From Nikkei Business Online
When is it time to get a new CEO? This is the question that every board of directors asks – or at least has to ask – itself every year when evaluating performance of their CEOs. While we know that CEOs get fired for really bad performance, most of the time performance is not bad enough to justify such a drastic measure. On top of that, what are the guarantees that the new CEO will be any better? Therefore, the default choice is to stick with the current CEO.
If we could identify who is a good CEO and who is a bad one, then replacement decisions would be easier. But in practice, it is a very difficult task. In my recent work with co-authors, we tried to address this question. We use state-of-the-art methodology and a large sample of CEOs to identify who is good and who is bad. Of all possible predictors of CEO quality, three factors emerged to have the strongest predictive power. These factors are CEOs’ age, tenure, and founder status. In our study, we define young CEOs as those whose age is below 58 and old CEOs as those whose age is above 65. Short-tenured CEOs are those who have been in the office for less than 8 years, and long-tenured – above 18 years. (These cutoffs – 58 and 65 for age, and 8 and 18 for tenure – are tercile breakpoints for age and tenure in our sample.)
We find that young CEOs tend to be good on average. They account for more than 4% of the market value of their firms. This means that if they leave, firm value drops by 4% on average. On the other hand, old and long-tenured CEOs tend to be bad. They destroy more than 3% of firm value, which means when they leave, firm value rises by as much as 3%. Among founder-CEOs, the age and tenure effects are even stronger. Young founders account for almost 9% of firm value, while old and long-tenured founders destroy more than 5%. These differences are striking. Our study is the first one to document such strong and heterogeneous age and tenure effects.