CEO Turnover in the Wake of Perceived Likelihood of Intervention By The Board Of Directors

Abstract

The central puzzle surrounding the sensitivity between firm performance and CEO turnover lies in the presumable efficiency of the boards of directors to monitor the CEOs’ decision making, to determine the CEOs’ performance and compensation, and to retain or to fire the CEOs. Further scholarly work examines other exogenous factors (i.e., external shocks) or observable structural and individual characteristics that undermine the judgment and decision-making of the boards. However, these extant studies inevitably overlook the CEOs’ anticipation and possible preemptions facing the boards intervention by resigning as part of the decision-making process in managing their career concerns. Invoking the settling-up concept of Fama (1980), this paper provides a comprehensive examination of the role of unobservable cognitive decision-making factors that account for performance-induced CEO turnovers using a sample of publicly traded U.S. firms throughout 2004 to 2018. We find a U-shaped performance-induced CEO turnover, such that there are more CEO departures at the top or bottom performance deciles versus moderate firm performance. Our evidence is consistent with the concept of “settling up,” that is, given the higher risk of within-tenure compensation or ex-post career opportunity losses, CEO turnover is less likely to be induced by firm performance. Instead, prior CEO departures proxy the level of board intervention and distort the CEO’s decision-making to encourage departure when it might not be warranted. We conclude that given that replacing CEO is costly, increased probability of departure can be a neglected form of agency cost that is driven by increased board intervention. Our investigation of this new sample allows us to more fully understand CEO incentives to stay or to leave stemming from the anticipated risk of board intervention.