CEO Investment Cycles
University of Utah - Department of Finance
Tracy Yue Wang
University of Minnesota - Twin Cities - Carlson School of Management
Michael S. Weisbach
Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)
August 12, 2014
Charles A. Dice Center Working Paper No. 2013-12
Fisher College of Business Working Paper No. 2013-03-12
This paper documents the existence of a CEO Investment Cycle, in which firms disinvest early in a CEO’s tenure and increase investment subsequently, leading to “cyclical” firm growth in assets as well as in employment over CEO tenure. The CEO investment cycle is present for both firings and non-performance related CEO turnovers, and its magnitude is substantial: The estimated difference in investment rate between the first three years of a CEO’s tenure and subsequent years is close to the differences caused by business cycles or financial constraints.
This investment cycle appears to be best explained by agency-based arguments. Early in his tenure the CEO disinvests poorly performing assets that his predecessors established and was unwilling to sell. Subsequently, the CEO overinvests when he gains more control over his board. When the CEO eventually steps down, the process is repeated by the next CEO. There is no evidence that the investment cycles occur because of shifting CEO skill or productivity shocks.
Overall, the results imply that public corporations’ investments deviate from the first-best, and that managerial-related factors internal to the firm are quantitatively as important as economy-wide factors in explaining firms’ investments. Our results also imply that a policy of regular management turnover in public corporations potentially can be valuable. Such a policy will likely minimize overinvestment resulting from a CEO’s growing capture of his board, and facilitate correction of errors he is unwilling to acknowledge. Finally, since some asset pricing theories predict that investment is an important determinant of expected equity returns, our results suggest that there could be CEO cycles in expected equity returns.
Number of Pages in PDF File: 59
Keywords: Investment, disinvestment, CEO turnover, exogenous turnover, career concerns, CEO power, overinvestment
JEL Classification: G32, G34, M12, M51working papers series
Date posted: August 16, 2013 ; Last revised: August 13, 2014
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