CEO pay is a controversial topic, particularly in an era when The Great Recession and Occupy Wall Street are making headlines. CEO pay continues to outpace not just rank-and-file workers but also fellow executives.
Yet for all the outrage, new research from Lehigh University suggests that CEO pay reflects reality. Modern day CEOs considerably exceed their forbears in importance and the stock market agrees.
In a paper to be presented at the annual meeting of the Academy of Management in Boston, Aug. 5-7, Timothy J. Quigley, an assistant professor of management, will present his investigation of 60 years of stock market responses to the sudden deaths of chief executives. His conclusion: The size of the market reaction, positive or negative, has jumped significantly between 1950 and 2009, almost doubling in some instances.
"When a CEO passes unexpectedly a shareholder is left to perform some simple calculus,” says Quigley. “Did the passing CEO possess exceptional, average, or poor ability? And, what is the likelihood that a replacement will be significantly different, either positive or negative? If shareholders believed CEOs generally had little or no impact on firm outcomes, the loss of a CEO would be a non-event as each would be equally constrained and the overall effect of the transition would be trivial."
According to Quigley, the fact that this effect has been growing, though, suggests otherwise. "Shareholders clearly place a greater emphasis on the individual heading publicly traded corporations today versus these earlier periods,” says Quigley.
In the 30 years from 1950 through 1979, the mean cumulative abnormal stock market response, or CAR, to sudden deaths was 3.5 percent. It rose to 5.6 percent from 1980 through 2009. CAR is the change in a firm's stock price, whether up or down, from the day before a CEO's unexpected death through the day after.
Results were even more striking for longer intervals. In the four days before CEO deaths through two days after, the mean CAR rose from 2.8 percent in the period 1950-1969 to 7 percent during 1990-2009. In the longest interval tabulated in the study, from the day before death through the following 30 days, the mean CAR rose from 7.0 percent during 1950-1969 to 14.7 percent during 1990-2009.
“These results suggest these changes are coupled with changing beliefs about CEO impact that go beyond media and casual observation,” said Quigley. “While it is easy to see journalists and average viewers overemphasizing the human causes of firm outcomes, it is less clear that shareholders would succumb to the same thing."
To author The Changing Value of CEOs: Evidence from Market Reaction to Unexpected CEO Deaths, 1950-2009, Quigley mined CEO obituaries for each year between 1950 and 2009 and determined whether each death was unexpected. A total of 193 were identified.
What accounts for the increased importance assigned to CEOs? Quigley tackled that question with Penn State co-author Donald C. Hambrick in a prior paper t hat considers CEO impact over the same 60 year period .In the decades following World War II, CEOs were almost invariably "appointed through succession processes that generally placed a premium on stability and continuity,” said Quigley in the study. “As a result, there were limited differences in the profiles and outlooks of successive CEOs; more broadly, boards went to great lengths to minimize the degree to which succession was momentous at all."
That changed considerably when "during the latter decades of the century, an array of macrosocietal forces aligned to increase the amount of influence CEOs had over corporate outcomes. The shift to investor capitalism [influenced by Milton Friedman and Ronald Reagan] impelled CEOs to engage in more novel and riskier strategies. Heightened task demands, emanating from more intense competition and a more dynamic environment, amplified the performance disparities between better and worse CEOs. And there was a broader menu of legitimate strategic alternatives to consider" -- for example, "an expanded array of international alternatives both in terms of where [firms] could sell and where they could produce."
Quigley and Hambrick results show "the effects of CEOs on performance outcomes became more pronounced in the latter decades of the century -- for good and for ill."
As the new study for the Academy of Management meeting suggests, investors recognize this.
Founded in 1936, the Academy of Management is the largest organization in the world devoted to management research and teaching.