Aurora Borealis
1 May 2015 CFA Institute Journal Review

Corporate Culture and CEO Turnover (Digest Summary)

  1. Marc L. Ross, CFA

The existence of a negative correlation between a firm’s performance and the tenure of its CEO seems to be beyond dispute. The authors make a unique contribution to the literature on corporate governance by demonstrating how corporate culture affects the dynamics of company performance and turnover of its CEO.

What’s Inside?

The authors find that corporate culture plays an important role in CEO turnover. The probability of CEO turnover is higher in competition- and creation-oriented cultures. The negative relationship between firm performance and CEO turnover is reinforced by a control-oriented culture and reduced by a creation-oriented culture. Companies oriented toward creation are more likely to select an insider as a successor.

How Is This Research Useful to Practitioners?

Corporate culture is an implicit and explicit pact that influences an organization’s behavior. The authors distill this concept to identify its role in performance and leadership change. They propose four types of culture based on previous external research: control, competition, collaboration, and creation. Parsing the culture types further, they subdivide them into (1) internally oriented culture and (2) externally oriented culture. An internally oriented culture is marked by collaboration and control; the drivers originate from within and emphasize interaction or strict hierarchy. Externally oriented culture is marked by competition and creation; the drivers are external and motivation is drawn from outside competitive forces to serve clients and from the constants of change and entrepreneurship.

The authors present five hypotheses to test their assertion of culture’s role in the interaction between CEO change and financial performance.

  • The likelihood of a change in CEO increases with a decline in firm performance.
  • The motivation to change its CEO is greater for a company whose culture is one of competition, creation, or collaboration.
  • The motivation to change its CEO is greater for a company with a competitive culture than for a company with a creation- or collaboration-oriented one.
  • With declining performance, companies with a competition-, creation-, or collaboration-oriented culture appear to have a greater motivation at the margin to change their CEO than those firms with a control-oriented culture.
  • With declining performance, companies with a competition-oriented culture would appear to have a greater motivation at the margin to change their CEO than those firms with a creation- or collaboration-oriented culture.

Empirical evidence confirms the first three hypotheses but not the last two. The authors note the positive correlation between turnover and age and between turnover and duality when the CEO is also the chair, which is a largely discontinued governance practice. Higher turnover seems to be prevalent at larger firms. CEOs with properly aligned interests and long employment within the company, including executive management, are less likely to undergo turnover.

Those interested in the impact of corporate governance on firm performance would glean important insights from this article.

How Did the Authors Conduct This Research?

The authors collect CEO data from ExecuComp and firm data from Compustat. The final sample includes all US-listed companies between 1994 and 2011 for which information is available on top managers, accounting-based performance, measurement of relevant cultural dimensions, and all relevant control variables to account for both the firm’s and its incumbent CEO’s characteristics.

The authors assess a firm’s corporate culture by applying textual analysis to its 10-K filings taken from the SEC’s EDGAR database over the same time period. Textual analysis facilitates the identification of the four dimensions of corporate culture by measuring what the authors call the “semantic content” of publicly available documents. This analysis entails looking for the frequency of synonyms that connote collaboration, competition, control, and creation.

The authors measure CEO turnover, selecting the chief executive with longer tenure if a company experiences change in a given year. Accounting-based performance is better able to focus on short-term profit and predict CEO turnover than are stock market returns. Common metrics include return on assets and EBITDA. Control variables for the CEO include age, tenure, equity incentives, duality, and executive committee membership. For the firm, the variables are size, capital expenditure, financial leverage, and firm age.

Using both a univariate and a multivariate approach, the authors test their hypotheses on the extent to which poor performance relates to leadership change. The univariate approach considers past performance quintiles, with return on assets as the key metric. The multivariate approach takes into account firm-specific and peer group components of performance. Both approaches include the four measures of corporate culture and their impact on the interaction between firm performance and CEO turnover. Robustness checks help to avoid the possibility of correlations between the cultural dimensions and to account for a prolonged crisis.

The research confirms the authors’ assertions that poor performance influences CEO turnover and that such influence is more prevalent in control-oriented than in creation-oriented firm cultures. Complementary research on CEO succession mirrors the approach the authors used and seems to confirm the increased likelihood of an outside successor CEO in control cultures but not creation cultures.

Abstractor’s Viewpoint

Corporate governance has evolved in complexity and demands further research efforts, which the authors establish with what appears to be a seminal contribution to the study of the interrelationship between firm performance and CEO turnover. Performance and turnover are linked, but firm culture affects this link. It would be interesting to see a similar effort applied to firms in other large developed markets and to additional top members of a company’s management team.

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