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Do CEOs exercise managerial discretion to save their jobs?

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Abstract

Chief Executive Officers (CEOs) wield considerable power and authority. In many industries and contexts, CEO turnover is studied in terms of antecedents, the event itself, and the related consequences. However, the extent to which CEOs exert their power and attempt to prevent their dismissal has not been thoroughly examined. In this study, we examine the role of CEOs exercising managerial discretion in their effort to prevent their own corporate demise. We hypothesize that CEOs cut discretionary expenses such as research and development, advertising, and rent in order to boost earnings and enhance financial performance. A sample of CEO turnover from Standard and Poor’s ExecComp database for the period 1992–1998 in US firms yielded 474 turnover firms and 2,066 control firm-years. We tested the effects of CEO turnover and managerial discretion on firm performance measured by cumulative abnormal stock returns. We also compared the turnover and non-turnover firms in terms of pattern of discretionary spending prior to CEO turnover. The results are consistent with our prediction that CEOs facing termination attempt to post higher earnings by reducing discretionary spending after controlling for firm performance, firm diversification, book to market ratio, and CEO ownership, industry-, and year dummies.

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Notes

  1. SFAS 131 was issued by the FASB in June 1997 and is effective for fiscal years commencing after December 15, 1997. The main difference between SFAS 131 and SFAS 14 deals with how a segment is defined. Under SFAS 14, business segments are defined by industry groupings of products and services sold to external customers. In contrast, SFAS 131 defines segments based on how management organizes divisions within the enterprise for making decisions and assessing performance. The management approach along with the other provisions of SFAS 131 offers several tradeoffs relative to SFAS 14's industry approach. However, the definition of what comprises a geographic segment is more discretionary under FASB 131, and may result in a noisy measure.

  2. Market adjusted cumulative abnormal returns over a 12-month period starting from April 1t to Marcht+1.

  3. All variables are deflated by the beginning market value of equity to control for market expectation.

  4. Herfindahl Index is a measure of the size of firms in relation to the industry and an indicator of the amount of competition within the industry. It is defined as the sum of the squares of the market shares of the all the firms within the industry, where the market shares are expressed as fractions. The result is proportional to the average market share, weighted by market share. As such, it can range from 0 to 1.0, moving from a huge number of very small firms to a single monopolistic producer. Increases in the Herfindahl Index generally indicate a decrease in competition and an increase of market power, whereas decreases indicate the opposite. High (low) values of Herfindahl Index imply high (low) levels of industry concentration and hence low (high) levels of competition.

  5. We winsorize the bottom and top 1 % of the continuous variables, as such is customary in removing the outliers in a market study like ours. A total of 438 firm-years were deleted as outliers, as reported in Table 1.

  6. The results of DISC2 are qualitatively the same as DISC1.

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Authors and Affiliations

  1. Rutgers School of Business, Rutgers University, Camden, NJ, 08102, USA

    Sungsoo Kim & Rakesh B. Sambharya

  2. School of Business, Sogang University, Seoul, Korea

    Joon Sun Yang

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  1. Sungsoo Kim
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  2. Rakesh B. Sambharya
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Correspondence to Rakesh B. Sambharya.

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Kim, S., Sambharya, R.B. & Yang, J.S. Do CEOs exercise managerial discretion to save their jobs?. J Manag Gov 20, 179–200 (2016). https://doi.org/10.1007/s10997-014-9300-2

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