CEO turnover in public and private organizations: analysis of the relevance of different performance horizons.

AutorLafuente, Esteban
  1. Introduction

    Organizations have always faced the challenge ofmanaging the process of replacing the chief executive officer (CEO). CEO turnover is one of the most researched topics in the finance and management fields and constitutes a "trendy topic" among scholars and practitioners (see, e.g. Chen et al., 2019; Dalton et al., 2007; Dasgupta et al., 2018; Hermalin and Weisbach, 2003; Jenter and Kanaan, 2015; Jenter and Lewellen, 2021; Kim et al., 2020). Most empirical evidence comes from the study of public firms. But, how different is the CEO turnover-performance sensitivity in private businesses compared to public firms?

    High-profile corporate scandals-e.g. Enron, WorldCom or Lehman Brothers-fuelled the debate over what governance structures provide incentives to directors to effectively monitor the CEO's management. But, the debate is open and the governance of privately held businesses has increasingly drawn scholarly attention (Coles et al, 2003; Gao et al, 2017; He and Sommer, 2011). Problems derived from poor oversight of management and self-serving practices by CEOs are not the exclusive domain of public firms, and some recent cases (e.g. Arthur Andersen or FIFA) give ammunition to the argument that the study of CEO turnover in private organizations is also needed.

    The analysis of how past performance changes triggers CEO turnover in public and large private firms is the focus of this study. By examining the effect of different performance horizons-i.e. short- and long-term performance changes-on CEO turnover in publicly traded and privately-owned businesses, we seek to address the following research question: are CEO turnover in publicly traded companies different from privately-owned ones? In our approach, CEO turnover is modeled as a dynamic process in which the effects of past performance changes matter, but also past CEO turnover and changes in the chairperson play important roles [1].

    Literature rooted in finance and corporate governance has mostly adopted agency theory postulates to analyze CEO turnovers (e.g. Adams et al, 2010; Dalton et al, 2007; Jenter and Lewellen, 2021). The CEO-board dynamics are important and have started to be more analyzed recently with longer panel data (Graham et al, 2020). There is important evidence consistent with the idea that CEOs are monitored less intensely and gain power over their tenures, especially conditional on a strong performance. To explore further these issues of successful CEOs being more protected and to see if long tenure affects a firm's value, we start examining CEO replacement conditional on performance. Traditionally, existing studies emphasize that boards learn the quality of their CEOs from past performance records and that, in conjunction with other mechanisms, CEO turnover follows poor performance (see, e.g. Dasgupta et al, 2018; Chen et al, 2019; Denis et al, 1997; Finkelstein et al, 2009; Huson et al, 2001; Graham et al, 2020, Jenter and Lewellen, 2021). Nevertheless, and although private businesses represent the overwhelming majority of firms in the economy, existing work on the negative relationship between performance and CEO turnover has mostly focused on public firms.

    But, can we expect a different CEO turnover-poor performance pattern in private vis-a-vis public businesses? In our approach to CEO turnover, we argue that discrepancies in the performance horizon (short- and long-term performance changes) between public and private firms may condition the directors' responsiveness to poor performance results.

    In the case of private businesses, the absence of market controls gives boards a broader spectrum of information to evaluate the quality of their CEOs, which creates a fertile ground to harmonize financial and non-financial goals (Gomez-Mejia et al, 2011). In public businesses, CEO turnover is affected by the board's responsiveness to shareholder pressures (Dasgupta et al, 2018; Fisman et al, 2014). Investors have been criticized for excessive short-termism which is detrimental to both the development of long-term projects and the evaluation of CEOs (Jenter and Lewellen, 2021). This may explain why some public firms are taking actions to escape the quarterly demands and the short-term horizon imposed by stock markets (e.g. Alliance Boots in the UK or Panera Bread and H. J. Heinz in the United States). Private businesses enjoy a greater level of managerial freedom that opens a window of opportunity for developing long-term, and high-risk, high-return ventures. The 2013 decision to take Dell private constituted an example of how a (formerly) public business shifts its strategic focus to prioritize the maximization of long-term results [2]. Also, many public businesses-e.g. Google and Facebook-have introduced non-voting shares to reduce shareholders' power and unchain their strategic choices from the market's quarterly demands (Fisman et al, 2014).

    Concerns about excessive shareholder influence seem at odds with agency notions that increased alignment between boards and investors is good for performance (Fama and Jensen, 1983; Huson et al, 2001). In the context of our study, this would imply that CEOs' monitoring is consistently efficient across firms. This assumption lacks theoretical and empirical support, which may explain the mixed results in prior studies linking performance to CEO turnover (Aguilera, 2005; Chen et al, 2019; Jenter and Kanaan, 2015; Jenter and Lewellen, 2021).

    In this study, we adopt a management perspective to CEO turnover. By evaluating how different performance horizons (short- and long-term performance changes) as well as other relevant governance features (prior CEO turnovers and changes in the chairperson) impact CEO turnover, we seek to unveil how managers are evaluated in public and private firms. The empirical application considers a sample of 1,493 Spanish public and large private firms during 1998-2004, a period during which we documented 1,679 CEO replacements. We employ the dynamic binary choice technique developed by Bover and Arellano (1997) to model CEO turnover.

    The Spanish context is particularly suitable for studying the sensitivity of CEO turnover to different performance horizons in public and private businesses. In Spain, similar to most developed economies, capital markets are less predominant-compared to the US and UK-and ownership concentration levels in public and private businesses are high (Cuomo et al, 2013). Additionally, during the analyzed period many capital offerings by private firms have swelled Spain's stock market. This is especially relevant for this study. In a scenario dominated by large owners, the analysis of how short- and long-term performance changes impact CEO turnovers gains relevance to evaluate the effectiveness of governance systems in public and comparable private businesses.

    This article extends the existing literature on CEO turnover in two main ways. First, to the best of our knowledge, the specific analysis of the role of different performance horizons (short- and long-term) on CEO turnover in public and private businesses has been largely side-lined in prior work (Gao et al, 2017). Therefore, our study contributes to fill this gap by specifically looking into the role of different performance horizons on CEO turnover in publicly traded and private-owned businesses. Our study is in line with the call made by Hermalin and Weisbach (2003) and Adams et al. (2010) for more research addressing the processes behind executive turnovers in different organizational scenarios. Second, decisions related to CEO turnover have important economic and strategic implications. Existing literature suggests that, as a result of investors' pressure, boards can make flawed turnover decisions (Fisman et al, 2014). We show that CEO turnover works differently in public vis-a-vis private businesses. By examining the outcomes that flow from the monitoring of CEOs in different organizational contexts-i.e. public and private firms-this research contributes to a richer understanding of the forces shaping real-world CEO turnovers.

  2. Theoretical underpinning and hypotheses development

    Literature on CEO turnover has traditionally explored how directors can simultaneously monitor management and provide value-creating advice to the business (e.g. Adams et al, 2010; Chen et al, 2019; Dasgupta et al, 2018; Hermalin and Weisbach, 2003; Jenter and Lewellen, 2021; Kim et al, 2020; Zhang, 2008). Boards play a central role in the monitoring of managers, and research generally supports the notion that performance metrics provide valuable information to evaluate the CEO's ability and the quality of management (Graffin et al, 2013; Jenter and Lewellen, 2021; Tuggle et al, 2010).

    Empirical research examining the relationship between firm performance and executive turnover is extensive and has been carried out in different countries. Examples include Huson et al. (2001), Zhang (2008), Wiersema and Zhang (2011), Graffin et al. (2013), Dasgupta et al (2018) and Jenter and Lewellen (2021) for the United States; Conyon and Florou (2002), Dahya et al (2002), Florou (2005) and Chen et al. (2019) for the United Kingdom; Kaplan (1995) for Germany; Brunello et al. (2003) for Italy; Crespi et al (2004) for Spain; or Lafuente and Garcia-Cestona (2019) for Costa Rica, among others. These studies support the assumption that boards use performance-based variables to monitor managers, and that the negative relationship between performance and CEO turnover is indicative of the quality of the governance system. Notwithstanding the increased relevance of governance for scholar and policymakers, the vast majority of studies analyze CEO turnover in publicly traded companies whose organizational and ownership structures are representative of a small portion of the population of businesses worldwide.

    Existing studies on the relationship between performance and CEO turnover in private organizations are very...

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