Career Concerns of Top Executives, Managerial Ownership and CEO Succession

• Date: 01 May 2008
• Author: M. Martin Boyer,Hernán Ortiz‐Molina
• DOI: http://doi.org/10.1111/j.1467-8683.2008.00679.x
• Published date: 01 May 2008

Career Concerns of Top Executives, Managerial

Ownership and CEO Succession

M. Martin Boyer* and Hernán Ortiz-Molina†

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: Wehypothesize that a top manager’s stock ownership in the firm signals to the board information

about his or her privately known ability to run the company.As a consequence, the outcome of a CEO succession is affected

by the managers’ ownership choices, which therefore depend on their career concerns.

Research Findings/Results: Our study of CEO turnover events in US firms provides support for our basic hypothesis.

Specifically, we find that (1) lower insider ownership makes outside CEO succession more likely; (2) higher ownership by

an insider increases his or her chances of promotion; (3) non-appointed managers with higher ownership are more likely to

reduce their ownership stake or to leave the firm following CEO succession; and (4) ownership reduction and departure

decisions are more likely following outside CEO appointments.

Theoretical Implications: Consistent with signaling theory, our analysissuggests that (1) managerial ownership plays a role

in resolving asymmetric information problems between top managers and the board of directors in the context of CEO

succession, and (2) managers’ portfolio decisions and their departure decisions are driven in part by their career opportu-

nities in the firm.

Practical Implications: By monitoring managerial ownership decisions surrounding CEO turnover, boards of directors can

acquire information about the potential candidates’ ability to run the firm and thus better identify the best successor. As

managers can more easily signal their information to the board when their ownership choices are observable to the public,

security laws that encourage the disclosure of managers’ beneficial ownership stakes may increase the efficiency of boards’

choices and firm value.

Keywords: CEO succession Policy, Board Policy Issues, Signaling Theory, Ownership Issues

INTRODUCTION

We argue that career concerns induce top managers to

take costly actions that improve their chances of

appointment in CEO succession events. In particular, when

managersare privatelyinformed about their ability to run the

firm, they can increase their chances of appointment if they

can find a way to convey their private information

to the board. We posit that managerial ownership choices

can serve for this purpose. Maintaining larger ownership

stakes upon appointment atthe CEO position is less costly for

more talentedmanagers because they can more profitablyrun

the firm. As a result, managers should use their ownership in

the firm to signal their ability to the board;and more talented

managers should own a larger equity stake in the firm than

less talented managers. After developing the conceptual

framework in which the ownership decisions of managers

with career concerns signal managers’talent to the board, we

derive and empirically test several predictions relating CEO

appointment decisions, managerial ownership, and execu-

tive departure surrounding CEO succession events.

Our first two predictions follow directly from the intuition

that higher insider ownership signals higher managerial

ability. First, the board is more likely to appoint an outsider

when the insiders’ ownership in the firm is low. Second,

conditional on the decision to appoint an insider, the board

is more likely to appoint as CEO the manager whose own-

ership in the firm is larger.

*Address for correspondence: HEC Montréal, Université de Montréal, 3000 chemin de

la Côte-Ste-Catherine, Montréal QC H3T 2A7, Canada; and CIRANO. Tel: 514 340-

6704; Fax: 514-340-5632; E-mail: martin.boyer@hec.ca

†Address for correspondence: SauderSchool of Business, University of British Colum-

bia, 2053 Main Mall, VancouverBC V6T 1Z2, Canada. Tel: 604-822-6095; Fax: 604-822-

4695; E-mail: ortizmolina@sauder.ubc.ca

178 CORPORATE GOVERNANCE

Volume 16 Number 3 May 2008 © 2008 TheAuthors

Journal compilation © 2008 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00679.x

Our next two predictions relate changing career opportu-

nities to managerial portfolio choices. If more talented

managers signal their skill to the board by holding larger

ownership stakes, they will be the most overinvested in

the firm’s stock. When their chances of promotion to CEO

vanish after the appointment of another executive, these

non-appointed managers are more likely to reduce their

investment in the firm to diversify the risk of their portfolio.

Moreover, ownership reductions by non-appointed manag-

ers are more likely following outside succession because

such succession events convey worse news about their

career prospects in the firm.

Our last two predictions relate changing career opportu-

nities to executive departures. As more talented managers

choose higher ownership, non-appointed executives with

higher ownership are more likely to leave the firm in search

of better career opportunities elsewhere following the CEO

turnover event. Moreover, non-appointed insider depar-

tures are more likely following outside succession because

of the additional negative information about their career

prospects contained in such board decision.

Using a comprehensive sample of CEO succession events

in large US firms we find empirical support for our hypoth-

eses. We find that firms are less likely to appoint an outsider

when inside candidates have a higher financial involvement

in the corporation. Moreover, the most likely inside candi-

date to be appointed is the manager with a higher owner-

ship. We also find that, among those non-appointed

managers that stay in the company after CEO succession,

those with higher pre-succession ownership are more likely

to reduce their ownership in the firm following succession

than those with lower pre-succession ownership. Moreover,

these managers reduce their ownership in the firm by more

following outside appointments. Last, we find that non-

appointed insiders with higher ownership relative to that of

their coworkers are more likely to leave the company and

that executives’ departuresare more likely following outside

succession. Our results are robust to controlling for a host of

empirical determinants of boards’ appointment decisions

and managers’ portfolio and departure decisions.

Taken together, our results provide support for the

hypothesis that CEO appointment decisions, managerial

ownership choices, and executive departure decisions are all

related through the career concerns of top managers. The

remainder of the paper is organized as follows. Thefirst two

sections review the related literature and develop our

hypotheses. The next section presents the data and defines

our variables. The section with our main empirical results

follows. We then summarize and discuss our findings. The

last section concludes.

RELATED LITERATURE AND

CONTRIBUTION

CEO succession has long been the subject of research inter-

est in both the financial economics and management litera-

tures. Previous research examines the economic and

behavioral determinants of CEO turnover (e.g., Vancil, 1987;

Harrison, Torres and Kukalis, 1988; Weisbach, 1988; Parrino,

1997; Conyon, 1998) and the consequences of succession for

organizational change and firm performance (e.g., Beatty

and Zajac, 1987; Friedman and Singh, 1989). Other studies

examine the decision to appoint an insider or an outsider

(e.g., Dalton and Kesner, 1985; Boeker and Goodstein, 1993;

Cannella and Lubatkin, 1993; Parrino, 1997; Clutterback,

1998; Huson, Malatesta and Parrino, 2004; Johnston, 2005;

Agrawal, Knoeber and Tsoulouhas, 2006). Moreover, recent

work explores how organizational complexity affects suc-

cession planning (e.g., Naveen, 2006), and uses proxies for

the presence of an heir to study which insider is appointed

CEO (e.g., Cannella and Shen, 2001) as well as to study how

the existence of a succession plan is valued by the stock

market (Behn, Riley and Yang, 2005). We add to previous

work by showing that managerial ownership in the firm

may signal managers’ privately known skill to the board and

thus is an important predictor of the outcome of CEO

succession.

A few studies also examine the reasons for executive

departures and show that internal promotion opportunities

affect managerial retention (e.g., Fee and Hadlock, 2003).1As

in our framework executives with higher ownership are

likely to be those with higher talent and better outside job

opportunities, our finding that such executives are more

likely to leave the firm when they are passed up for promo-

tion is largely consistent with this view.

A large literature since Berle and Means (1932) argues

that boards choose managerial ownership to help align

managerial and shareholder interest (e.g., Himmelberg,

Hubbard and Palia, 1999). However, recent work by Ofek

and Yermack (2000) shows that managerial ownership

largely reflects portfolio decisions by managers, who can

undo any incentive effect of new stock and stock option

grants by selling previously owned shares. Our evidence

suggests that managerial portfolio decisions reflect not only

diversification incentives, which call for lower ownership,

but also managers’ incentives to signal their skill to the

board in promotion contests, which calls for higher owner-

ship in the firm surrounding CEO succession.

Finally, Leland and Pyle (1977) argue that retained mana-

gerial ownership in initial public offering serves as an effec-

tive signal to convey a manager’s private information to

outside parties. Empirical studies provide support for their

theoretical predictions in the US (e.g., McConnell and

Servaes, 1990; Mikkelson, Partch and Shah, 1997) and in

Europe (e.g., Pagano, Panetta and Zingales, 1998, for Italy;

Jaskiewicz, González, Menéndez and Schiereck, 2005, for

Germany and Spain; Chahine, Filatotchev and Wright, 2007,

for the UK and France). Our evidence shows that signaling

with stock ownership is also effective in resolving asymmet-

ric information problems between top managers and the

board of directors in the context of CEO succession.

HYPOTHESES DEVELOPMENT

Career concerns naturally arise whenever the labor market

uses an employee’s observable actions to update its beliefs

about his or her privately known ability, and then uses these

beliefs to base promotion, remuneration, or appointment

decisions (Gibbons and Murphy, 1992).As first put forth by

Spence (1973), if more talented employees can take a costly

CAREER CONCERNS OF TOP EXECUTIVES 179

Volume 16 Number 3 May 2008© 2008 TheAuthors

Journal compilation © 2008 BlackwellPublishing Ltd