Growing evidence that the personal characteristics of CEOs affect firm policy choices and performance prompts us to investigate the implications of CEO turnover for the value of a company. In a recent paper, we examine whether CEO succession gaps (i.e., the difference in characteristics between predecessor and successor CEO) have any influence on firm performance.
A change at the top is often considered good for a company, but evidence suggests that under certain conditions continuity is advisable. To address this, we seek to identify the characteristics of succession events involving CEOs with radically different personal traits that could harm firm value. A natural subset of these events is firms already operating under disruptive conditions. These include successions after a CEO is forced out and after a period of poor firm performance or strategic instability.
To test our hypotheses, we examine a sample of S&P 500 companies from 1996 to 2016. We construct an index of CEO characteristics from hand-collected data on gender, age, career variety, cultural background, highest education level, and social status (“eliteness”) of undergraduate school. Each of these characteristics has been shown to affect firm performance. We construct the index by adding +1 for every difference in these six attributes between the predecessor and successor CEOs. Index values therefore range from zero to six, with zero indicating close alignment between the successor and predecessor, and six suggesting significant differences. Future performance of each firm undergoing a succession (a treatment firm) is compared with that of other companies. To minimize the effect of any sample selection bias, we use a propensity score-matching methodology, where for every firm experiencing a leadership change, we identify five matching firms that did not go through such an event but share similar pre-succession characteristics. The treatment firms and their matched samples have similar characteristics, with the only difference being that treatment firms had a CEO change.
Our main findings are as follows.
- For the full sample of CEO successions, we fail to see any impact of the succession gap index on future firm performance. Shifts in corporate culture can be beneficial or harmful to performance, and in a portfolio the positive effect in some firms is neutralized by the adverse effect in others.
- We next split the sample into firms that had disruptive changes leading up to the succession event and those that did not. We find that when the succession involves a forced removal of the CEO, or when pre-succession firm performance has been poor, or the succession is preceded by strategic instability, an attempt to further shake up the status quo through a radical shift in the personal traits and experiences of the CEO leads to lower firm performance. This result is even stronger in the long term. Interestingly, and consistent with our conjecture, the adverse impact of the succession is limited to the set of successions that are either disruptive or were preceded by poor performance, since firms in the complementary subsample (i.e. non-disruptive successions) showed significant improvement in performance in the years following the succession event.
- One theoretical prediction is that more successor-induced personnel and structural changes would be expected when the event itself signals a change in firm policy or direction. Consistent with this, we find that successor CEOs who differ considerably from their predecessors tend to co-opt a greater portion of the board one year after assuming office, and they have greater discretion to make far-reaching changes in staffing and business.
Overall, we find evidence that appointing a successor with a gap in characteristics does not always increase firm value. In fact, it can be harmful when the succession event is disruptive. Our empirical findings have strong implications for how firms manage CEO successions, especially when the succession is forced succession or preceded by poor firm performance. In particular, our findings suggest that a firm should not appoint a dramatically different CEO under disruptive circumstances. Instead, the successor should have in-depth industry knowledge and a good understanding of the corporate culture. Such successors will be less likely to demand drastic changes and will experience less resistance within the organization, enhancing rather than disrupting existing relationships. They may also find it easier to seek help from incumbent board members and top managers to successfully implement reforms that add value.
This post comes to us from Renzhu Zhang, Gurmeet S. Bhabra, and Hsin-I Chou at the University of Otago and from Eric K. M. Tan at the University of Queensland. It is based on their recent paper, “CEO Succession Gap and Firm Performance,” available here.