How a company’s consistent earnings can get a CEO fired

When a corporation’s earnings are steady, its board of directors is more likely to fire its CEO after a bad earnings period, according to new research from the School of Management.

Recently published in the journal Management Science, the study analyzed corporate earnings persistence — whether or not the earnings of a company are expected to recur or not — and how it impacts CEO turnover.

“Firms with high earnings persistence understand that the performance in the current period is likely to carry forward with the incumbent CEO, so they’re more likely to fire a CEO who yields poor earnings,” says Inho Suk, the study’s lead author and associate professor of accounting and law. “In contrast, boards of firms with low earnings persistence are less likely to fire a CEO with a poor performance because it’s likely temporary.”

The researchers analyzed data of more than 1,500 CEO turnovers from 1993-2017, measuring earnings performance by industry-adjusted return on assets (IAROA), with the three-year average of IAROA, industry-adjusted ROA changes and non-Generally Accepted Accounting Principles (GAAP) earnings as alternative measures.

Their results show that earnings persistence is the most direct and dominant earnings attribute in explaining CEO turnover decisions.

“Compared to CEO compensation, turnover decisions have longer-term consequences on firm performance and corporate policies,” says co-author William Kross, professor of accounting and law. “Failure to replace a poorly performing CEO, or to retain a CEO with potential, is the costliest manifestation of agency conflicts.”

Suk and Kross collaborated on the study with Seung Won Lee, assistant professor of accounting in the Penn State Harrisburg School of Business Administration.