Title: Apprentice, Departure, and Demotion: An Examination of the Three Types of CEO–Board Chair Separation (Fee or subscription required)
Authors: Ryan Krause and Matthew Semadeni (both Indiana University)
Publisher: Academy of Management Journal
Date Published: Forthcoming in June 2013
Scores of analysts, governance experts, and legislators have argued that firms should separate the roles of CEO and chairman of the board, contending that boards cannot perform their crucial oversight functions without the guidance of an independent leader. Indeed, since the enactment in the United States of the 2002 Sarbanes-Oxley Act, the proportion of S&P 500 companies splitting the roles has increased from 25 to 43 percent, studies have reported.
But this paper concludes that the benefits of doing so are not cut-and-dried, and that how a firm is faring at the time of the separation has a major impact on whether the move is successful. Specifically, the authors found that the two roles typically should be divided only when the firm’s performance is flagging. And even then, the separation should take place only through a “demotion” strategy, wherein the CEO holds on to that role but an independent chairman is brought on board. In fact, changing the model during a period of positive returns generally causes a drop in stock prices and analyst ratings, the researchers report.
To better understand the factors underlying “CEO duality,” or having one person serve as both chairman and CEO, and its impact on firm performance, the authors analyzed 309 firms in the Fortune 1000 and S&P 1500 indices that separated their CEO and chairman positions between 2002 and 2006. Each company used one of three separation techniques. The apprentice method involved a sitting CEO–chairman giving up the title of chief executive officer but staying on as chairman, moving aside for a groomed successor as CEO. Departures occurred when a company filled both positions with new people. And demotions took place when the CEO retained that title but gave up his or her board seat and made way for a new chairman, and in doing so effectively relinquished control over governance.
Across measures of both stock performance and analyst ratings, demotions—the strategy that was least likely to be used by the surveyed companies—showed more positive effects on future performance than the other two strategies. Specifically, in times of subpar performance, firms that divided their CEO and chairman positions through a demotion mechanism saw significantly better stock returns and analyst ratings in the year following the change than firms that used apprentice or departure strategies.
But the demotion strategy is all about timing—and if the status quo is working, companies should think twice before demoting their chief executive. For example, demoting a CEO in a year when the firm was delivering a total shareholder return (TSR) of about 30 percent resulted in an average decrease in TSR of about 42 percent the next year, compared with no separation of roles, the researchers found. But when firms demoted the CEO in a year in which TSR was down 30 percent, the exact opposite result was obtained: TSR soared 42 percent the next year. By comparison, departure separations led to no significant change in returns following either a surge or a downturn in shareholder value, and apprentice moves produced a return of only about 8 percent following a 30 percent fall in value.
“Although the demotion strategy carries some risk, it is the most corrective option when used in cases of poor performance because it imposes independent oversight on the CEO and provides the best opportunity to change course,” said one of the authors in a press release. “It is an unambiguous signal to the CEO that the firm needs to be fixed and the CEO’s only job is to provide a solution.”
Despite the pressure from policymakers and advocacy groups to split the roles, and the temptation to follow the lead of competitors that have done just that, companies should proceed slowly. A careful review of current performance is required before even contemplating such a shift, the authors caution.
“Boards that do this under the wrong conditions can send their company off a cliff,” they conclude in the press release, “so our caution to them, in the simplest terms, is ‘if it ain’t broke, don’t fix it.’”
In recent years, the number of companies that have divided their CEO and chairman roles has risen sharply, in part because of recommendations from analysts and legislators. But it’s not the right move for all companies. Indeed, the separation typically pays off only when a company’s performance is subpar, and even then only when the CEO stays on and works alongside a newly appointed chairman.