Company value over a CEO’s tenure

A recently concluded study investigated the relationship between a CEO’s tenure and company value.

The prevailing theory on this topic is informed by another earlier study, which proposed that CEOs experience “seasons” during their tenure. As CEOs advance in their position, they get better and more capable at making decisions that enhance the value of their company. This leads to better company performance over time. However, company performance declines over time the longer those CEOs stay in their positions, as a result of a combination of a diminished ability to learn, an accumulation of power, and becoming gradually less engaged. This theory predicted that “performance very early and very late in the tenure will be lower”.

The latest study defines company value by looking at Total q, an adjustment of Tobin’s q which takes into account intangible assets by capitalizing R&D and a portion of SG&A expenses.

Data from S&P 1500 companies spanning 1992 to 2017 was examined. The study authors found an inverted-U shaped relationship between company value and CEO tenure. This relationship indicated that company value typically declines after the 14th year of a CEO’s tenure.

Does this finding hold true across CEOs, companies, and other external conditions? The authors believed they vary and tested to identify these relationships. They specifically looked at three patterns.

Firstly, the authors noted the relationship between environments and CEO tenure i.e. how CEO tenures vary with companies in dynamic environments (e.g. in industries with higher R&D expenditures or are more globalized) vs those in stable environments. They found that in dynamic environment companies, the company value peaked earlier in the CEO’s tenure. In stable environments, company value peaked later in the CEO’s tenure. (The authors define dynamism with respect to changes in globalisation, R&D spending and total sales of the companies in the sample. They define companies with higher than median changes as being in dynamic environments as opposed to the stable companies who experienced changes that were below the median.)

Secondly, the authors note the relationship between CEO learning and company value. They found that, unsurprisingly, inflexible CEOs didn’t deliver on company value over the long term. Specifically, they found that company value peaked earlier during a CEO’s tenure for CEOs who were older, were less adaptable to change, and were more specialist with relatively low general management skills. It was the inverse for younger CEOs with more generalist experience. Firm value peaked later for these CEOs.

The authors further posited that there was a reason why CEOs were not replaced when company value stagnated or declined. However, the sample was comprised of US companies only. US CEO tenures are longer than the tenures in other countries such as Australia see HERE. Some consider this to be a consequence of US company governance systems that accept the predominance of executive chairman, and a plurality voting systems that means a board nominated director need not receive a majority of votes for election.

The research found that companies experiencing greater labour market frictions (e.g., companies with more local peers with larger market capitalisation) led to company value peaking earlier. This was probably due to these companies facing a more difficult time with talent attraction and retention. There may be greater costs involved in replacing these CEOs.

There is a remarkable similarity in outcomes between this study and others conducted earlier and on other sectors or groups. The inverted U shape was found in studies looking at relationships between the tenure of college basketball coaches and their team performances, finding that the turning point arrived in the 13th year. Another study with similar outcomes found that profitability of movies produced by seven major Hollywood studios declined between the 14th and 16th year tenure of their CEOs.

Finally, the authors argue that their findings do not support term limits championed by proxy advisers due to the varied nature of the company value relationship across companies and CEOs. In short, there is no one-size-fits-all term limit for a CEO. They also note that many CEOs do not last as long as 14 years in the position, thus missing their peak.

The report and study can be found HERE.

© Guerdon Associates 2021
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