Investor Myopia and CEO Turnover

AuthorVidhan K. Goyal,Angie Low
Date01 December 2019
Published date01 December 2019
Investor Myopia and CEO
Hong Kong University of Science and Technology, Clear Water Bay, Kowloon,
Hong Kong and
Nanyang Technological University, Singapore
We nd that Chief Executive Ofcer (CEO) turno ver is signicantly higher
and considerably less sensitive to performance in rms with short investor
horizons. Decisions to dismiss a CEO lead to worse operating performance,
which is even poorer wh en investors have sho rt horizons. Furthe rmore,
new managers respond to investor short-termism by increasing industry-
adjusted capital e xpenditures whil e maintaining R&D and patenting activ-
ity. In addition, in rms w ith short-horizon investors, total risk increases
around forced CEO turnovers, largely because of an increase in idiosyn-
cratic risk. The evid ence is consistent wi th short-term inves tors distorting
corporate policies of rms through their inuence on top management
JEL Codes: G30; G32
Accepted: 21 April 2018
The recent substantial increase in annual Chief Executive Ofcer (CEO) turn-
over has attracted considerable attention from both academics and practi-
tioners. The average CEO tenure has declined from about 10 years in the 1970s
and the 1980s to just over 6 years in the 19982005 period, and continues to
shrink. Changes in management have also become increasingly sensitive to
industry and market returns raising the possibility that boards may be making
systematic attribution errors when assessing the performance of CEOs. Many
commentators argue that the large increase in CEO turnover has arisen because
markets (and boards) have become more impatient. These commentators argue
that shareholders are increasingly focused on short-run performance changes,
* We are grateful to Henrik Cronqvist for many helpful comments and suggestions on this project.
We also thank Zilong Zhang for his excellent research assistance. The work described in this paper
was fully supported by a grant from the Research Grants Council of the Hong Kong Special Adminis-
trative Region, China (Project No. HKUST 641110).
© 2018 International Review of Finance Ltd. 2018
International Review of Finance, 19:4, 2019: pp. 759786
DOI: 10.1111/ir.12198
agitating for the dismissal of the CEO even when these changes are beyond the
CEOs control.
In this paper, we examine the extent to which the investment horizon of
institutional investors affects a rms decision to replace its CEO. Do rms with
myopic shareholders exhibit higher rates of CEO turnover? Do such rms
exhibit lower sensitivity of CEO turnover to rm performance? Does rm per-
formance suffer? Do newly hired CEOs respond to investor short-termism by
investing in short-term projects and avoiding long-term investments such as
R&D? We examine these questions by assembling a large sample of CEO
replacements, with turnover events during the period 19922004. In the pro-
cess, we collected detailed information about the reasons for the CEOs depar-
ture, and the identity and background of the departing and incoming CEOs.
Our results show that rms with a large fraction of shares owned by short-
term institutional investors are more likely to replace the current CEO. While
CEOs are replaced more frequently in the presence of short-term investors,
these replacements do not appear to be sensitive to performance. In other
words, CEO turnover is less sensitive to rm performance when investors have
shorter horizons. To examine further if these turnovers improve subsequent
performance, we study the size, industry, and preturnover-performance
adjusted return on assets of these rms following the CEO change. The results
show that forced turnovers of CEOs in rms with myopic investors results in
worse operating performance following the change. The evidence is consistent
with CEO dismissals being suboptimal in rms with short-term investors.
In the last part of the paper, we test the implications of shareholder myopia on
CEO actions. We nd that newly hired CEOs in rms with short-term inves tors
increase investments in xed assetsrelative to their size and performance-matched
industry peers. We nd a small decline in R&D and patenting activity following
such turnovers. However, the reduction in size, performance, and industry-
adjusted R&D andnumber of patents after turnovers is not statistically signicant.
The nal question we ask is whether new CEOs in rms with short-term
investors engage in excessive risk-taking. We examine total risk and also its
components - systematic risk and idiosyncratic risk. While we nd that rms
replacing their CEOs signicantly increase total risk (relative to size and perfor-
mance matched industry peers), much of the increase is coming from an
increase in idiosyncratic risk. Overall, the evidence suggests that new CEOs
respond to investor short-termism by increasing risk and by investing aggres-
sively into physical assets.
The paper is organized as follows. Section II presents a brief review of previous
studies. Section III describes our data and reports results from the univariate
analysis. We show our key multivariate results in Section IV. Section V examines
the effect of investor myopia on operating performance changes around CEO
turnovers. Section VI presents results from additional tests that examine institu-
tional investor ownership changes prior to turnovers and tests the robustness
using an alternative measure of investor short-termism. Section VII examines
CEO decisions in response to investor short-termism. Section VIII concludes.
© 2018 International Review of Finance Ltd. 2018760
International Review of Finance

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