Shareholder wealth effects of CEO departures: evidence from the UK

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Abstract

This paper examines share price behaviour surrounding announcements of CEO departures from UK firms listed on the All Share Index between 1990 and 1995. We find that many firms choose not to announce CEO departures, and that these firms have poorer performance records, and higher chances of future failure, than those firms who officially announce CEO turnover to the London Stock Exchange. The market reacts negatively to announcements of top executive departures, especially when the CEO is dismissed or leaves to take up another job. Share price reactions to the disclosure of top executive departure are significantly affected by the financial risk of the firm and whether the board announces a replacement CEO.

Introduction

This paper examines 331 CEO departures from All Share firms between 1990 and 1995. It focuses on three areas. Firstly, the issue of voluntary disclosure of CEO departure information. We find that half of the management departures in our sample are not announced officially to the London Stock Exchange (LSE), and that this failure to announce is associated with both prior and future firm performance. We also find evidence that firms attempt to mitigate the negative price effects of CEO departure disclosure by issuing other, ‘good news’ around the same time.

The second (and main) issue of interest in this study is the market reaction to the news of CEO departure. We find that this news is perceived as wealth reducing by the market. However, the average negative price effects of such events appear to be driven by the market reaction to CEO departures disclosed by the press, rather than those officially announced by the company. The reason for departure further influences the market reaction, as does the simultaneous announcement of a successor.

Finally, we look at post-departure performance, and find that the market is rational in reacting more negatively to those departures not officially announced to the LSE, as these firms are significantly more likely to fail post-CEO departure.

The rest of the paper is organised as follows. Section 2 discusses some of the prior literature across our issues of interest. Section 3 describes the sample and methodology. This is followed by a descriptive analysis of our sample firms. Section 5 contains the results of the event study, while Section 6 summarises and concludes.

Section snippets

Voluntary disclosure literature

Theoretical and empirical studies have provided evidence that firms manage the release of voluntary information. For example, Lewellen et al. (1996), find evidence of self-serving behaviour in the discretionary disclosure of performance benchmarks, with firms selecting downwardly biased benchmarks in order to boost their relative performance. Several empirical studies document that managers reveal ‘good news’ more often than ‘bad news’ and that the good news announcements enjoy, on average, a

Sample selection

This study is based on a sample of FT All Share Index firms from April of each year from 1990 to 1995. This index represents over 95% of the UK Stock Market by market capitalisation. The information was taken from the London Business School (LBS) Risk Measurement Service (RMS), which publishes a quarterly list of constituents of various stock market indices. Some firm years are discarded for two main reasons, resulting in a loss in sample size. Firm deaths (liquidations or takeovers)

Research methodology

This paper uses standard event study research methodology, including a short test window (i.e. including day −1, day 0, and day +1) and a 150-day estimation period (i.e. a period between day −160 and day −11). The market model is used to measure abnormal returns. Both Student's t-test and Patell's standardised residual statistics tests are used to examine whether the abnormal returns for the test period are statistically different from zero.

Descriptive analysis

Table 2 describes the reasons for CEO departure, partitioning the sample by whether the firm made an official announcement to Extel (via the LSE), or had the event reported by the FT, and by whether the company released other news items during the test period.

It may be argued that firms anticipate a drop in investor confidence on the discovery of certain types of CEO departure (e.g. sudden death, departure to take up a new job). Firms may try to restore investor confidence in these

Event study

This section applies standard event study research methodology, as detailed in Section 4, to the 251 CEO departures covered by either Extel and the FT, and Datastream.

Table 6 provides the results of tests on the market's reaction to CEO departure announcements.9 Day −1, day 0, and the entire 3-day

Regression analysis

In this section, we examine the causes of day 0 and 3 day event window returns using OLS regression. The previous sections have identified several possible factors which influence the sign and magnitude of the market reaction to news of a CEO departure. These potential factors include:

(a) Prior performance. If the market anticipates an increase in firm performance post-CEO departure, then we would predict a positive reaction to the departure news. However, if the old manager was seen as

Summary and conclusions

This paper examines the market reaction to CEO departure announcements for UK firms included in FT all share index during 1990–1995. The CEO departure announcements generally induce a negative market reaction, especially for those announcements where no other news is released during the 3-day test period. We also find that CEO departure announcements are very likely to be released with other news, which tends to relate to earnings, dividend, and other board changes. Firms appear to announce

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