shareholder wealth effects of management changes

Journal of Business Finance @Accounting, 20(3), April 1993, 0306-686X 39.1

SHAREHOLDER WEALTH EFFECTS OF MANAGEMENT CHANGES

ARVIND MAHAJAN AND SCOTT LUMMER*

INTRODUCTION

A change in senior management of a corporation can have a significant impact on the perceived future performance of that firm u i s - h i s its current performance. The resulting perceptions can induce changes in a company’s value placed by investors that register themselves in the price of its common stock determined in eficient financial markets. This paper analyzes the direction and magnitude of changes in stock prices and stockholder wealth resulting from the announcement of specific types of changes in senior corporate management. A change in management entails two events: (a) an executive losing decision making authority, and (b) the hiring or promotion of another executive to fill the void created by the first event. Though together they comprise ‘managerial change’, they remain two distinct events, and hence, have different implications. This study focuses on the first occurrence, i.e., the announcement of an executive losing decision making authority or being redeployed. This event will be alluded to as a ‘management change’ in this paper.’

This study tests three hypotheses by examining the impact of various types of management changes on shareholder value. An event-study is performed on the common equity securities of firms for 498 separate announcements of management changes from 1972 to 1983. For the purposes of this study, a management change is defined as a change in the management team comprised of the chairman of the board, the chief executive officer, and the president. The sample of management changes is divided into five categories depending upon the precise nature of how an executive lost power or was redeployed. These five categories are firings and forced resignations, voluntary resignations, deaths, mandatory retirements and reshuffles (where executives are redeployed within the top management team of the corporation but the aggregate composition of the team remains intact).

The empirical analysis of this study investigates three basic questions regarding management changes. First, was ‘smoothness’ during the transition of management an important determinant of the change in firm value? In particular, was the stock price dependent upon whether the departing manager remained with the firm in an advisory capacity? Second, did the market perceive decisions made by the corporate power nexus that further entrenched it to be

*The authors are respectively, Professor of Finance, Texas A & M University, College Station, Texas; and, Vice President, Ibbotson Associates, Chicago, Illinois. (Paper received June 1990, revised and accepted September 1990)

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394 MAHAJAN AND LUMMER

in the interest of the shareholders? Finally, did the market perceive that management change decisions instigated by the firm’s management (in contrast to externally instigated changes outside the domain of corporate decision makers) were in the interest of the owners?

ISSUES TO BE INVESTIGATED

Smoothness of Transition

In the organizational behavior literature, three sociological views have been expressed regarding the impact of executive succession on organizational performance. The first view is founded on the premise that individuals can control organizational outcomes; thus, a departing executive’s mistakes will presumably be avoided by his or her replacement. This view hypothesizes that administrative change improves performance. A second perspective suggests that leadership has no significant bearing on organizational performance. Empirical evidence supporting this view (which is predominantly obtained from evaluating the performance of sports teams after a change of their manager or coach) is provided by Gamson and Scotch (1964), Eitzen and Yetman (1972) and Brown (1982). Lieberson and O’Connor (1972) and Pfeffer (1977) suggested that one reason for such findings is that leadership effectiveness could be limited in large and complex organizations by social and environmental constraints. The third view, empirically supported by Grusky (1963) and Allen, Panian and Lotz (1 979), is that executive succession adversely affects organizational performance. It reasons that a management change causes tension, instability and an enhanced probability of subsequent changes, and hence will detrimentally influence future performance.

This study will determine the empirical efficacy of the above mentioned views. Announcement of management changes which were significantly anticipated by the market (for example, mandatory retirement of an executive due to known company policy) carry iittle or no ‘news’ content and hence should not result in incremental uncertainty. However, to the extent the third view above is valid, i.e., that unanticipated management changes cause uncertainty which adversely affects corporate performance, changes where departing executives completely sever all ties with the company should result in more uncertainty than those changes where the executives exit from the decision making nexus but remain affiliated with the firm in another capacity. In this case, we should observe a more positive (or less negative) impact on firm value of those changes where executive ties were retained than of those where ties were severed.

Managerial Ef f t iveness

The incentive problem of managers (agents) who are not the firms’ security holders (principals) has been a well recognized source of potential conflict in

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SHAREHOLDER WEALTH EFFECTS 395

decision making within a firm. Many empirical studies have analyzed stock price reaction to a multitude of corporate control events.‘ These studies attempt to judge whether internal or external discipline of management is effective in aligning agents’ actions with the best interest of the principals. On the normative side, agency theory focuses on the development of optimal contracts between the principal and the agent. For example, Shave1 (1979) and Holmstrom (1979) suggested that, when ex post measurement of a manager’s productivity is not perfect, risk averse managers will choose to share the risk with the principals. Eaton and Rosen (1983) maintained that the composition of executive compensation packages should be related to each executive’s age, to the firm’s ability to monitor executive behavior, and to the uncertainty of future earnings. On the positive side, agency theory is concerned with corporate behavior in the presence of the principal-agent problem. Jensen and Meckling (1976) proposed that in a single period context, with less than perfect ex post settlements, managers will shirk or consume ‘perks’ on the job. On the contrary, Fama (1980), in a multiperiod context whereby ex post settlement is almost complete, argued that managers will be motivated to maximize shareholders’ wealth.

The question of whether managers have been acting in the shareholders’ interest is ultimately an empirical issue. We obtain evidence to answer the following narrowly focused question: do managers and board members act in the shareholders’ interest when changing the composition of the management team? This will be accomplished by stratifying a sample of management change announcements into two groups based on whether an announcement signals a shake-up in the top management team or an increase in the incumbent team’s entrenchment. Clearly, a positive (negative) reaction by the market to such announcements will suggest that the market perceives the current decision to be (not be) in the stockholders’ interest. Evidence obtained to answer this question can also be utilized to draw inferences regarding the broader issue of whether previous management in general has been perceived as working in the interest of the shareholders. If shareholders held the incumbent management personnel in high esteem, they will react positively to announcements of management entrenchments but negatively to shake-ups which dilute the incumbent team’s control. On the other hand, if incumbent management was not percieved to be working in the shareholders’ interest, the opposite market reactior, to the two types of announcements should be observed. 3

.Effects of Management Change

Somewhat distinct from the issue of perceived managerial quality is the question of expedience of the change in management. Obviously, there are too many factors affecting corporate managerial alterations which preclude categorically stating whether or not managerial changes on the whole are desirable. The effect of a management change on firm value determined in an efficient capital


396 MAHAJAN A N D L U M M E R

market should reflect the perceived loss or gain of the departing executive’s marginal economic contribution (his marginal product minus his compensation) which would not have resulted with his continued employment.

Based upon the source that instigates a management change, we can categorize all management changes into two groups. Internally instigated management changes are those that are brought about by the corporate decision- making or power nexus, i.e., the top executives and the board of directors. An example of an internally instigated change is the firing of an executive. Externally instigated changes are those that are outside the direct domain of the power nexus and include changes brought about by the departing managers themselves, or resulting from other external sources such as death or illness. If the market perceives the power nexus to be acting in the interest of the shareholders, internally instigated changes should have a higher reaction than those instigated by external factors.

In either case, departure of an executive will result in discontinuation of any (positive or negative) rents to shareholders whose value will be reflected in the change (negative or positive) in the firm’s stock price. Since internally instigated managerial changes are brought about by the shareholders’ agents, these decisions should be made only if they further the interests of the shareholders, and should result in increasing the stock price. O n the other hand, externally instigated changes, in particular those made by the departing executives themselves, need not be instigated by the same motive. Hence, stock price reaction to management changes should be a function of whether they are internally or externally instigated.

HYPOTHESES AND EMPIRICAL TESTS

The effects of various management changes on stock prices were investigated utilizing the concept of event-time methodology which has become quite common in financial research (see Brown and Warner 1980 and 1985). A sample of announcements of managerial changes was compiled and common stock returns around the time of these announcements were analyzed. This section describes the data as well as the statistical procedures that are used in the empirical analysis.

Sample

Each year, Forbes magazine publishes information on the 800 highest paid executives employed by US corporations. This information includes the length of time that each executive has served as the firm’s chief executive. When the list indicates that a particular executive has held the position for only one year, it implies that the firm must have undergone a top management change within the previous two years. A sample was compiled of all firms with an executive



cited by Forbes as being on the job for one year. These data were gathered for each year from 1972 to 1983. The original sample contained 1,243 observations.

For each of the observations, we searched the Wall Street Journal Index to determine whether the executive change was reported in the Wall Street Journal ( W S J ) ; the search involved scanning the index during the two years prior to the publication of the Forbes list. If some mention of the management change as traced from the Forbes list was found in the Index, the original referenced article in the WSJ was located. Only those firms for which an article reporting the change in executive control could be found are included in the ample.^ In order to more specifically define the term ‘top’ management change, this study includes only those executive changes which involved at least one of the following three officers: chairman of the board of directors, chief executive officer, or pre~ident .~ Another criterion for inclusion in the test sample is that the particular firm be listed on the Center for Research in Security Prices (CRSP) Stock Master Price File. This ensured the availability of daily security return data for each of the firms in the final sample. Of the original 1,243 observations, 646 observations remain with a management change announcement reported in the WSJ and return data available on CRSP.

If any contaminating information concerning the firm was published in the WSJ within three trading days before or after the announcement date, the observation was eliminated from the sample. Information which caused sample deletion included earnings and dividend announcements, capital expenditures, security offerings, acquisition activity, and various forecasts (sales, earnings, growth, capital expenditures, etc.). Application of this criterion reduced the final sample size to 498 observations.

Various pieces of information were gleaned from the article in the WSJ. Of foremost importance is the publication date of the article. As the focus of this study is on the announcement of a managerial change (and not on the announcement of a managerial replacement), the date of interest was the one on which the executive change was first announced. If the article appearing in the WSJ contained the first release of information to the public concerning the change in executive control, the valuation impact would have occurred either on the publication date of the article or on the prior day. Therefore, the empirical analysis focuses on the securities’ ‘announcement period return’ - the yield during the two-day period ending on the date of publication of the article.

Sample Strat $cation

Management turnover results from a variety of circumstances. The resulting impact on the existing decision making nexus within the organization and perceived future performance of the organization will, to a large extent, depend upon the precise nature of a particular change. T o stratify the sample into the categories discussed below, each WSJ article was read to identify the category

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of the change reported in it . Those cases for which the announcement’s categorization was not clear were dropped from the sample (these deleted cases were not included in the 646 observations reported earlier).

This study evaluates stock price reaction to new information arriving in the market pertaining to management changes. As changes in which the executive retires due to pre-stated company policy regarding mandatory retirement age should be anticipated by the market, a priori we expect no stock price reaction to these announcements. Although this age is company specific, in most cases it was 65 years. These changes are classified as group 111, comprised of 100 observations. These include 16 cases where an executive retired early, but always within three years of the mandatory retirement age, with the stated purpose of facilitating a smooth transition of power.

It is generally perceived that an event of management change is associated with a change in the firm’s top management team comprised of the chairman of the board of directors, the president, and the chief executive officer. However, a management change frequently results in a mere reshuffling of the existing executives, keeping intact the original team with no executive losing power. Hence, the remaining sample of 398 events is split into two groups: group I (2 18 observations) containing management changes which resulted in at least one top executive losing power thereby changing the composition of the controlling group, and group I1 (180 observations) comprising ‘reshuffles’. Analysis of these two groups will be used to test the second hypothesis of this study.

Figure 1

Sample Stratification

Wholc Sample

I . Loss of Power 11. Reshuffle 111. Mandatory Retirements

IA. Involuntary Loss of Power

I B l , Resigning Executive IR2. Resigning Executive Severs Ties with Firm Retains Tics

with Firm

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T o answer the question pertaining to internally versus externally instigated management changes, group I was further stratified into three groups based on the instigator of the change. Group IA contains 39 announcements of internally instigated changes made by the power nexus in which an executive was explicitly fired or involuntarily lost power. The remaining two groups contain externally instigated managerial changes. Group IB is composed of 155 observations in which the manager losing power made a voluntary decision to step down, and group IC contains 24 announcements of the death of an executive. This study’s third hypothesis will be tested by analyzing the stock price reaction in these three groups.

To test the first hypothesis regarding the impact of managerial change on organizational stability and performance, the subsample of voluntary resignations (group IB) was further subdivided into two groups. Group IB1 contains 108 observations of those voluntary relinquishments of power where the departing executive severed all ties with the corporation. The remaining 47 announcements, categorized as group IB2, were those in which the executive voluntarily left the position but remained with the firm in some advisory capacity, typically as a consultant or member of the board of directors.

Statement of Hypothesis

Figure 1 describes the manner in which the whole sample was stratified. The categorized sample will be used to test the following three hypotheses, originally stated in the section headed, Issues to be Investigated.

Hl : Management changes cause corporate instability which adversely affects firm value.

H2a: Decisions made by the corporate power nexus regarding reshuffling executives and fine tuning the composition of the management team are not perceived to be in the interest of the shareholders.

HZb: At the time of a management change, shareholders perceive that the incumbent management team was not acting in their interest, and a new management team is more likely to maximize shareholder wealth. Shareholders perceive that executive displacements initiated by factors external to the company are preferable to internally instigated changes.

These hypotheses will be tested in the following manner. The first hypothesis (H1 ) pertains to the relationship between management change, corporate instability and firm performance. If instability is a factor influencing value, then ceteris paribus, changes involving the retention of the departing manager in an advisory role (group IB2) should have a more positive (or less negative) effect on firm value than management alterations in which all ties are severed between the executive and the company (group IBl). The announcement period returns of these two subsamples will be compared to evaluate this hypothesis.

If part (a) of the second hypothesis is valid, then shareholders would react

H3:



negatively to alterations in the managerial structure where no executive loses power but is instead redeployed in another capacity within the decision making team. These corporate reshuffles more solidly entrench the incumbent management team. Part (a) of the second hypothesis predicts that announcements of a reshuffle (group 11) should have a negative effect on equity value. If part (b) of the second hypothesis is valid, the market would perceive management changes which alter the composition of the management team with at least one executive losing power more favorably than executive changes which imply strengthening of the incumbent management’s control over the firm. Hence, this hypothesis predicts that changes involving a loss of power (group I) should have a less negative (or more positive) effect on shareholder wealth than reshuffles (group 11). The announcement date returns for groups I and I1 will be compared to test hypothesis H2b.

The final hypothesis (H3) suggests that the announcements of management changes which are instigated internally as opposed to externally should have different impacts on firm value. To the extent shareholders are skeptical of the decisions made by the encumbent management team, they would react more negatively to encumbent management instigated managerial changes than those brought about by external factors. Hence, firings (group IA) should have a negative effect on equity value since these are internally instigated decisions made by the board. In contrast, management changes due to voluntary resignations (group IB) and death (group IC) are externally initiated, therefore the effect of both these on firm value should be positive (or less negative) vis-d- vis internally instigated firings. Table 1 summarizes the hypotheses tested in this study.

Methodology

The traditional event study approach is used to detect whether the announcement period returns for the securities in the sample were abnormal. Specifically, the market model residual method is employed as detailed in Brown and Warner (1980 and 1985) and applied by Dodd and Warner (1983). Briefly, this pro- cedure involves calculating abnormal returns for an event-time portfolio. For every security in the sample, a time series of daily returns is regressed against the corresponding yields from the equally weiqhted market index, using the equation:

where R,, and R,, are the returns during period t for security i and the market index, respectively, and E , , is the residual error term with mean equal to zero. The returns used in the regression are those over a comparison period of between 11 1 and 210 days prior to the event (i.e., the publication) date. The estimates of the constant and the coefficient obtained from the regression, along with market index yield data, are used to generate a time series of return predictions:


SHAREHOLDER WEALTH EFFECTS

Table 1

Hypotheses Tested

40 1

~

Hypothesis Effect * Reason

HI: Instability affects R(IB1) < R(IB2) Difference in whether shareholder wealth manager remains with

firm or severs ties

HZa: Reshuffling composition R(I1) < 0 Difference in assignments of management team is within the management not in shareholders' interest

team which further entrench it

H2b: Encumbent managers R(1) > R(I1) Difference in composition do not maximize of encumbent shareholder wealth management team

H,: Internally instigated R(IB) > R(IA) Difference in internally management changes R(1C) > R(1A) versus externally are not in shareholders' interests

instigated changes

~

Noic ' R ( t ) IS abnormal announcement period return for group t

where & and B are the estimates derived from regression equation (1). These predicted returns are subtracted from the corresponding actual returns to obtain a time series of excess returns:

The excess return is then divided by the prediction error to compute the standardized excess return:

where

and S, is the standard error of regression equation ( l) , and R, is the average market return during the comparison period.

The test statistic to determine whether the average cumulative excess return over day - 1 and day 0 for observations in group G is significantly different from zero is given by:



where NG is the number of observations in group G. Under the null hypothesis that the announcements of managerial changes have no effect on firm value, ZG - N(0,l).

RESULTS

Table 2 presents summary statistics concerning the two-day excess returns for the 498 observations in the sample. The measures of skewness and kurtosis are much too large for the distribution to be considered drawn from a normal population. For example, the fourth moment of a normal distribution is three times larger than the square of the variance, while the fourth moment of the sample is 19 times the square of the variance. Moreover, the Kolmogorov- Smirnov D-statistic for goodness of fit is 0.134, while the 0.01 critical level is 0.073. Hence, the hypothesis that the sample of excess returns is drawn from a normal distribution is rejected. Brown and Warner (1985) concluded that daily stock returns exhibit non-normality in the form of high skewness and kurtosis, and designed their test methodology, which is employed in this study, to account for this non-normality.

Table 3 contains a summary of the results obtained using the procedures described in the previous section. The average two-day announcement date excess return (ER) for the entire sample of 498 observations was -0.02 percent

Table 2

Descriptive Statistics for Return Data

Number of Returns 498

Maximum Median Minimum

Mean Standard Deviation Skewness” Kurtosisb Kolmogorov-Smirnov D-statistic

31.60% 0.04%

- 14.41 %

-0.02% 3 . 5 5 %

1.89 16.96 0.134;

Notes: ‘Indicates significance at the 0.01 level. “Computed as the ratio of the third moment to the cube of

bCornputed as the ratio of the fourth moment to the square the standard deviation.

of the variance, minus 3.00.



Table 3

Mean Two-day Announcement Period Excess Returns and Related Statistics for Subsamples

Proportion Two-day of

Sample Excess Z- Positive Size Return (76) Statistic Returns

Entire sample 498 -0.02 -0.08 0.512 Excluding mandatory retirements 398 -0.10 -0.52 0.500 Mandatory retirements (Group 111) 100 0.29 0.85 0.56 Loss of Power (Group I) 218 0.24 1.26 0.528 Reshume (Group 11) 180 -0.50'' -2.16 0.467

Involuntary loss of power (Group IA) 39 -0.73' -1.96 0.487 Voluntary resignations (Group IB) 155 0.21 0.78 0.548 Deaths (Group IC) 24 1.97'* 4.31 0.458

Leave firm (Group IB1) 108 -0.15 -0.72 0.509 Retain ties (Group IB2) 47 1.04** 2.51 0.638

Notes:

*. Indicates significance at 5 percent level. 'Indicates significance at 10 percent level.

with a 2-value of -0.08, which suggests that overall, managerial turnover has no effect on shareholder wealth.6 This finding holds even when the anticipated mandatory retirements (group 111) are excluded from the overall sample. However, since our sample contains a variety of circumstances under which a change in corporate leadership occurred, this evidence is not sufficient to warrant any generalized conclusion.

Managerial Eflectiueness

A remarkably different picture emerges when the overall sample is stratified based upon whether any top executive lost power. The excess return associated with group I, containing all management changes in which an executive lost power, was positive 0.24 percent with a Z-value of 1.26. For group 11, which contains announcements of managerial changes that were mere reshuffles with the top management team remaining intact, a negative excess return of - 0.50 percent was observed during the announcement period, yielding a Z-value of -2.16, which is significant at the 0.05 level. Furthermore, the stock price reaction of the two groups differed significantly from each other with a Z-value of -2.45 - firms announcing a managerial change involving an executive's loss of power had a significantly positive increase in their equity values relative to companies announcing a reshuffle in their managerial positions which further entrenched the encumbent team.



Internally uersuJ Externally Instigated Changes

Group I was further subdivided into three categories based upon who instigated the change. The first subgroup IA contains observations where an executive was involuntarily stripped of power by the decision making nexus. This group contained 34 outright firings and five cases where the executive did not sever employment with the organization but was forced to give up decision making authority and was squeezed out of the top management team. The excess return for this group was negative ( - 0.73 percent) and significantly different from zero (Z-value = - 1.96), suggesting that the market reacted unfavorably to the board of directors’ internally instigated decision to strip an executive of power.

The second subgroup IB contains 155 announcements of a manager voluntarily resigning from the power nexus. The excess return for this externally instigated managerial change group was 0.21 percent with a Z-value of 0.78. Although this return is insignificantly different from zero, it is significantly greater than the excess return for the group of internally instigated firings. Furthermore, the mean excess return for the voluntary resignations group is significantly greater than the excess return for the reshuffles group (Z-value = 2.05).

The third subgroup IC contains 24 announcements of the death of an executive. The two-day announcement period excess returns were 1.97 percent with a highly significant 2-value of 4.31. These findings are consistent with those observed by Johnson, Magee, Nagarajan and Newman (1985). Further- more, the excess returns associated with deaths are significantly greater than those due to voluntary resignations, and also from internally instigated reshuflles and firings (Z-values = 3.72, 4.79 and 4.60, respectively).

Managerial Instability

The final stratification of the sample involved dividing the set of voluntary resignations into two groups based on whether the resigning executive remained with the firm in some advisory capacity. In those cases where all ties between the company and the departing manager were severed (group IBl), statistically insignificant but a negative excess return of -0.15 (2-value = -0.72) was observed. When the manager who resigned from the power nexus remained with the firm in a non-decision making capacity (group IB2), the excess return was positive 1.04 percent, which is significant at the 0.05 level (Z = 2.51). The excess returns of the two groups were significantly different at the 0.05 level (Z = 2.49). Hence, severance of all corporate ties with an outgoing manager appears to be significantly negatively regarded by the market relative to cases in which ties are ~naintained.~

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IMPLICATIONS OF RESULTS

In general, a management change entailing the severance of all ties between the corporation and the departing executive would entail more instability than when corporate-executive ties are conserved, since there would be some administrative continuity in the latter case. For this reason, the first hypothesis (HI ) of this study predicted that excess returns for the former group would be less than for the latter group. Results reported in the previous subsection cannot reject this hypothesis, and consequently lends support to the view in sociology and organizational behavior disciplines that executive succession adversely affects organizational performance.

The empirical evidence obtained in this study fails to reject hypotheses H2, and H2b. The observation of a significant decline in firm value associated with the announcement of reshuming the management team suggests that the market perceives executive reallocations which conserve the composition of the power nexus and further entrench management not to be in the shareholders’ interest. Conversely, the market responds favorably (albeit not in a statistically significant manner) when an executive in the decision making nexus loses power. The observation that the market reacts negatively to further entrenchment of the management team and positively to a shake-up which dilutes the previous team’s control, along with the finding of a statistically significant difference in excess returns between these two groups, is consistent with the view that the previous management team must not have been perceived by the market to be solely maximizing shareholder wealth.

Our empirical results also fail to reject the final hypothesis that shareholders perceive executive displacement initiated internally by the company less favorably (or more negatively) than those resulting from external factors. Managerial turnover resulting from death is instigated by factors as independent and as far removed from the decision making nexus as are possible; yet, the market responds most favorably to these announcements. A list of all changes can be compiled based upon their nature in the order of their being the farthest removed from the control of the power nexus to those being squarely in its domain. This list is (group number, excess return, and Z-value - all in parenthesis): death (IC, 1.97 percent, 4.31), voluntary resignation (IB, 0.21 percent, 0.78), involuntary loss of power (IA, -0.73 percent, -1.96), and reshuffle with no loss of power (11, -0.50 percent, -2.16). The pattern of abnormal returns and their significance associated with this ordering is revealing, When management change decisions are in the domain of the power nexus (the management team or the board of directors), the market reacts negatively to them. As the decision of change moves away from the power nexus, the negative market reaction gets moderated and turns positive. Finally, the effect on market value becomes significantly positive for the management change whose decision is the farthest removed from the organization’s decision making group.

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Although not the most palatable, one implication of these results is that they do cast a shadow on the belief that managers and the board of directors solely utilize shareholders’ wealth maximization as their decision criterion. The results of this study suggest that the market perceives the controlling group of a company to be not solely motivated by shareholder wealth maximization considerations, at least with respect to the structure of the management team.

Two problems are encountered when interpreting the empirical results obtained and should be mentioned. First, none of the non-parametric tests conducted using the Binomial test statistic for various subsamples detected any significance; i.e., the proportion of observations with positive excess returns for each group displayed in Table 3 was never significantly different from the comparison period proportion. This suggests that the market value effects of management changes are not uniformly encountered by all of the firms in the respective groups.

The second problem is more severe. It is possible that the stock market returns during the announcement periods are not reactions to the announcement of management changes per se, but instead reflect information correlated with the announcement. For example, voluntary resignations may signal that the departing manager feels his or her mission of making the firm successful is accomplished, and hence, it is time to step down. This might signal good news to the market. Likewise, the market may feel that the firing of a poorly performing executive is good, but the firing itself conveys the notion of poor performance.

Two factors mitigate the second problem to some extent. First, all of the companies contained in our sample are large, widely-traded firms. It is unlikely that good or poor performance of these firms would go unnoticed by security analysts prior to the announcement of the management change. Most of the WSJ reports on firings suggest that analysts had previously held the firing firm in low regard. For example, the WSJ article concerning the firing of the president and an executive vice president of Bendix Corp. (September 15, 1980) states that the chairman:

refused to comment on whether their departures were related to the company’s lackluster financial performance this year. . . . some analysts believe that the company could post a profit drop for the year ending Sept. 30.

Second, the possible release of any implicit information with the management change announcement cannot explain the market reaction to reshuffles and deaths. It would be illogical for the market to feel that a management entrenching reshuffle was good news, but that the motives for that reshuffle conveyed negative information.

CONCLUSION

This paper has investigated the direction and magnitude of changes in stock prices and stockholder wealth resulting from announcements of redeployment


SHAREHOLDER WEALTH EFFECTS 40 7

or loss of decision making power of senior corporate managers over a twelve- year period. In specific, three hypotheses were developed and tested. Stock price reaction to announcements of management changes where an executive voluntarily resigned from the decision making position but stayed associated with the firm in an advisory role was significantly higher compared to when all ties were severed between the company and the executive. This supports our first hypothesis that management departures cause instability which adversely affect corporate performance.

Significant abnormal returns were observed when the analysis was conducted based upon whether the managerial alteration announcement entailed no fundamental change in the composition of the power nexus or when it entailed an executive actually losing power. Significant negative abnormal returns resulted when the power of the constituents of the top decision making team was merely swapped but the encumbent management team was fundamentally conserved - a decision instigated and implemented by the management team and the board of directors. Hence, our results lend support to the second set of hypotheses that (a) the decision of the power nexus to reshuffle and fine tune the management team are not perceived by the market to be in the shareholders’ interest, and (b) at the time of a management change, shareholders judge the previous management team to have not been acting in their interest.

A conspicuous trend emerged when observations of executives’ losing power were further categorized based upon who initiated the managerial change. While negative abnormal returns were observed when the change was internally instigated by the corporate power nexus, no abnormal returns were observed when the change was due to a voluntary decision by the executive relinquishing the power, and significantly positive abnormal returns were associated with the initial news of an executive’s death - an event farthest removed from the domain of the decision making nexus. These results support the third hypothesis that executive displacements initiated internally by a company’s senior corporate executives decrease firm value and are less preferable to management changes resulting from external factors. This study’s findings associated with hypotheses H, and H3 are consistent with the strand of agency theory literature which argues that decisions of the management and the board of directors may not be solely motivated by considerations of shareholder wealth maximization.

NOTES

1 An excellent survey of past research on top management changes is provided by Jensen and Warner (1988). The eight studies identified by them (Mahajan, Klein and Kim, 1985; Reinganum, 1985; Borstadt, 1985; Bonnier and Bruner, 1986; Furtado, 1986; Furtado and Rozeff, 1987; Weisbach, 1988; and Warner, Watts, and Wruck, 1988) along with a few others (Beatty and Zajac, 1987; Johnson, Magee, Nagarajan and Newman, 1985; and Lubatkin, Chung, Rogers, and Owers, 1986 and 1989) provide conflicting evidence regarding the direction and magnitude of the wealth effect due to management changes. This is due to: (a) different definitions of what constitutes a management change, and (b) different samples of management changes utilized in the statistical analysis.

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2 These include mergers (see Asquith, 1983; Asquith, Bruner and Mullins, 1983; Dodd, 1980; Malatesta, 1983; and Ruback, 1983). tender offers (see Bradley, 1980; Bradley, Desai and Kim, 1983; and Dodd and Ruback, 1983), voting rights (see Bhagat and Brickley, 1984; Lease, McConnell and Mikkelson, 1983; and Manne, 1964), proxy fights (e.g., Dodd and Warner, 1983) and corporate charter amendments (Bhagat, 1983; DeAngelo and Rice, 1983; Linn and McConnell, 1983; and Lambert and Larcker, 1984). One may question this argument since, if in general, management teams are held in low regard by the stock market, the new managers would suffer the sample adverse opinion. However, (a) there is no reason to presume that all management, in general, is held in low regard, and (b) even if it were, i t is likely that the security market perceives the new executives to be less entrenched than the previous managers, and hence, less likely to digress from the shareholders’ interests. Since the source of the sample in this study is the Forbes list of 800 highest paid executives in the US who predominantly belong to large corporations, the results reported in this paper are applicable for large corporations which account for a very significant portion of the aggregate US market portfolio. For some firms, a president or a chairman may not be considered top management. It would be virtually impossible to determine for every firm in the sample which of the three officers truly was the head of the organization. However, by construction of the sample, for every observation a new executive had become one of the highest paid managers in the country according to Forbes. Hence, it is reasonable to assume that for each company in the sample, a major managerial change had occurred. Significance tests were also conducted for the cumulative excess returns (CERs) before day - 1 and after the event date, i .e., day 0. Only one stratified group yielded returns before or after the announcement date that were significant at the 0.05 level. The death subsamples returns were significantly positive between day 1 and day 10 (in addition to being significantly positive during the two-day announcement period). We also partitioned the sample of mandatory retirements according to whether the departing manager remained with the firm in an advisory capacity. There was no significant difference in the mean abnormal announcement period returns between mandatory retirements in which the retiree stayed on as an advisor and retirements in which the executive severed all ties with the company. This lack of significance is not surprising, since the cases of mandatory retirements are likely well anticipated by the market.

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shareholder wealth effects of management changes

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