“One of the biggest tasks I face as CEO”, said Craigie Zildjian, CEO of the oldest family business in the United States, “is getting succession right.” (Hindle 2008)
Keywords
TMT, corporate governance, succession planning
Related Studies
The retirement and inauguration of a CEO represent turnover in the top management team (TMT) of a firm. This transition of power happens frequently, for instance, every day six CEOs left their job from American public companies, according to a survey (Hindle 2008). TMT turnover affects shareholder’s perception of the value of the firm, via a mechanism of uncertainty about firms’ future operations (Bills et al. 2017). Therefore, practitioners have been looking for clues that signal success leaderships. Recent studies have inquired about CEO biographies which seem to warrant an increase in post-succession performance, such as board experience, military backgrounds, personal lavish spending, possessing charismatic traits, or simply at a younger age (Harrell 2016). Despite the relentless efforts, most CEO turnover events were followed by a decrease in firm value.
“The market reacts negatively to announcements of top executive departures, especially when the CEO is dismissed or leaves to take up another job.” (Dedman & Lin 2002)
A firm’s market value is a function of investors’ perceptions of its managers’ ability to anticipate and respond to future changes in the firm’s economic environment (Healy & Palepu 2001). Given the market has incomplete information about new CEOs’ ability, shareholders require a premium to keep holding the stock of the firm enduring a TMT turnover, hence inevitably increase firm’s cost of capital. Past research in accounting literature supports this perspective, based on evidence form audit fee. In effect, CEO succession influences the perception of reporting risk amongst auditors, who charge higher audit fees for firms with new CEOs. The audit fee increases dissipate over time as the new CEO stays longer at the firm, “reinforcing the inference that audit fees increase in response to the uncertainty surrounding a new CEO” (Bills et al. 2017).
To mitigate turnover-induced uncertainty, SEC recently encourage board to prepare for succession. In one of its October 2009 releases, the SEC (SEC Division of Corporation Finance Staff Legal Bulletin No. 14E (CF)) identified succession planning as one of the board’s “key functions” implying that inadequate succession planning or non‐disclosure of it may be viewed as evidence of insufficient board oversight (Tao & Zhao 2019). Nonetheless, a survey in 2014 by the National Association of Corporate Directors found that two-thirds of American public and private companies had no succession plan. Another survey, by Korn Ferry, a headhunting firm, suggested a similar figure for both American and non-American companies (2014). The fact that few companies adhere to the SEC ruling indicates a more pessimistic view toward succession planning.
“If left to their own devices, chief executives, like the rest of us, are inclined to replace themselves with a clone (on the grounds that such a person is without doubt the best person for the job).” (Hindle 2008)
Corporate governance scholarship has attempted to figure out why. Yet, the research of relay (i.e., planned) succession vary, and the results are mixed. First, shareholders value the smooth turnover, as share price reactions to the disclosure of top executive departure are significantly affected by whether the board announces a replacement CEO (Dedman & Lin 2002). Second, succession planning can serve as a tool for smooth turnover, as documented by Behn et al. (2005) that firms with an heir apparent already designated upon the death of the CEO have significantly higher cumulative abnormal returns on the date of death than firms that have not identified an heir apparent. To enhance this argument, in the CEO turnover-audit fee relation examined by Bills et al. (2017) there is also an attenuating effect upon careful CEO succession planning (i.e., promoting an “heir apparent”) against auditors’ perceptions of higher risk. In the same way, firms with relay successions achieve higher post-turnover accounting performance, higher long-term stock returns, and lower volatility (Tao & Zhao 2019). Yet, not all firms enjoy the fruits of succession planning, as the results from a natural experiment by McConnell and Qi (2018) who exploited the 2009 SEC ruling as an intervention that induced more succession planning disclosures show. They find that succession planning is value-enhancing only for larger, older, more complex firms with lower stock return volatility. To sum up, succession planning increases firm value, however boundary condition may affect this relation. To advance this line of research, this research examines the moderating effects of family firm.
We argue that the reason of the aforementioned mixed results is originated from the agency problem of relay succession planning per se. On the one hand, given the heir apparent (i.e., CEO-to-be) received assignment to take the position in the future, he might no longer perform at his best, rather he tends to follow the corporate groupthink, leading to a decreased performance which otherwise might not have happened if there is no such planning. This conjecture receives supports from Joseph Bower of Harvard Business School who suggests that boards should pay more attention to “insider-outsiders: strong candidates who know enough of the company’s ways to ensure continuity but have outside experience, either at other firms or at some distant outpost of the business, a long way from head-office groupthink” (2014). A real-world case in 2010 demonstrates the prevalence of this issue, where Justin Wender, the anointed successor of John Castle, the founder of an American firm called Castle Harlan, left amid a dispute about “future ownership” (2017) In short, the agency problem of assigning heir apparent might have limited firm’s motivation to succession planning early.
On the other hand, the “internal bickering” further curbs the benefit of succession planning. Not only does transferring outsize ownership stakes to other partners risk internal bickering (2017), the threats from non-heir apparent who might initiate unnecessary competition to challenge the heir apparent in order to replace it by himself, altogether might bring chao and distract TMT. This concern arises (and is settled carefully) particularly in the turnover of authoritarian political regimes. The Economist compares the succession planning of North Korea’s Worker Party in 2010 with those of global firms, highlight that “the Workers’ Party… has made sure that potential rivals have a “stake” in young Un’s success, by threatening dissenters with death; and it has also provided the rising CEO with a knowledgeable “board” of advisors” which were aimed to avoid “any of the debilitating family quarrels that have convulsed almost any family business that you can imagine (think of the Gallos, the Ambanis, the Guinnesses, the Pritzkers and, of course, the Kochs)” (from 2010).
Practitioners also address this concern. For example, Hindle (2008) states that “the difficulties are usually linked to the incumbent/founder’s failure to take on board his own mortality, or his inability to tell his beloved second child that (after his death or retirement) there can be only one chief executive.” Another article from the Economist also tells alarm where “(incumbents) have a personal interest in having no clear replacement: it keeps them in the job longer and gives them more bargaining power with their boards” (2014). To illustrate how internal bickering destroyed succession, we refer to a real-world case below:
“Friction over succession and profit-sharing at Charterhouse, a British firm, came to light in 2014 in the form of a lawsuit by a disgruntled former partner, who alleged, among other things, that the firm tried to force him to sell his stake at an excessively low price. Charterhouse won the case.” (2017)
Taken together, the agency problem of appointing an heir apparent is costlier against the gains from itself. To mitigate the problem, this research examines the moderating effect of family-owned firm, which family owners commit capital for longer horizon, and are incentivized to increase the long-term firm value, therefore dispose lower extent of agency problem in a relay succession event. To the best of our knowledge, very few prior works have been devoted to this vein. Amongst them, Tao and Zhao (2019) investigate the boundary condition where relay succession leads to superior firm performance. They conclude that this relation is stronger for larger, more diversified, more R&D intense, and more M&A intense firms, pertaining to a longer horizon in firm strategy, similar to that of family firms. By investigating the moderating effects of family firm, this research will complement the existing literature on succession, while extending the bourgeoning stream of family firm research.
Reference
2010. Succession planning. In: The Economist
2014. Making a success of succession. In: The Economist.
2017. KKR, a private-equity giant, lays out its succession plan. In: The Economist.
Behn, B.K., Riley Jr, R.A., Yang, Y.-w., 2005. The Value of an Heir Apparent in Succession Planning. Corporate Governance: An International Review 13, 168-177
Bills, K.L., Lisic, L.L., Seidel, T.A., 2017. Do CEO succession and succession planning affect stakeholders’ perceptions of financial reporting risk? Evidence from audit fees. The Accounting Review 92, 27-52
Dedman, E., Lin, S.W.J., 2002. Shareholder wealth effects of CEO departures: evidence from the UK. Journal of Corporate Finance 8, 81-104
Harrell, E., 2016. Succession planning: what the research says. Harvard Business Review 94, 70-74
Healy, P.M., Palepu, K.G., 2001. Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature. Journal of Accounting and Economics 31, 405-440
Hindle, T., 2008. Guide to Management Ideas and Gurus. John Wiley & Sons.
McConnell, J.J., Qi, Q., 2018. Does CEO Succession Planning Create Shareholder Value? Available at SSRN 3176648
Tao, R., Zhao, H., 2019. “Passing the Baton”: The effects of CEO succession planning on firm performance and volatility. Corporate Governance: An International Review 27, 61-78