Managerial Entrenchment and the Effectiveness of Internal Governance Mechanisms
31 Pages Posted: 18 Jul 1998
Date Written: May 8, 1998
We test the effectiveness of internal corporate governance systems by examining the replacement of founder CEOs at poor performing firms. Managerial entrenchment in these firms is expected to constrain the effectiveness of external corporate governance through the market for corporate control. Specifically, we study the replacement of founder CEOs at firms that have performed poorly based on two-year stock returns that rank them in the bottom 5% of all AMEX and NYSE firms. We find that simply replacing a founder CEO is not sufficient to increase long-term stock returns. However, shareholders do receive a wealth gain if the founder leaves both the firm and the board. This suggests that managerial entrenchment is a significant deterrent to improving the fortunes of poor performing firms led by a founder CEO. In addition we find that they are less likely than non-founder led firms to (i) replace a CEO in a poorly performing firm, (ii) replace the CEO with a financier, (iii) experience financial distress, (iv) file for bankruptcy, (v) engage in asset restructuring, or (vi) be targeted for takeover.
JEL Classification: D23
Suggested Citation: Suggested Citation
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By Yongqiang Li