CEOs of publicly traded companies are fired too quickly, putting firms at a long-term disadvantage, shows a forthcoming UBC Sauder School of Business study. The research suggests investor pressure to increase stock value in short timeframes sets leaders up to fail.
The study, co-authored by UBC Sauder finance professor Kai Li, compared CEO turnover at public and private firms, and revealed that the CEOs of public firms didn’t last as long as their private firm counterparts due to a problematic focus on short-term performance among investors and boards of directors.
“When share prices go down, boards need to find a scapegoat – so they fire the CEO to please the shareholders,” said Li, W.M. Young Chair in Finance at UBC Sauder. “Unfortunately most shareholders, and even board members, don’t have the time and expertise required for an in-depth look at a CEO’s performance, so they just look at easy metrics like stock price and accounting performance measures.”
She says that in a given year, 10 per cent of public firms will replace their CEOs, compared to eight per cent of private firms.
Li says that the excessive focus on short-term performance is driving the strategies of CEOs who know that the security of their jobs is tied to driving up stock price rather than developing long-term strategies and competitive advantages.
“I’m concerned that modern firms aren’t investing in R&D enough because it has no short-term payoff, and CEOs are worried about their own jobs too much,” said Li. “We are in a knowledge-based economy, and innovation is a key driver of economic growth, productivity and corporate competitive advantages, so short-termism is a very real problem.”
For the study, the researchers compared 2,881 cases of CEO turnover from public and private firms in the United States from 2001 to 2008. Within public firms, they also compared firms with different levels of investor short-sightedness – measured by the ownership of short-term institutional investors based on their portfolio turnovers – and found that firms with the most short-sighted investors were the quickest to fire their CEOs, and experienced the weakest performance improvement after CEO turnover.
The study, “CEO Turnover-Performance Sensitivities in Private Firms,” by Huasheng Gao, Jarrad Harford and Kai Li, is forthcoming in the Journal of Financial and Quantitative Analysis.