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Published: July 15, 2002


Why CEOs Fall: The Causes and Consequences of Turnover at the Top

On average, combining data from 1995, 1998, 2000, and 2001, we see that 50 percent of the CEO successions are regular transitions, 25 percent are merger-driven, and 25 percent are performance-related. However, across our total sample, the mix of reasons for the CEO’s departure has changed over time (see Exhibit 2). The figures represent the percentage of the 2,500 companies whose CEO departed for that reason in a year. For example, in 2001, 9.2 percent of the CEOs among the 2,500 largest companies departed — 4.4 percent in regular transitions, 2.5 percent because of mergers, and 2.3 percent for performance-related reasons. From 1995 through 2001, the chart shows, the rate of regular transitions has remained relatively constant. The increased total rate of CEO succession over the years studied has been driven almost entirely by the tripling in the rate of merger-linked departures and the 130 percent increase in performance-related transitions.

One of our most surprising findings is that the proportion of CEOs departing for performance reasons is higher in Europe than in North America (see Exhibit 3). Across the years studied, European CEOs have the lowest likelihood of achieving a regular transition.

In our remaining analyses, we exclude merger-driven successions, except where specifically noted. Mergers have a widely studied logic that is only partly related to the actions of the CEO of the target; a takeover also inflates short-term returns to shareholders. In addition, we exclude CEOs who served on an interim basis while their boards searched for a “permanent” replacement. Focusing instead only on CEOs who are expected to serve a full term, and who depart in either a regular or a performance-driven transition, provides the best understanding of the changing CEO career path and the growing importance of financial performance to that career path.

The Performance Principle
For each year studied, we identified the 2,500 largest companies and then measured each company’s financial performance during the tenure of a CEO in two ways. First, we calculated total returns to shareholders, including both stock price appreciation and dividends. Since the returns on the stock market fluctuate so much over time — potentially causing anomalies in the assessment of any individual’s performance at the point of his or her departure — we normalized CEO performance by subtracting the returns in the region during the CEO’s tenure (as measured by Morgan Stanley’s regional stock indices) from the returns in the CEO’s company. Hence, a total shareholder return of 1 percent in a given year means that the returns to shareholders of the CEO’s company that year were one percentage point higher than the returns on a basket of all publicly traded stocks in the region.

The second way we measured each company’s financial performance was by calculating the growth rate in net income during the CEO’s tenure. Recognizing the significant accounting differences between regions and the discrepancies in industry growth rates, we adjusted net income growth by both region and industry, using the 23 Industry Groups of S&P/Morgan Stanley’s Global Industry Classification Standard.

In each succession year studied, returns to shareholders during the tenure of the departing CEOs were significantly higher from companies whose CEOs left in a regular transition than from companies whose CEOs resigned for performance-related reasons (see Exhibit 4). Across all the years studied and all regions, regularly departing CEOs beat the market by 1.3 percent, whereas those resigning for performance reasons underperformed the market by 8.3 percent.

Since Exhibit 4 reflects performance throughout a CEO’s entire tenure — good years and bad — it understates the performance shortfall that triggers the premature departure of a chief. Departing CEOs always underperformed the total market during their last year in office. However, companies whose CEOs achieved a normal transition outperformed companies whose CEOs left because of performance by 25.7 percentage points (see Exhibit 5).

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  1. Anthony Bianco and Louis Lavelle, “The CEO Trap,” Business Week, December 11, 2000; Click here.
  2. Jay Dahya, John McConnell, and N.G. Travlos, “The Cadbury Committee, Corporate Performance, and Top Management Turnover,” Journal of Finance, February 2002
  3. Pamela Mendels, “The Real Cost of Firing a CEO,” Chief Executive, April 2002; Click here.
  4. Jay Dahya and John McConnell, Outside Directors and Corporate Board Decisions, Krannert School of Management, Purdue University, Working Paper, April 15, 2002