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CEO Investment Cycles

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  • Yihui Pan
  • Tracy Yue Wang
  • Michael S. Weisbach

Abstract

This paper documents the existence of a CEO Investment Cycle, in which firms disinvest early in a CEO’s tenure and increase investment subsequently, leading to “cyclical” firm growth in assets as well as in employment over CEO tenure. The CEO investment cycle occurs for both firings and non-performance related CEO turnovers, and for CEOs with different relationships with the firm prior to becoming CEO. The magnitude of the CEO cycle is substantial: The estimated difference in investment rate between the first three years of a CEO’s tenure and subsequent years is approximately 6 to 8 percentage points, which is of the same order of magnitude as the differences caused by other factors known to affect investment, such as business cycles or financial constraints. We present a variety of tests suggesting that this investment cycle is best explained by a combination of agency-based theories: Early in his tenure the CEO disinvests poorly performing assets that his predecessor established and was unwilling to give up on. Subsequently, the CEO overinvests when he gains more control over his board. There is no evidence that the investment cycles occur because of shifting CEO skill or productivity shocks. Overall, the results imply that public corporations’ investments deviate substantially from the first-best, and that governance-related factors internal to the firm are as important as economy-wide factors in explaining firms’ investments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19330.

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Date of creation: Aug 2013
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Handle: RePEc:nbr:nberwo:19330

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  1. Morten Bennedsen & Kasper Meisner Nielsen & Francisco Pérez-González & Daniel Wolfenzon, 2007. "Inside the Family Firm: the Role of Families in Succession Decisions and Performance," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 122(2), pages 647-691, 05.
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  5. Yihui Pan & Tracy Yue Wang & Michael S. Weisbach, 2013. "Learning about CEO Ability and Stock Return Volatility," NBER Working Papers 18882, National Bureau of Economic Research, Inc.
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  7. Adair Morse & Vikram Nanda & Amit Seru, 2011. "Are Incentive Contracts Rigged by Powerful CEOs?," Journal of Finance, American Finance Association, American Finance Association, vol. 66(5), pages 1779-1821, October.
  8. Boot, Arnoud W A, 1992. " Why Hang on to Losers? Divestitures and Takeovers," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1401-23, September.
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  10. Murphy, Kevin J. & Zimmerman, Jerold L., 1993. "Financial performance surrounding CEO turnover," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 16(1-3), pages 273-315, April.
  11. Bertrand, Marianne & Mullainathan, Sendhil, 2003. "Enjoying the Quiet Life? Corporate Governance and Managerial Preferences," Scholarly Articles 3429713, Harvard University Department of Economics.
  12. Bertrand, Marianne & Schoar, Antoinette, 2003. "Managing With Style: The Effect of Managers on Firm Policies," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 4280-02, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  13. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 323-29, May.
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