -0.32 (0.26) (0.25) (0.26) (0.24) (0.24) (0.46) (0.52) (0.51) (0.49) (0.58) CEO replacement during Year 0 0.14 0.11 0.14 0.11 0.10 -0.38 -0.28 -0.15 -0.20 -0.01 (0.15) (0.15) (0.15) (0.14) (0.14) (0.29) (0.31) (0.32) (0.30) (0.33) CEO replacement during Year +1 0.03 0.03 0.03 -0.13 -0.11 -0.29 -0.16 -0.07 -0.18 -0.04 (0.17) (0.17) (0.17) (0.16) (0.16) (0.33) (0.35) (0.35) (0.34) (0.37) Sales-problem firms 0.25 0.23 0.25 0.60+ 0.63* -0.29 0.08 0.07 -0.79* -0.22 (0.19) (0.18) (0.19) (0.31) (0.31) (0.27) (0.30) (0.30) (0.32) (0.36) Successor’s outsiderness -0.00 0.05 0.00 0.08 0.12 0.09 -0.13 0.14* 0.12+ -0.01 (0.15) (0.15) (0.15) (0.15) (0.15) (0.06) (0.09) (0.07) (0.07) (0.11) Throughput-oriented successor -0.03 0.06 -0.03 -0.01 0.06 0.15 0.08 -1.05* 0.02 -0.64 (0.06) (0.07) (0.06) (0.05) (0.07) (0.30) (0.32) (0.47) (0.31) (0.50) Output-oriented successor b 0.15 0.13 0.16 0.09 0.13 -0.29 -0.96+ -0.40 -1.21* -1.77* (0.15) (0.15) (0.16) (0.14) (0.15) (0.45) (0.58) (0.46) (0.57) (0.72)
Performance severity 0.74* 0.58+ 0.71** 0.52* * Successor’s outsiderness (0.34) (0.32) (0.20) (0.24) Performance severity 0.08 0.12 2.41** 1.77+ *Throughput-oriented successor (0.47) (0.43) (0.97) (1.09) Sales-problem firms 0.66+ 0.69+ 1.91** 1.66* * output-oriented successor (0.38) (0.37) (0.60) (0.69) Constant 0.69 0.80 0.70 0.27 0.36 -1.80+ -0.29 -0.46 -0.85 0.74 (0.53) (0.52) (0.53) (0.49) (0.49) (1.09) (1.19) (1.20) (1.18) (1.32) Observations 140 140 140 140 140 140 140 140 140 140 Adj/(Psudo)-R-squared 0.34 0.36 0.33 0.35 0.37 0.13 0.24 0.24 0.21 0.31
a Logarithm transformed b Other function (e.g., general counsel) is the omitted dummy variable †:p < 0.10; *: p < 0.05; **: p < 0.01
155 Table 6 The Moderating Effects of Predecessor’s Misfit on the Relationship between Successor’s Fit and the Likelihood of Successful Turnaround
Control Model (1) (2) Performance severity * Successor’s outsiderness 0.71** 0.68** (0.20) (0.27) Performance severity * Successor’s outsiderness 0.24* * Incumbent(predecessor)’s tenure (0.12) Pseudo R-squared 0.13 0.24 0.26
Performance severity * Throughput-oriented successor 2.41** 2.30** (0.96) (0.79) Performance severity * Throughput-oriented successor 1.20 * Non-throughput incumbent (0.80) Pseudo R-squared 0.13 0.24 0.25
Sales-problem firm * Output-oriented successor 1.91** 2.05** (0.60) (0.67) Sales-problem firm * Output-oriented successor 1.09 * Non-output incumbent (0.96) Pseudo R-squared 0.13 0.21 0.21
N=140 †:p < 0.10; *: p < 0.05; **: p < 0.01
156 Table 7 Descriptive Analysis and Correlations (Predicting New CEOs’ Initial Compensation) Mean S.D. 1 2 3 4 5 6 7 8 9 10 11 12 1 Firm size (log) 7.44 1.66 1.00 2 Firm growth 11.81 52.29 0.04 1.00 3 Firm performance at Y0 -0.03 0.64 0.18 -0.13 1.00 4 Independent directors’ ownership 0.62 2.27 -0.22 0.02 -0.04 1.00 5 Institutional shareholders’ ownership 0.53 0.21 0.07 -0.06 0.11 -0.08 1.00 6 CEO duality 0.50 0.50 0.13 0.05 0.01 -0.02 0.03 1.00 7 Outside director ratio 0.66 0.17 0.16 0.03 0.03 -0.03 0.10 0.27 1.00 8 CEO ownership 0.77 2.76 -0.11 0.01 0.03 0.01 -0.04 0.05 -0.17 1.00 9 Company tenure 9.70 11.17 0.23 -0.08 0.16 -0.02 0.03 0.02 -0.08 0.13 1.00 10 Industry tenure beyond the focal firm 5.23 8.67 0.05 0.08 0.03 -0.08 0.00 0.00 0.08 -0.06 -0.27 1.00 11 S&P prestige 0.21 0.40 0.04 -0.01 -0.02 0.02 0.06 0.03 0.03 -0.09 -0.29 0.16 1.00 12 Educational prestige 0.16 0.36 0.09 0.00 0.09 -0.05 -0.01 0.04 0.07 -0.01 0.15 0.04 -0.07 1.00 13 CEO age 54.27 6.92 0.16 -0.11 0.07 -0.02 0.09 0.08 0.05 0.06 0.26 0.02 -0.10 0.05 14 Prone to CEO succession 0.74 0.37 -0.18 0.10 0.31 0.16 -0.05 -0.09 -0.05 0.14 0.00 0.00 -0.05 0.00 15 Outsider CEO 0.29 0.45 -0.13 0.05 -0.18 0.04 0.02 0.05 0.06 -0.10 -0.56 0.18 0.30 -0.05 16 Firms in turnaround situations 0.15 0.36 0.06 -0.10 -0.05 -0.08 0.03 0.03 -0.08 0.00 -0.03 0.00 0.03 0.00 17 Predecessor’s total pay (log) 7.51 1.22 0.60-0.07 0.16 -0.15 0.14 0.02 0.08 -0.04 0.18 -0.02 0.07 0.05 18 Predecessor’s stock-based pay (log) 0.38 0.29 0.24 -0.08 0.02 -0.11 0.14 -0.07 0.00 -0.01 0.04 0.05 0.05 -0.05 19 New CEO’s total pay (log) 7.85 1.17 0.50 0.09 0.08 -0.17 0.14 0.03 0.08 -0.12 -0.05 0.03 0.24 0.05 20 New CEO’s stock-based pay (log) 0.52 0.29 0.20 0.11 -0.03 -0.09 0.14 0.00 0.06 -0.07 -0.10 0.04 0.18 -0.03
13 14 15 16 17 19 19 20 13 CEO age 1.00 14 Prone to CEO succession -0.09 1.00 15 Outsider CEO -0.05 -0.06 1.00 16 Firms in turnaround situations 0.00 -0.33 0.08 1.00 17 Predecessor’s total pay (log) 0.14 -0.05-0.14 0.05 1.00 18 Predecessor’s stock-based pay (log) 0.11 0.03 -0.01 0.05 0.68 1.00 19 New CEO’s total pay (log) 0.00 -0.05 0.17 0.09 0.55 0.31 1.00 20 New CEO’s stock-based pay (log) -0.03 0.00 0.15 0.07 0.28 0.19 0.71 1.00
Notes: N=525, including 94 new CEOs hired in turnaround situations and 431 matching new CEOs; Correlations above |0.08| are significant at 0.05 level.
157 Table 8 Predicting New CEOs’ Initial Compensation
Initial Total Pay ($) Stock-based Pay (%) 1 2 3 1’ 2’ 3’ Predecessor’s total pay in models 1 to 3 0.28** 0.28** 0.28** 0.07+ 0.07+ 0.07+ (stock-based pay in models 1’ to 3’) (0.04) (0.04) (0.04) (0.04) (0.04) (0.04) Firm size 0.25** 0.25** 0.25** 0.04** 0.04** 0.04** (0.03) (0.03) (0.03) (0.01) (0.01) (0.01) Firm growth 0.00** 0.00** 0.00** 0.00* 0.00* 0.00** (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Firm performance at the succession year 0.07 0.06 0.05 -0.01 -0.01 -0.01 (0.07) (0.07) (0.07) (0.02) (0.02) (0.02) Independent directors’ ownership -0.04* -0.04* -0.03* -0.01 -0.01 -0.01 (0.02) (0.02) (0.02) (0.01) (0.01) (0.01) Institutional shareholders’ ownership 0.00 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) CEO duality -0.03 -0.04 -0.04 -0.01 -0.02 -0.02 (CEO is also board chair) (0.08) (0.08) (0.08) (0.03) (0.03) (0.03) Outside director ratio 0.07 0.13 0.08 0.10 0.12 0.11 (0.26) (0.26) (0.26) (0.08) (0.08) (0.08) CEO ownership -0.23** -0.25** -0.25** -0.02 -0.03 -0.03 (0.07) (0.08) (0.07) (0.02) (0.02) (0.02) Outsider CEO 0.52** 0.50** 0.39** 0.08* 0.08* 0.05+ (0.10) (0.10) (0.11) (0.03) (0.03) (0.03) Company tenure -0.00 -0.00 -0.00 -0.00 -0.00 -0.00 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Industry tenure beyond the focal company -0.01 -0.01 -0.01 -0.00 -0.00 -0.00 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) S&P prestige 0.28** 0.28** 0.25* 0.07* 0.07* 0.06+ (0.10) (0.10) (0.10) (0.03) (0.03) (0.03) Educational prestige 0.15 0.14 0.14 -0.00 -0.01 -0.01 (0.11) (0.11) (0.11) (0.03) (0.03) (0.03) CEO age -0.01 -0.00 -0.00 -0.00 -0.00 -0.00 (0.01) (0.01) (0.01) (0.00) (0.00) (0.00) Prone to CEO succession 0.05 0.13 0.11 0.05 0.08* 0.07+ (0.12) (0.12) (0.12) (0.04) (0.04) (0.04) Industry dummies (included) ------Year dummies (included) ------Firms in turnaround situations 0.25* 0.00 0.08* 0.03 (0.12) (0.14) (0.04) (0.04) Firms in turnaround situations * 0.66** 0.16* Outsider CEO (0.22) (0.07) Constant 4.23** 3.96** 3.69** 0.08 -0.02 -0.08 (0.97) (0.97) (0.97) (0.30) (0.30) (0.30) Observations 525 525 525 525 525 525 Adj-R-squared 0.49 0.500.51 0.18 0.190.20 †:p < 0.10; *: p < 0.05; **: p < 0.01
158 Table 9 Descriptive Analysis and Correlations (Predicting Implications of New CEOs’ Initial Compensation in Turnaround Situations)
Mean S.D. 1 2 3 4 5 6 7 8 9 10 11 12 1 Prior Perf (ROE, Y-2 & Y-1) 0.10 0.13 1.00 2 Prior Perf (ROA, Y-2 & Y-1) 0.05 0.05 0.87 1.00 3 Performance at Year 0 (ROE) -0.10 0.24 -0.13 0.01 1.00 4 Performance at Year 0 (ROA) -0.04 0.08 -0.11 -0.07 0.94 1.00 5 Firm size (log) 7.50 1.30 -0.05 -0.11 0.25 0.27 1.00 6 Firm age (log) 3.19 0.71 -0.10 -0.20 0.04 0.11 0.45 1.00 7 Prone to CEO succession 0.46 0.28 0.08 0.07 0.10 0.07 -0.08 -0.08 1.00 8 Prone to continue service 1.96 0.70 0.04 0.04 0.03 0.03 0.00 0.01 -0.02 1.00 9 Outsider CEO 0.35 0.48 0.06 0.06 -0.15 -0.18 0.06 -0.05 0.14 0.51 1.00 10 Company tenure 9.18 10.69 -0.05 -0.03 0.18 0.18 0.13 0.12 -0.13 -0.55 -0.63 1.00 11 Industry tenure beyond the focal firm 4.77 8.31 0.07 0.09 -0.05 -0.07 0.05 -0.10 -0.16 0.16 0.13 -0.24 1.00 12 S&P prestige 0.23 0.41 0.07 -0.01 -0.14 -0.20 0.19 -0.12 -0.13 0.35 0.54 -0.42 0.29 1.00 13 CEO age 52.48 8.13 0.10 0.15 0.12 0.11 0.15 -0.06 -0.13 -0.06 0.00 0.23 0.24 0.03 14 Educational prestige 0.20 0.40 -0.24 -0.19 -0.08 -0.07 0.10 0.14 -0.10 0.05 -0.07 0.01 0.07 -0.20 15 New CEO’s total pay (log) 8.03 1.38 -0.03 0.00 0.06 0.04 0.52 0.17 -0.14 0.38 0.50 -0.23 0.15 0.46 16 ROE (Y+2 and Y+3) 0.06 0.22 0.04 0.01 0.21 0.23 0.06 0.07 -0.20 0.43 0.14 0.10 0.07 0.18 17 ROA (Y+2 and Y+3) 0.03 0.08 0.08 0.06 0.20 0.24 0.10 0.09 -0.26 0.35 0.12 0.11 0.03 0.19 18 Successful turnaround (Y+2 and Y+3) 0.51 0.50 0.00 -0.04 0.13 0.18 0.02 0.12 -0.14 0.20 0.02 0.21 -0.06 -0.08
13 14 15 16 17 18 13 CEO age 1.00 14 Educational prestige -0.20 1.00 15 New CEO’s total pay (log) 0.05 0.18 1.00 16 ROE (Y+2 and Y+3) 0.24 -0.22 0.20 1.00 17 ROA (Y+2 and Y+3) 0.23 -0.16 0.25 0.90 1.00 18 Successful turnaround (Y+2 and Y+3) 0.11 -0.08 0.02 0.63 0.59 1.00
Notes: N=188 (94 new CEOs hired in turnaround situations); Correlations above |0.13| are significant at 0.05 level.
159 Table 10 Predicting Performance Consequences of New CEOs’ Initial Compensation in Turnaround Situations ROE ROA Successful turnaround 1 2 3 4 1’ 2’ 3 4’ 1’’ 2’’ 3’’ 4’’ Prior performance (average of 0.15 0.14 -0.14 -0.17 -0.05 -0.08 -0.13 -0.20* 0.13 0.17 -0.41+ -0.38 performance at Y-2 and Y-1) (0.13) (0.13) (0.11) (0.11) (0.12) (0.11) (0.11) (0.10) (0.29) (0.29) (0.24) (0.23) Firm performance at Year 0 0.26** 0.26** 0.31** 0.28** 0.33** 0.33** 0.40** 0.36** 0.53** 0.52** 0.55** 0.53** (0.08) (0.07) (0.06) (0.06) (0.08) (0.07) (0.08) (0.07) (0.17) (0.16) (0.13) (0.13) Firm size 0.00 -0.01 -0.05** -0.06** -0.00 -0.01+ -0.02** -0.02** -0.01 -0.03 -0.09** -0.10** (0.02) (0.02) (0.02) (0.02) (0.01) (0.01) (0.01) (0.01) (0.03) (0.04) (0.03) (0.03) Firm age 0.02 -0.00 0.01 -0.00 0.01 -0.00 0.01 -0.00 -0.08 -0.11 -0.08 -0.10* (0.03) (0.03) (0.02) (0.02) (0.01) (0.01) (0.01) (0.01) (0.07) (0.07) (0.05) (0.05) Prone to CEO succession -0.09 -0.05 -0.02 0.02 -0.05* -0.02 -0.04+ -0.02 -0.01 0.05 0.14 0.20 (0.06) (0.06) (0.05) (0.05) (0.02) (0.02) (0.02) (0.02) (0.15) (0.15) (0.12) (0.12) Prone to continue service 0.12** 0.11** 0.12** 0.11** 0.03** 0.02* 0.02* 0.02 0.03 -0.00 0.05 0.03 (0.02) (0.02) (0.03) (0.02) (0.01) (0.01) (0.01) (0.01) (0.05) (0.06) (0.06) (0.06) CEO age 0.00* 0.00** 0.00+ 0.00 0.00* 0.00* 0.00 0.00 -0.00 -0.00 -0.01* -0.01** (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Industry dummies (included) ------Year dummies (included) ------New CEO’s total pay 0.03* 0.03* 0.02** 0.02** 0.06* 0.05+ (0.01) (0.01) (0.01) (0.01) (0.03) (0.03) S&P prestige 0.16** 0.14** 0.05* 0.02 0.27** 0.24** (0.05) (0.05) (0.02) (0.02) (0.09) (0.09) Educational prestige -0.12** -0.15** -0.02* -0.04** -0.38** -0.42** (0.03) (0.03) (0.01) (0.01) (0.07) (0.08) Company tenure 0.01** 0.01** 0.00+ 0.00 0.02** 0.02** (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Industry tenure beyond the focal firm -0.00 -0.00 -0.00 -0.00 -0.00 -0.00 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Outsider CEO 0.08* 0.05 0.04* 0.02 0.20* 0.14 (0.04) (0.04) (0.02) (0.02) (0.09) (0.09) Constant -0.46* -0.59** -0.00 -0.16 -0.08 -0.16* 0.02 -0.07 1.31** 1.03* 2.08** 1.87** (0.22) (0.22) (0.19) (0.19) (0.08) (0.08) (0.08) (0.07) (0.50) (0.52) (0.42) (0.43) Wald Chi-squared 211** 224** 442** 486** 165** 200** 259** 320** 171** 180** 358** 373** Pseudo R-squared 0.39 0.40 0.48 0.50 0.39 0.42 0.46 0.49 0.31 0.32 0.40 0.41
†:p < 0.10; *: p < 0.05; **: p < 0.01
160 VITA Guoli Chen
ACADEMIC POSITION
2008 Assistant Professor of Strategy INSEAD, Singapore
EDUCATION
2008 Ph.D. (Business Administration) Concentration: Strategic Management Smeal College of Business Pennsylvania State University, USA
2000 M.Sc. (Management) NUS Business School National University of Singapore, Singapore
1996 B.A. (Economics) University of International Business and Economics, Beijing, China
PUBLICATIONS
Chen, G., Hambrick, D. C., & Pollock, T. G. (2008), Puttin' on the Ritz: Pre-IPO enlistment of prestigious affiliates as deadline-induced remediation. Academy of Management Journal, 51(5), Forthcoming
Chen, G. (2008), Performance consequences of CEO replacement in turnaround situations. Best paper proceedings of the Annual Conference of the Academy of Management z Finalist for the Robert J. Litschert Best Doctoral Student Paper Award
Chen, G., Trevino, L., & Hambrick, D. (in press) Executives who engage in elitist association: A new vantage on the imperial CEO. Leadership Quarterly
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