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 …………………………………………………………