Information, Incentives and CEO Replacement
52 Pages Posted: 19 Aug 2019 Last revised: 20 Nov 2020
Date Written: August 15, 2019
This paper provides a new explanation for CEO turnover. In an environment in which all potential CEOs are endowed with the same ability and the firm is not looking for a strategy change, I demonstrate that CEO turnover may still occur in equilibrium. Specifically, a performance-contingent CEO replacement policy changes the reward structure of the departing CEO and thereby helps reduce excessive compensation earned by a CEO who stays on the job. At the same time, hiring a new CEO to implement the project also implies that the newly hired CEO will receive a limited liability rent. The trade-off between the benefit and cost of CEO replacement may lead firms to optimally commit to a more aggressive CEO replacement policy than the one that is ex-post efficient.
Keywords: CEO replacement, CEO compensation, Severance pay, Information rent
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