The process of replacing key individuals is crucial to organizations’ performance. This is as true for presidents of countries as it is for CEOs. When a firm announces the departure of a CEO without announcing a successor, the incumbent CEO becomes a lame duck. Consistent with the name’s pejorative connotations, some market participants argue that firms with lame-duck CEOs suffer from a lack of leadership that may create high levels of uncertainty and stall important decisions. This has prompted the SEC and other regulators around the world to require more disclosure of succession plans. For example, in October 2009, the SEC released a bulletin recognizing the importance of CEO succession planning and urging investors to press boards for more information about it.
Using hand-collected data on CEO successions in S&P 1500 firms from 2005 to 2014, we identify 1,739 CEO turnover events. As much as 31 percent are protracted and involve lame-duck CEOs. Our study shows that firms exhibit large positive abnormal returns during the reign of lame-duck CEOs, with an annual four-factor alpha of 11 percent. Consistently, firms with lame-duck CEOs experience better than expected earnings, generating a 1 percent higher return around earnings announcements. Overall, these results suggest that a vacancy in the CEO position is not necessarily detrimental to firm performance.
We then explore possible explanations. First, we focus on the market’s under-reaction to the passage of time. After news comes that the incumbent CEO is stepping down, the probability that the identity of a new CEO will be announced on any given date changes over time. Efficient stock prices should already incorporate the probability that the identity of a new CEO will be announced in the following period. Instead, the market seems to underreact to such foreseeable news, since we find that positive weekly returns are concentrated in weeks when the probability is high that a new CEO will be announced.
Second, we explore the role of competition among senior executives to become the new CEO. Candidates are likely to engage in a tournament and, following tournament theory, competition increases when various candidates have an equal probability of becoming CEO. We measure this as the similarity in compensation. Consistent with tournament theory, we find that firms with high tournament incentives deliver an additional 15.6 percent abnormal return, and firms that ultimately appoint an internal candidate obtain a 26 percent annualized excess return during the reign of a lame duck CEO. Overall, our results indicate that tournament competition explains a large part of the excess return during the lame duck period. 
Finally, we find that firms perform better in the long run after a protracted succession. Over three years after the CEO succession, firms that had a lame duck CEO earn 15 percent higher abnormal returns than do firms with relatively quick CEO successions, suggesting a lengthy process produces a better CEO.
After the SEC warned firms about the risks of poor succession planning, the discussion has been overwhelmingly skewed toward the view that prompt successions are superior to protracted ones. Our results indicate that firms that opt for protracted successions perform better than expected, insofar as the market underestimates some benefits of such successions. Hence, our results do not support the increased regulatory attention to CEO succession planning that guarantees prompt CEO successions.
 In a recent paper “Changing of the Guards: Does Succession Planning Matter?”, Dragana Cvijanović, Nickolay Gantchev, and Sunwoo Hwang study the impact of formal succession planning on turnover decisions. You can find an entry on the CLS Blue Sky Blog here.
 This finding is consistent with Giglio, Stefano, and Kelly Shue, 2014, “No News Is News: Do Markets Underreact to Nothing?”, Review of Financial Studies, 27, 3389–3440, who find stock market under-reaction to the information revealed by the passage of time in the M&A market.
 Edmans, Alex (2011), “Does the stock market fully value intangibles? Employee satisfaction and equity prices,” Journal of Financial Economics, 101, 621-640, documents mispricing in intangible assets. Since internal tournament competition is a type of intangible asset, our results are consistent with his previous evidence.
This post comes to us from Professor Marc Gabarro at the University of Mannheim, Professor Sebastian Gryglewicz at Erasmus University Rotterdam, and Shuo Xia at the Halle Institute for Economic Research, Erasmus University Rotterdam. It is based on their recent paper, “Lame-Duck CEOs,” available here.