The compensation a CEO receives has a significant impact on acquisition activity. A CEO’s compensation typically increases significantly with acquisitions, which can be an incentive to pursue acquisitions early in his or her career. With the age of a CEO being one of the influences on corporate policies, age is an important factor for boards to consider in their selection process.
What’s Inside?
Company acquisitions are typically accompanied by a large permanent increase in the compensation of the chief executive officer (CEO). This increase creates a situation in which CEOs are highly incentivized to actively look for potential acquisitions early in their careers. The author finds that relative to young CEOs (defined as 27–48 years old), CEOs who are 20 years older are about 30% less likely to announce an acquisition. This effect is more profound when there is an expectation of high permanent post-acquisition compensation. Declining overconfidence with age or the hiring of young CEOs by acquisition-prone firms does not explain the effect of age on acquisition behavior.
How Is This Research Useful to Practitioners?
During 1992–2007, the value of mergers and acquisitions was more than $7 trillion. But there is no consistent evidence that acquisitions create value for the shareholders of the acquiring firm. This finding is typically attributed to agency problems associated with the CEO, which are further exacerbated by weak governance, excessive free cash flow, and poor compensation practices. Each of these explanations takes the firm as a starting point and ignores the fact that agency problems with CEOs may vary for individual CEOs.
A sizable acquisition (i.e., one that exceeds 5% of the firm’s market capitalization) yields an average increase in permanent CEO compensation of $300,000 per year. In addition, regardless of age, the CEO of an acquiring firm is much less likely to be terminated than the CEO of the firm being acquired. The combination of increased permanent compensation for the remainder of a CEO’s career and limited termination risk provides strong incentives for a younger CEO with a longer career horizon to pursue an acquisition. The age effect is even more prominent in acquisitions in which expected compensation is larger and the CEO has the power to influence post-acquisition compensation. These acquisitions also turn out to have the lowest announcement day returns, implying that CEO age is a source of agency problems in driving value-destroying acquisitions. Age thus becomes an important consideration for a board when hiring a CEO.
The age effect is not present in other firm investment activities that do not include a permanent compensation increase.
How Did the Author Conduct This Research?
The author’s conclusion that CEO age has an impact on acquisition behavior is based on an analysis of top management compensation data of S&P 1500 companies, including CEO age and tenure during 1992–2007. Only CEOs whose period of service exceeds six months are included in the sample. To be able to attribute acquisitions to individual CEOs, instances of overlapping tenure by multiple CEOs are excluded from the sample. Although the sample contains only U.S.-based acquiring companies, both national and international targets are included.
The data show that the number of sizable acquisitions is only 15% of the total number of acquisitions during the period. The author finds that acquiring firms tend to be small in size, which is related to the fact that large firms are less likely to find target firms of the same size. Acquiring firms also tend to be younger, have higher market-to-book ratios, and be led by younger CEOs who earn higher salaries. The average CEO is found to be 55 years of age, with five-year tenure and earnings of $2 million a year.
Several age-related characteristics established by other research, such as changes in personal circumstances, the inclination to lead a quiet life, and overconfidence, are considered as part of the research. Although the findings do not support the overconfidence theory, the relevance of other age-related characteristics cannot be completely ruled out. But the findings clearly show that when a firm has a young CEO, the potential compensation after the acquisition has a much larger impact on an acquisition decision. Equally, the findings indicate that when there is no compensation benefit, there is no difference in acquisition behavior.
Abstractor’s Viewpoint
The research provides an interesting insight on how CEO age may influence the desire of the CEO to pursue acquisitions and thus affect shareholder value. The research also shows that the potential size of future compensation is a stronger driving force for a younger CEO than it is for an older one. Further research into why financial benefits do not feature in the acquisition decision-making process at a later age may provide even further insight for boards when they consider their next CEO.