CEO Turnover, CEO-Related Factors, and Innovation Performance

by R. Christopher Small for The Harvard Law School Forum, December 29th, 2010.

In the paper New Dogs New Tricks: CEO Turnover, CEO-Related Factors, and Innovation Performance, which was recently made publicly available on SSRN, we examine the association between CEO turnover and innovation performance in the sample period 1993-2005. We find strong empirical support for the notion that CEO turnover is associated with higher levels of innovation, which we measure with patent counts and citations. After controlling for the endogeneity of CEO turnover, we present evidence consistent with CEO turnover increasing a firm’s patent counts, patent citations, patents per research and development dollar, and citations per patent in the subsequent three and five years. We also find that internal new CEOs create more innovation than external new CEOs. Moreover, we find that relatively overconfident CEOs, CEOs with higher option compensation, and an environment with relatively high information asymmetries are associated with more (and higher quality) innovation. Finally, we find that stock-option compensation and information asymmetries arenegatively associated with subsequent innovation around the time of CEO turnover.

Our study has a number of interesting implications. First, from an ex post perspective, the replacement of CEOs appears to be an effective mechanism for investors to modify the investment behavior of a firm that is under-innovating. Second, we find that the replacement of a CEO with someone from outside the firm has implications for firms’ innovation performance. This result can have implications for research that examines the degree to which firm-performance varies depending on whether the new CEO is from inside or outside the firm. Third, we provide additional support to previous studies that examine the effects of option compensation and overconfidence on innovation. However, we offer novel results regarding these variables’ effects around the time of CEO turnover.

In particular, we document that the joint effect of CEO turnover and option compensation on innovation reduces the effects of the individual variables. Finally, we present evidence of the effects of information asymmetries on innovation, finding a positive association in general and a negative association around the time of CEO turnover. These effects indicate that controlling for the effects of CEO turnover can provide helpful insights on the various determinants of a firm’s innovation performance.

The full paper is available for download here.

 

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