Does the Market Value CEO Styles?

Luo Zuo is Assistant Professor of Accounting at Cornell University. This post is based on an article authored by Professor Zuo and Antoinette Schoar, Professor of Entrepreneurship at MIT.

In our article, Does the Market Value CEO Styles?, recently published in the American Economic Review, we study how investors perceive the skill set that different types of CEOs bring into their companies. A growing body of research offers evidence that CEOs and other top executives show large and persistent person-specific heterogeneity in their management styles. Bertrand and Schoar (2003) document that such person-specific styles explain a substantial fraction of the variation in firms’ capital structures, investment decisions and organizational structures. The idea that CEOs greatly differ in their styles is also supported by a number of papers that show substantial changes in a firm’s stock price and accounting performance when its top management changes. For example, Perez-Gonzalez (2006) and Bennedsen, Nielsen, Perez-Gonzalez and Wolfenzon (2007) focus on transitions to family CEOs, and Parrino (1997) focuses on internal versus external successors. Similarly, a large literature suggests that CEOs’ specific traits play a role in their management approach. See, for example, Malmendier and Tate (2008) on CEO overconfidence; Kaplan, Klebanov and Sorensen (2012) on general ability and execution skills; Graham, Harvey and Puri (2013) on optimism and risk aversion; and Benmelech and Frydman (2015) on prior military experience.

But there is still considerable debate about the importance of managerial style. First, there is the question of where individual management styles come from: do they predominantly depend on the optimal, endogenous choice of managers, who want to invest in the skill set that promises the highest expected returns? Or are they shaped by formative events that are largely outside a manager’s control? The latter would imply that managers might not be at liberty to change styles, even when they might wish to. And if one’s management style depends on exposure to certain experiences or learning opportunities in a manager’s formative years, there might be constraints in the distribution of management styles (or skills) available in the managerial labor market.

The second question is whether managers “matter” to the firms they run. In other words, do managerial styles constitute a value added or even an idiosyncratic bias that the CEO “imposes” on the firm? Or are they just the expression of an endogenous choice made by the board to purposefully hire managers with certain types of skills based on the firm’s needs? An extreme view of a frictionless CEO labor market might suggest that even if CEOs have heterogeneous styles, they do not have a causal impact on the firms they run, since boards will always hire the CEO with the right match of skills for the firm. Under this view, CEOs are interchangeable inputs into the production function, such as machines or other capital investments that firms undertake. So if the full spectrum of CEO styles is abundantly available in the market, there should be no systematic impact on the firm or its stock price when a new CEO hire is announced. However, if frictions exist in the CEO labor market or if certain skills are in short supply, then not all firms would be able to hire the type of CEO they would prefer.

In this paper, we build on Schoar and Zuo (2011), which shows how starting one’s career during a recession (as an exogenous formative event) affects the manager’s career progression and management style. Here we provide evidence on how the market values these recession styles: announcement period returns around the appointment of recession CEOs are very significant and positive; the cumulative abnormal return in the three days around the announcement is 1 percent. This positive announcement period return is driven by cases where a recession CEO replaces a non-recession CEO.

We perform several additional analyses. First, the positive stock price reaction when a recession CEO replaces a non-recession CEO is stronger for firms with a worse (market-adjusted or industry-adjusted) stock price performance over the year prior to the CEO turnover announcement. Second, the positive stock price reaction when a recession CEO replaces a non-recession CEO is stronger for well-governed firms. This finding underlines the idea that certain skills are in short supply in the market. In a well-governed firm, investors should have expected that the board would try to hire a CEO with the skill set the firm needs. The fact that even for these firms, the announcement effect of hiring a recession CEO is significant and positive suggests that investors are positively surprised that an appropriate individual was available in the market.

The results of this article suggest that investors value the skill set that recession CEOs bring into their companies. It is possible that a board selects recession CEOs based on the firm’s specific needs. However, if it were obvious that a firm would always hire a recession CEO when it has a specific need for this skill set, the announcement of such a hire should not contain any news for the market; all the potential performance impact should have been priced in previously. Thus, our results show that the announcement of a recession CEO hire is seen as unexpected good news for a firm, most likely since this skill set is in short supply in the market and the announcement confirms that the firm was able to hire this type of CEO. But it also implies that the market believes that this particular style has a value added for the firm.

The full article is available for download here.

Both comments and trackbacks are currently closed.