Do Firms Contract Efficiently on Past Performance When Hiring External CEO's?

Abstract

Prior research finds that firms tend to select external CEO hires from companies with superior past performance and that this past performance is associated with a compensation premium in the hiring firm. We test whether this pay premium is associated with future performance in the hiring firm. We find that the pay premium for predecessor firm performance, though economically significant, does not predict higher performance in hiring firms. In fact, we document a negative relation between this pay premium and future performance. We also find external CEOs’ prior firm performance is not associated with a pay premium in the years subsequent to the year of hire. Finally, we find that measures of board inattentiveness predict the degree to which boards rely on prior firm performance to evaluate external CEO candidates. Overall, our results are consistent with the view that boards over-weight executives' prior firm performance when evaluating external CEO candidates.

Keywords: External CEOs, Executive Labor Markets, Executive Compensation

JEL Classification: G34, J33