First Year in Office: How Do New CEOS Create Value?

Abstract

Career concerns and possible “escalation of commitment” bias imply that replacing key decision makers is often necessary for effective re-optimization on poor prior investment decisions. Thus, examining firm actions immediately post CEO turnover can shed important light on the error correction process in a corporation. We find that the probability that a poorly performing business segment will be terminated almost doubles when the CEO who established it steps down. More generally, corrective actions such as operational downsizing tend to follow CEO turnover, while expansion and other corporate policy changes do not. Management shakeup greatly facilitates the correction process, especially after CEO turnover. The higher intensity of corrective actions and their positive value impact post CEO turnover hold pervasively, whether the pre-turnover firm and industry conditions are good or bad, and even for turnovers due to the death and retirement of the department CEOs. The intensity and value impact of post-turnover corrective actions can also explain the well documented performance difference between new insider and outsider CEOs. Our study suggests that a main source of value creation associated with CEO turnover is the facilitation of error correction and re-optimization. We also identify institutional frictions that can hinder error correction at CEO turnover.