American Journal of Industrial and Business Management, 2013, 3, 583-588
http://dx.doi.org/10.4236/ajibm.2013.36067 Published Online October 2013 (http://www.scirp.org/journal/ajibm)
583
Shareholder Wealth Effects of CEO Succession
Kevin Banning
Auburn University Montgomery, Montgomery, USA
Received August 4th, 2013; revised September 4th, 2013; accepted September 13th, 2013
Copyright © 2013 Kevin Banning. This is an open access article distributed under the Creative Commons Attribution License, which
permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
ABSTRACT
Companies often dismiss their chief executive officers (CEOs) when financial performance falters. This study examines
why, despite the positive stock market effects, the replacement of the CEO often does little to change a company’s fi-
nancial performance. Thanks to the agency arrangements in some companies, new CEOs are able to negotiate favorable
contracts which benefit the CEO rather than the shareholders. In a sample of 140 publicly-traded firms, we found that
compensation systems for new CEOs differed as a function of institutional ownership, with total executive compensa-
tion higher and compensation risk lower in firms with lower levels of institutional ownership. Financial performance
was also weaker in firms with less institutional ownership.
Keywords: CEO Compensation; Institutional Ownership
1. Introduction
Previous research has identified several causes of CEO
turnover, such as mergers and acquisitions [1], but poor
firm financial performance is the most common reason
[2]. When a firm replaces its CEO because of poor finan-
cial results, there are positive consequences for financial
markets, and more so if the new CEO comes from out-
side the firm [3]. The consequence of CEO succession
for company financial performance, however, is more
ambiguous than the effect on financial markets. While
there is some evidence that replacing a CEO has positive
implications for firm performance [4], there is also evi-
dence that CEO turnover is associated with performance
declines [5]. Other studies suggest that instead of im-
proving financial performance, CEO succession has often
had no relationship to company performance [6]. The
presence of institutional owners, who might serve as ef-
fective monitors of new CEOs, could explain the mixed
empirical results concerning the consequences of execu-
tive succession.
Replacing the CEO when firm financial performance
is lacking creates some confusion for equity owners.
There is some evidence the board of directors will grant
significant decision autonomy to new CEOs, which can
lead to significant change, regardless of whether the in-
coming chief executive came from inside or outside the
company [7,8]. However it is also the case that because
the effects of succession on financial performance are
mixed, and the changes initiated by new CEOs may or
may not lead to improved company performance, the
objective of changes initiated by new CEOs may be to
protect their positions of power in the organization [9].
New CEOs who fail to deliver strong or improved fi-
nancial performance are vulnerable throughout their first
few years on the job [10], and it would be rational for
them to fortify their positions after appointment, regard-
less of the circumstances of the succession. Because ex-
ecutives who serve on the firm’s own board are known to
contest the new CEO [10], new chief executives have
strong incentives to solidify their positions if post-suc-
cession financial performance is unimproved. Conse-
quently a new CEO has both the incentive, because of
contests among board members, and the opportunity,
thanks to a brief “honeymoon period” associated with
succession, to arrange an attractive agency contract dur-
ing the transition.
The agency contract specifies the relationship between
a CEO and board of directors. An agency contract will
include how the CEO will be monitored and how the
CEO will earn his or her compensation [11]. Because
there are too many unknowable contingencies, perfect
and completely specified contracts are not feasible, re-
sulting in a “relational contract” [12]. Relational con-
tracts are necessarily ambiguous, and could result in
some problems relevant to how new CEOs could en-
trench themselves after succession. One possibility is

Shareholder Wealth Effects of CEO Succession 584
opportunistic behavior, arising from private information,
moral hazard, or adverse selection, throughout the con-
tract negotiations. A new CEO could negotiate terms
more favorable to him or her because of undisclosed
knowledge. Another possibility is post-contractual op-
portunism, where a new CEO takes advantage of any
ambiguities in the contract, because there are many un-
anticipated contingencies. Such opportunism seems es-
pecially likely when the board does not adequately moni-
tor the CEO.
There is some utility in exploring how the incentive
structure differs after succession as a way to understand
how the new CEO could strengthen his or her position.
For example, when there are some equity holders, such
as institutional owners who control large enough blocks
of stock to influence management, it seems likely that the
agency contract will be more favorable to the board of
directors. The greater oversight by institutional owners
could result in lower levels of CEO control as might be
seen in more effective compensation contracting and
incentive alignment and potentially stronger firm per-
formance.
2. Agency Theory in Organizations
When viewed through an agency framework, sharehold-
ers of public companies contract with managers to act on
their behalf, and thus delegate to managers the ability to
utilize company resources. Because both the shareholders
and managers are thought to be rational, the owners must
devise ways to effectively supervise the actions of man-
agers. This supervision typically occurs through the con-
tract which specifies how managers will be monitored or
share risks with owners, and effectively aligning owners’
incentives for success with managers pay, with tools like
performance-contingent compensation. When well con-
structed and executed, monitoring and incentive align-
ment support strategic choices which benefit both share-
holders and managers.
One solution to the agency problem in organizations is
monitoring by individual owners. Individual owners of-
ten own too small a position or are otherwise unable or
unwilling to carefully monitor managers of companies in
which they have ownership [12]. Some researchers (e.g.,
[13]) have observed that institutional owners pay more
attention to managerial decisions in the firm because the
decisions and consequent company performance are
critical to their financial holdings. Consequently when
those institutional owners act in ways likely to be benefi-
cial to shareholders, markets react positively [14-16].
While it is clear that there are positive, stock-market
effects associated with activism by institutional investors,
this activism has produced less consistently positive re-
sults with respect to a firm’s financial performance, but
the finding that performance improvements are associ-
ated with investor activism is more common than not
[17]. With the generally positive performance effects
associated with institutional ownership, there may be
other consequences of these owners on outcomes favored
by shareholders, and one such outcome is CEO compen-
sation.
2.1. Creating Incentive Alignment
Agency theory suggests that a new CEO will attempt to
negotiate both more total pay and a smaller perform-
ance-contingent component of pay than the predecessor
CEO [18], and these conditions are more likely to be
granted in the absence of institutional owners. Previous
research suggests CEO pay for incumbent CEOs will be
lower overall and favor performance-contingent forms of
pay when the proportion of institutional investors is
higher [19]. Similarly previous research suggests that
new CEOs receive compensation packages favoring in-
centive pay instead of guaranteed forms of compensation
[8], but whether the presence of institutional ownership
affects the compensation structure has yet to be tested
with the compensation of new CEOs.
There are impediments to proper management control
in modern corporations, as well as reduced incentives for
monitoring by singular, individual owners, and conse-
quently a new CEO could negotiate a compensation con-
tract with more total pay and less risk. The greater levels
of total compensation and their smaller proportions of
performance-contingent pay are negotiated with the
board upon succession. This kind of contract, highly fa-
vorable to the incoming CEO, is possible because of the
relative weakness of managerial oversight in firms with
no strong institutional investors. Any weakness in mana-
gerial oversight might be exploited at the time of succes-
sion, and the new CEO may achieve an attractive com-
pensation package.
H1: The level of post-succession CEO compensation
will be greater in firms with lower institutional holdings.
H2: The level of post-succession CEO compensation
risk will be smaller in firms with lower institutional hold-
ings.
2.2. Performance and CEO Succession
Improved firm-financial performance constitutes the
most effective defense strategy for new CEOs, and better
financial results would reduce any vulnerability to other
managers who serve on the board of directors [10]. There
is likely to be some risk of dismissal for a new CEO
whose appointment follows poor financial performance.
It is reasonable to expect new CEOs in firms lacking
effective institutional owners to negotiate contracts with
strong defensive mechanisms, and that such arrange-
ments could harm firm performance. Several studies

Shareholder Wealth Effects of CEO Succession 585
show that compensation strategies favoring the CEO tend
to be more common in firms lacking effective owner-
oversight. Similarly, compensation contracts which are
structured to de-couple CEO pay from firm performance
are associated with decreased financial performance
[8,20]. Thus, new CEOs in firms with less oversight by
institutional owners might have fewer decision con-
straints than CEOs in firms with effective institutional
oversight, and financial performance could suffer.
H3: Lower post-succession financial performance is
associated with lower institutional holdings.
3. Method
The COMPUSTAT database provided the financial data
and succession events were identified in the Wall Street
Journal. Initially there were 157 publicly-traded firms
experiencing a single succession event during the event
period from 2004 to 2008. At five years, the succes-
sion-event window was short enough to attribute effects
to the new CEO and not to exogenous events, yet long
enough to capture enough succession events for statisti-
cal purposes. No firms experiencing multiple succession
events during the five years, or firms with a CEO succes-
sion in the four years immediately preceding the window,
or in the year following the window were included. In-
cluding companies with multiple successions, with the
associated negations of the compensation contracts,
would have unnecessarily muddled the analysis and hy-
pothesis tests. Ultimately there were 140 firms across the
five years with fully usable data. Using a fixed-effects
specification, where a dummy variable represents the
year of the succession event to test the hypotheses, per-
mitted robust testing but was simple to operationalize.
3.1. Dependent Variables
The first dependant variable, total CEO compensation,
was determined from proxy statements for the year fol-
lowing appointment. Total CEO compensation was com-
prised of all forms of pay reported in the proxy statement,
including the Securities and Exchange Commission (SEC)
estimate of the present value of stock options received
[19]. Despite the difficulty in estimating the present
value of stock options, the nearly ubiquitous use of stock
options as a large part of the total CEO compensation
package justifies their inclusion. The second dependent
variable is a measure of compensation risk that is com-
puted as the proportion of total pay that is performance
contingent [21]. The performance measure uses return on
investment, and is measured in both the year before and
year after the succession event. The value from the year
before the succession event is used as a control in the
regressions, while the post-succession performance serves
as the third dependent variable.
All three dependent variables are adjusted for mean
values of their corresponding four-digit SIC industry for
the first full year following the succession event. The
resulting dependent variable for each observation is the
observed value minus the industry mean. In a conceptual
sense, correcting the observed-value of each firm’s total
compensation and compensation risk with the mean of
the relevant industry creates a value of each dependent
variable that controls for any industry-effect. Thus in the
case of Total CEO Compensation, positive differences
indicate that the CEO for that firm received more than
the industry average total pay, and negative differences
indicate that the firm’s CEO received total pay less than
the relevant industry average. The computation for com-
pensation risk and for firm performance works in the
same way. This method permits controlling for industry
effects in the regression without the corresponding loss
of degrees of freedom [22].
3.2. Independent and Control Variables
This research addresses the question of whether a suffi-
ciently powerful institutional owner affects the negoti-
ated agency contract for a new CEO and if there is a fi-
nancial performance effect. The agency contract, includ-
ing the compensation component, would be expected to
differ in firms where the CEO exercised more control
relative to the board of directors, which represents own-
ers. Researchers seem to agree that effective oversight of
managers is associated with several important conse-
quences [9,23], but there is less consensus as to how to
operationalize the influence of institutional owners. This
paper uses an institutional ownership measure, after Ha-
dani [17], which takes the percentage of outstanding
shares held by the single largest institutional owner. The
measure has gained currency based on earlier findings
suggesting that only the largest institutional owner would
likely possess any information advantage [24].
The influence exercised by institutional owners is only
possible reason that compensation contracts for CEOs
might differ among firms. There are other firm-specific
variables that might affect the contract, such as the size
of the company, whether the new CEO came from within
the firm, and the conditions under which the previous
CEO exited the position. These influences are treated as
control variables.
Size. Firm size is operationalized as the natural log of
annual revenues reported for the first full year of the
successor CEO’s tenure.
Successor origin. The new CEO’s origin is deter-
mined by the last employer prior to becoming the CEO at
the focal firm [25,26]. If that position was held anywhere
other than the focal firm or its subsidiaries, successor
origin was one. If the successor CEO was promoted from
within the firm or any of its subsidiaries, successor origin

Shareholder Wealth Effects of CEO Succession 586
was zero.
Predecessor disposition. There is also the question of
the circumstances of the succession. In assessing the
predecessor’s disposition in text sources, such as the
company proxy statement and the Wall Street Journal, if
these were clear the predecessor had voluntarily retired,
died, or had voluntarily taken another position, or if it
was unclear despite multiple sources, this variable was
coded as zero. Only if it was clear that the predecessor
was forced to resign or retire, this variable was coded as
one.
Lagged performance. Pre-succession firm perform-
ance is measured as described above as the firm minus
the industry average of the company’s return on invest-
ment in the last full year preceding the succession event.
Pooled panel year. The data cover a five-year span so
the specification used a control variable to capture any
unique variance for a particular year in the regression
specification.
3.3. Analysis
The hypotheses were tested in three pooled regression
analyses. The first specification regressed total CEO
compensation on the independent and control variables,
while the second specification regressed compensation
risk, which is the ratio of performance-contingent pay to
total pay earned in the first full year after succession, on
the same set of independent and control variables. The
third specification regressed post-succession firm per-
formance on the independent and control variables.
3.4. Results
Descriptive statistics and intercorrelations for the study
variables appear in Table 1. Only standardized regres-
sion coefficients are reported in the tables for the sake of
comparability.
Compensation effects. The regression results for total
CEO compensation appear in Table 2. Hypothesis 1,
which predicted that the level of total CEO pay would be
higher in firms with lower levels of institutional owner-
ship, was supported. Higher levels of CEO compensation
were also associated with pre-succession firm perform-
ance.
The regression results for compensation risk also ap-
pear in Table 2. Hypothesis 2, which predicted that the
level of CEO compensation risk would be lower in firms
with lower levels of institutional ownership, was sup-
ported. When the predecessor CEO was forced out, pay
risk was also higher.
Firm performance effects. Regression results for
post-succession firm performance appear in Table 2.
Hypothesis 3, which predicted that firms with lower lev-
els of institutional ownership would experience lower
levels of post-succession financial performance, was
supported. Financial performance was also lower if the
successor CEO originated from a position outside the
firm.
4. Discussion
This research suggests that the influence of institutional
owners matters to the nature and consequences of the
agency contract that is negotiated with new CEOs. It
appears that new CEOs who face relatively weaker insti-
tutional-investor oversight are able to negotiate more
favorable compensation contracts, in terms of both size
and risk. Though there are potentially many circum-
stances which would permit a new CEO to strike a more
favorable compensation contract, a lack of institutional
ownership appears to matter a great deal. It is important
for new CEOs to negotiate an attractive compensation
package, because in their early years as chief executive
they are subject to competition from their internal col-
leagues on the board of directors [10].
Other than the influence of an institutional owner and
the predecessor’s involuntary dismissal, compensation
contracts did not seem to vary based on the circum-
stances surrounding the succession events. In terms of
company financial performance, only influence of an
Table 1. Descriptive statistics and intercorrelations.
{PRIVATE} Variable Mean S.D. 1 2 3 4 5 6 7
1. Firm size 3.03 1.51
2. Lagged performance 4.11 5.10 0.06
3. Origin 0.80 0.12 −0.03 −0.04
4. Disposition 0.42 0.46 0.03 −0.16 0.19*
5. Total compensation 12.4 1.36 0.38** 0.02 0.14 0.03
6. Compensation risk 0.69 0.25 0.12 0.17 −0.05 0.09 0.73**
7. Post performance 4.41 4.93 0.10 0.65** −0.02 −0.21* 0.14 0.15
8. Institutional owner 0.10 0.04 −0.18*0.03 0.08 0.11 −0.27* 0.19* 0.26*
Note: *p  0.05 **p  0.01.

Shareholder Wealth Effects of CEO Succession 587
Table 2. Regression results.
Total compensation Compensation risk Post performance
{PRIVATE} β β β
Firm size 0.389** 0.351 −0.131 0.047 0.092 0.378
Lagged performance 0.162* 0.278 0.058 0.202 0.301** 0.216
Origin −0.006 0.054 0.029 0.001 −0.174* 0.037
Disposition −0.050 0.125 0.156* 0.023 −0.108 0.094
Institutional owner −0.194* 0.069 0.207* 0.182 0.286* 0.255
institutional owner and successor CEOs from outside the
firm were significant influences. Stronger financial per-
formance was associated with greater institutional invest-
tor influence, while outside successor CEOs were associ-
ated with worse financial performance post-succession.
4.1. The Effects of Institutional Ownership
The ways in which new CEOs protect their positions
appears to differ in firms based on institutional owner-
ship. CEOs in firms with lower levels of institutional-
owner influence were able to achieve less compensation
risk than new CEOs in firms with higher levels of influ-
ence exercised by institutional owners. These differences
in compensation and risk-sharing may account in part for
the finding that firms lacking significant institutional
ownership do not perform as well as those featuring more
institutional ownership, a result consistent with other
work that shows that greater institutional ownership is
associated with better financial performance [17].
The compensation contract, and in particular the ar-
rangements with respect to how contingent pay is earned,
is the primary means shareholders have to align manag-
ers’ interests with their own. CEOs in firms with less sig-
nificant institutional ownership appear to receive higher
pay and less compensation risk in their negotiated con-
tracts, while successor CEOs in firms with significant
institutional ownership experience higher compensation
risk. These results suggest managers in firms with low
levels of institutional have more influence over the
structure and magnitude of their pay, and thus the results
are consistent with previous research [20].
Though no direct effects were tested, it may be that the
negotiated agency contract impacts the firm’s financial
performance. In firms with less institutional ownership,
where the new CEO may have more influence relative to
the board of directors, financial performance is lower
than in firms with significant institutional ownership.
The overall results suggest that the relatively greater in-
fluence of the new CEO under low levels of institutional
ownership, as reflected in the terms of the compensation
contract negotiated at succession, is one possible reason
for the positive association of institutional ownership and
financial performance.
4.2. Negotiated Compensation Terms and
Performance
Though institutional owners appear to influence the
compensation terms of the agency-contract negotiated
with the board of and the incoming CEO, such that when
institutional ownership is small the successor CEO cap-
tures a more favorable compensation contract, at least
one other factor during succession seems to impact per-
formance as well. The disposition of the previous CEO
seems to have some effect on the compensation ar-
rangements. New CEOs who followed one who was dis-
missed received proportionally more pay which was per-
formance contingent, shifting more of the firm's future
performance risk to the new CEO. Compensation terms
shifting pay risk to the new CEO represent a reasonable
response by firms that have dismissed their previous
chief executive, because increased pay-risk signals the
board’s demand for better future performance.
Though not significant to compensation, whether the
new chief executive came from within the firm seems to
matter to financial performance. These results contradict
previous evidence suggesting that the successor CEO’s
origin, whether from inside or outside the company, has
no effect on post-succession firm performance [26]. Fu-
ture research that takes into account the social networks
of the departing CEO, such as proposed by Cao et al.
[27], might further elaborate these results.
Ultimately, the compensation contract terms seem to
depend on the interplay between an incoming CEO, in-
stitutional owners, and the board of directors. The direc-
tors appear to create terms more favorable to sharehold-
ers when institutional owners have more influence on the
firm. When managers exercise more control, however,
the evidence suggests that shareholder interests may be
traded for managerial compensation. Firm performance
following succession may thus depend more on who
controls the contracting process than on other character-
istics of the new CEO.
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