Why Are CEOs Rarely Fired?

In the paper, Why Are CEOs Rarely Fired? Evidence from Structural Estimation, which is forthcoming in the Journal of Finance, I evaluate the forced CEO turnover rate and quantify effects on shareholder value by estimating a dynamic model. The model features costly turnover and learning about CEO ability. To fit the observed forced turnover rate, the model needs the average board of directors to behave as if replacing the CEO costs shareholders at least $200 million.

I find three main results. First, the empirical forced turnover rate is low, in the sense that the model needs large turnover costs to fit the data. Second, these costs mainly reflect CEO entrenchment rather than a real cost to shareholders. According to the model, eliminating this entrenchment would raise shareholder value by 3%, assuming we could hold all else constant.

CEO entrenchment is bad for shareholders ex post, because it means that boards retain some CEOs whom shareholders would rather see fired. The model says nothing about whether this entrenchment is bad for shareholders ex ante. For instance, shareholders may rationally allow some degree of entrenchment, e.g. by appointing a CEO-friendly board, in order to attract a talented CEO. To understand what level of entrenchment is optimal ex ante, we need to extend the model to include the initial choice of governance structures.

The full paper is available for download here.