Investor Myopia and CEO Turnover

• Author: Vidhan K. Goyal,Angie Low
• Date: 01 December 2019
• Published date: 01 December 2019
• DOI: http://doi.org/10.1111/irfi.12198

Investor Myopia and CEO

Turnover*

VIDHAN K. GOYAL

†

AND ANGIE LOW

‡

†

Hong Kong University of Science and Technology, Clear Water Bay, Kowloon,

Hong Kong and

‡

Nanyang Technological University, Singapore

ABSTRACT

We find that Chief Executive Officer (CEO) turno ver is significantly higher

and considerably less sensitive to performance in firms 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 firms 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 firms through their influence on top management

turnover.

JEL Codes: G30; G32

Accepted: 21 April 2018

I. INTRODUCTION

The recent substantial increase in annual Chief Executive Officer (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 1998–2005 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. 759–786

DOI: 10.1111/irfi.12198

agitating for the dismissal of the CEO even when these changes are beyond the

CEO’s control.

In this paper, we examine the extent to which the investment horizon of

institutional investors affects a firm’s decision to replace its CEO. Do firms with

myopic shareholders exhibit higher rates of CEO turnover? Do such firms

exhibit lower sensitivity of CEO turnover to firm performance? Does firm 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 1992–2004. In the pro-

cess, we collected detailed information about the reasons for the CEO’s depar-

ture, and the identity and background of the departing and incoming CEOs.

Our results show that firms 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 firm 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 firms following the CEO change. The results

show that forced turnovers of CEOs in firms with myopic investors results in

worse operating performance following the change. The evidence is consistent

with CEO dismissals being suboptimal in firms with short-term investors.

In the last part of the paper, we test the implications of shareholder myopia on

CEO actions. We find that newly hired CEOs in firms with short-term inves tors

increase investments in fixed assetsrelative to their size and performance-matched

industry peers. We find 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 significant.

The final question we ask is whether new CEOs in firms with short-term

investors engage in excessive risk-taking. We examine total risk and also its

components - systematic risk and idiosyncratic risk. While we find that firms

replacing their CEOs significantly 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