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

55 Pages Posted: 20 Nov 2011 Last revised: 21 Aug 2012

Yihui Pan

University of Utah - Department of Finance

Tracy Yue Wang

University of Minnesota - Twin Cities - Carlson School of Management

Date Written: August 2012

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.

Suggested Citation

Pan, Yihui and Wang, Tracy Yue, First Year in Office: How Do New CEOS Create Value? (August 2012). Available at SSRN: https://ssrn.com/abstract=1961809 or http://dx.doi.org/10.2139/ssrn.1961809

Yihui Pan (Contact Author)

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

Tracy Yue Wang

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

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