Big Shoes to Fill: CEO Turnover and Pre-Appointment Firm Performance

Abstract

Bayesian learning implies that corporate owners’ performance expectations for their CEO are affected by both the CEO’s expected managerial ability and their firm’s performance observed prior to the CEO’s appointment. Consistent with this framework’s implications, we document that the sensitivity of CEO turnover to firm performance increases in pre-appointment firm performance; that is, an underperforming CEO is more (less) likely to be dismissed when appointed at a firm with comparatively better (worse) pre-appointment performance. Further, we show that the effect of pre-appointment performance increases in firm uncertainty and declines over a CEO’s tenure. We find no evidence that the effect is due to the incumbent CEO’s ability, corporate governance quality, or the cost of replacing a CEO. Overall, our results suggest that CEOs indeed face a “big shoes to fill” effect that affects the likelihood of their performance-related turnover.

Keywords: CEO turnover, Bayesian learning, relative performance evaluation, target setting, corporate governance

JEL Classification: G34, J63, M12, M51