Corporate Performance and CEO Turnover: The Role of Performance Expectations

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Corporate Performance and CEO Turnover: The Role of Performance Expectations This paper proposes that the inconsistent findings in previous studies of the relationship between corporate performance and CEO turnover may be due to insufficient attention to the type of performance indicator used by the individuals responsible for making CEO turnover decisions, namely, the board of directors. We argue that the board develops expectations of corporate performance, which it then uses to judge the CEO's performance. The study reported here analyzes financial analysts' forecasts of corporate performance, as a surrogate for the expectations board members could be expected to have, and then examines the relationship of forecasts to turnover. The principal finding is that turnover occurs when reported annual earnings per share fall short of expectations. For a sample of 408 CEOs under the age of retirmenet, this measure of corporate performance is a predictor of CEO turnover, whereas mechanical algorithms of abnormal security returns and historical accounting ratios are not.


Over the past two decades numerous studies have been published on the relation between corporate performance and chief officer (CEO) turnover (see Furtado and Karan, 1990, for an extensive review). Although several theories have predicted a negative relationship (Gamson and Scotch, 1964; Salancik and Pfeffer, 1980; Salancik and Meindl, 1984; Tushman and Romanelli, 1985), empirical findings have been mixed. For example, change in return on equity was significant in studies by Allen and Panian (1982) and Lubatkin and Chung (1985) but not in studies by Robinson and Brief (1985) or Harrison, Torres, and Kukalis (1988).

We content that the inconsistent findings may be due to insufficient attention to the performance indicators used by the individuals responsible for CEO turnover decisions, namely, the board of directors. Our thesis is based on three principal assumptions. First, a pivotal role of the management compensation contract is to ensure that actions taken by management are in the best interests of the shareholders. Second, the types of organizational performance indicators of interest to the board of directors are stipulated in CEO compensation contracts. Third, the board develops expectations of these performance criteria and evaluates actual performance in relation to whether expectations are met. Failure to meet expectations may contribute to the dismissal of the CEO. Therefore, to the extent that a performance measure reflects the board's heuristic of differences from expectations it should be an effective predictor of CEO turnover.

This study tests a model of CEO turnover that includes three performance criteria frequently stipulated in CEO compensation contracts: stock price performance, earnings targets, and selected accounting ratios. Stock price performance and accounting ratios were measured by mechanically derived algorithms, used in other studies. In contrast, earnings targets were formulated using financial analysts' forecasts of earnings per share as a surrogate for the board of directors' expectations of earnings targets. We assume that analysts' forecasts reflect the board of directors' expectations about future performance because much of the information analysts work with comes from executive officers of the firm who are members of the board of directors or advisors to the board. In addition, the board's concerns are assumed to be for the interests of the owner-shareholders, who would also be the target audience for the financial analysts' forecasts.

CEO Compensation Contracts

Relationship between the board of directors and the CEO. A fundamental concern of the shareholders in the modern corporation arises from the separation of ownership from control. Because of the complexities of corporate operations, the owners (the shareholders and their representatives, the board of directors) are not able to manage all aspects of the corporation, and so they are forced to delegate control of operations to hired professionals (the CEO and the management team). …