Omitted Agency costs in Preemptive Voluntary CEO Departures

Abstract

Much like the Newton’s first law of physics, the first law of the agency theory is to assume that CEOs are likely to entrench themselves unless a force acts to remove or recruit them. Given that the principal-agent relationship generates conflicts of interest between the CEOs and the shareholders, corporate governance focuses on balancing retention and termination and the boards of directors (BODs) time their actions and inactions. This paper theorizes that the CEOs are not necessarily waiting for the BODs to make a move. Increased likelihood of preemptive voluntary departures is a potentially value-destroying implication of BODs with a history of CEO dismissals. Furthermore, we argue that CEOs actively manage their careers and time their exits from their current firms based on their own relative (compared to other CEOs) past performance, firm’s relative current performance, their expectations about the BODs likelihood of terminating their employment, CEO-labor market conditions, the riskiness of the stability in firm and industry performances. To this end, we empirically predict the likelihood of CEO preemptive voluntary departure and its value-destroying implications for firms. Main findings suggest that the BODs with a history of executive dismissals increase the likelihood of preemptive voluntary CEO departures. These departures decrease firm value due to unrealized CEO career performance.