Firing on All Cylinders? CEO Retention and Performance: A Learning Approach

Abstract

The decision a board makes to dismiss or retain their manager is the most important one it faces. This paper utilises real options analysis to develop a new learning-based model of this decision. The model presents new implications for optimised CEO survival and termination thresholds through time. Empirical evidence is found to indicate a CEO is more likely to be publicly fired after poor recent stock performance and privately fired when the manager's average accounting performance falls. This suggests that when a firm’s current stock performance is poor, the board is forced to act publicly due to shareholder pressure. When this pressure does not occur, there is indication that the board evaluates the manager's performance through time and makes rational retention decisions. This is consistent with the view that boards are sensitive to the threat (real or perceived) of shareholder outrage (when their job is threatened), and that boards may be trying to optimise long-run firm value, whereas powerful shareholders (such as blockholders) have short term incentives in stock returns. This may indicate that powerful shareholders do not have incentives that are aligned with small shareholders in maximising firm value.