CORPORATE LEADERSHIP STRUCTURE:

ON THE SEPARATION OF THE POSITIONS OF

CEO AND CHAIRMAN OF THE BOARD

James A. BrickleyWilliam E. Simon Graduate School of Business

University of Rochester

Jeffrey L. ColesSchool of Business

Arizona State University

Gregg JarrellWilliam E. Simon Graduate School of Business

University of Rochester

First Draft: July 30, 1993This Draft: November 29, 1994

Preliminary and incomplete. We thank Dave Chapman, Dave Dennis, Gordon Hanka,Mike Hertzel, John Martin, Harold Mulherin, Bob Parrino, Dennis Sheehan, Cliff Smith,

" Rick Smith, Laura Starks, Mike Weisbach, Marc' Zenner, Jerry Zimmerman, and seminarparticipants at Arizona, ASU, North Carolina, Penn State, Texas, Virginia Tech and theJanuary 1994 AFA Meeting for helpful comments. We also thank Bert Cannella, Scott Lee,and Bob Parrino for sharing their work on the topic and Kevin J. Murphy for sharingsome of his data.

- ABSTRACT-

Shareholder activists and regulators are pressuring U.S. firms to separate the titles ofCEO and Chairman of the Board. They argue that separating the titles will reduce agency costsin corporations and improve performance. We argue that this separation has potential costs, aswell as potential benefits. Our empirical evidence provides preliminary support for thehypothesis that the costs of separation are larger than the benefits for most firms. Our resultsalso call into question previous empirical work which suggests that firms with separate titlesoutperform firms with combined titles. We tentatively conclude that proponents of legislationto force separation of titles have overlooked important costs.

CORPORATE LEADERSHIP STRUCTURE:

ON TIlE SEPARATION OF TIlE POSITIONS

OF CEO AND CHAIRMAN OF TIlE BOARD

I. Introduction and Overview

Many commentators complain that boards of directors of U.S. companies fail to provide

adequate discipline of top managers. Of particular concern is the common practice of combining

the 'titles of chief executive officer (CEO) and chairman of the board (Chairman).' Benjamin

Rosen, Chairman of Compaq Computer, voiced this concern succinctly;

"When the CEO is also chairman, management has de facto control. Yet the board issupposed to be in charge of management. Checks and balances have been thrown to thewind. "2

The United Shareholders Association and several large public pension funds in recent

years have sponsored shareholder proposals at Sears Roebuck and other large firms calling for

separation of the CEO and chairman titles.3 Key legislators and regulators have begun to push

for separation as a matter of general board policy. SEC Commissioner Mary Shapiro has spoken

favorably of a recent recommendation by the United Kingdom's Takeover Board that the

positions of CEO and chairman be separated, in order to "lessen the power of the chief executive

'For example, see "Balancing the Power at the Top, British Style", by Richard Stevenson, New York Times,Sunday, November 15, 1992; "Sears Pushed to Split CEO's Job", USA Today, Money Section, April 22, 1993;Jensen (1993), and Lorsch and MacIver (1989)

:Z"Stockholders Want Boards of Independents", USA Today, Money Section, May 14, 1993. Mr. Rosen isChairman of Compaq Computer and is credited in the story with "turning that company around in 1991 after firingCEO Rod Canion." Mr. Rosen, who made these remarks in testimony before Congress, also opined that the CEOshould be the only insider on the board.

3·Pension Funds Defy Sear's Management", Marlene Givant Star, Pensions & Investments, May 17, 1993.

over outside directors. ,,4 Congressman Edward Markey's subcommittee held hearings on a

corporate governance bill in the spring of 1993 to consider, among other structural board

reforms, requiring the board chairman to be independent, or establishing limits on the

circumstances in which a corporation's CEO can serve as chairman.!

In the United States, proponents of splitting the titles received a boost by the 1992 actions

of General Motors' board, which responded to poor financial performance and criticism from

shareholders by ousting Robert Stempel as chairman and CEO, appointing John Smith as CEO

from within the management ranks, and appointing John Smale, an outside director, as chairman

of the board. Many commentators argue that U. S. companies should follow the lead of General

Motors and appoint outside directors as chairmen.

Proponents of separating the titles tend to base their arguments on a mix of anecdotal

evidence and an intuitive appeal to "common sense," as when they claim that combining titles

results in the CEO grading his own homework." Also it is claimed that "there is no cogent

argument for why splitting the titles would hurt corporate performance" [Business Week,

11118/1991, p. 124)].

While the empirical evidence on leadership structure is limited, much of the recent

evidence appears to support the view that separating the titles would improve corporate

performance. Rechner and Dalton (1991) examine 141 firms that have stable leadership

""SEC Official Favors Shaking Up Boardrooms", Robert Sanford, St. Louis Post-Dispatch, April 24, 1993.

'"Congress to Study Shareholders' Rights", Marlene Givant Star, Pensions & Investments, April S, 1993.

'This school-work reference is attributable to Blenyth Jenkins, the director of corporate affairs for the Instituteof Directors, a London trade group. He was quoted in the New York Times article cited above as follows. "Oneof the major functions of the board is to supervise management. If the chairman of the board is also inmanagement, then he is in effect marking his own exam papers. "

2

..

structures over the period 1978-1983 (the titles are either combined or separate over the entire

period). In that sample, 21.3 percent of the firms separate the titles, while 78.7 percent have

one individual holding both titles. Using several accounting-based performance measures, they

find that firms with separate titles consistently outperform firms with combined titles. They

conclude that their results "may provide empirical support for some strongly worded admonitions

about a governance structure that includes the same individual serving simultaneously as CEO

and board chairperson" (page 59). The study, however, can be criticized for not controlling for

any other variables that might be jointly correlated with firm performance and leadership

structure. Pi and Timme (1993) examine a sample of banks over the 1987-1990 period.

Approximately 25 % of the firms have separate titles, while 75% have combined titles. Their

results suggest that, after controlling for firm size and some other variables, costs are lower and

return on assets are higher for firms with separate titles. They conclude that combining the two

titles is a potentially suboptimal leadership structure. The generality of these results, however,

is limited given that the study focuses on firms in one regulated industry. Baliga, Moyer and

Rao (1994) analyze a sample of 181 industrial companies over the period 1986 to 1991. Twelve

of the firms had separate titles over the entire time period, while 111 had combined titles. The

other 58 firms changed leadership structures over the sample period. The authors compare

industry-adjusted, standardized Market Value Added, as computed by Stern Stewart & Company,

across the three groups of firms for the sample period. They find some evidence that leadership

structure matters -- the firms, which switched leadership structures over the period, had better

long-term performance than firms, which maintained combined leadership. Overall, however,

the authors conclude that there is little evidence to support the hypothesis that separating the

3

titles leads to improved firm performance.

The compositions of the samples in these studies are consistent with frequently cited

statistics on the leadership structures ofU. S. firms. For instance, the New York Times reports,

"In the United States, according to various estimates, 75 percent to 80 percent of the firms

combine the two jobs" (November 15, 1992, page 4). In addition, Heidrick and Struggles

(1985) report that the percentage of firms with split titles among the. Fortune 1()()() and 300

leading non-industrial companies was up over 13 percent from 1980 to 1985. Rechner and

Dalton imply that this apparent trend is related to their finding that firms with separate titles

outperform firms with combined titles.

Our discussion to this point, suggests that a common view on leadership structure (among

regulators, financial reporters and certain academics) is as follows: (1) It is obviously better to

split the titles than to combine the titles. (2) About 20-25% of U. S. firms have separate titles

and the frequency of split titles might be increasing. (3) Firms with split titles outperform firms

with combined titles. (4) Firms with combined titles would increase their values by separating

the titles.

The purpose of our paper is to challenge this conventional wisdom. We begin by

providing a more complete discussion of both the costs and benefits of separate titles. This

discussion suggests that reformers have overlooked important costs, and that it is not

theoretically obvious which leadership structure is best. Next, we present data that are

inconsistent with the frequently-cited statistics and evidence on leadership structure. First, we

find that the commonly stated figures, that 20-25% of U. S. firms have separate titles, greatly

overstate the actual frequency of this leadership structure in large firms. Indeed, our data

4

suggest that if the popular arguments about having outside directors as chairmen are correct,

almost all major firms in the United States have inefficient board structures. This finding

challenges proponents of separate titles to explain how such a wide-scale inefficiency could have

existed for so long in a competitive market place. Second, the data suggest that the potential

costs of separating the titles, that we discussed in our theoretical section, are important in

determining the leadership structures in U. S. firms. Thus, there appear to be economic reasons

for why firms often combine the two titles. Third, we present event-study evidence, as well as

evidence from accounting returns, that questions the conclusion that firms with separate titles

outperform firms with combined titles.

Overall, our data reinforce and further define the impression that in the U.S. achieving

combined titles is the equilibrium and that separate titles signify normal succession periods or

extraordinary, transitory events. We tentatively advance the argument that this widespread

practice is indeed efficient and generally consistent with shareholders' interests for the typical

large U.S. company and that legislative reforms forcing separate titles are misguided. Clearly,

however, more detailed estimates of the costs and benefits of alternative leadership structures

are required before more definitive conclusions can be reached.

In our subsequent analysis, we use the following vocabulary. We define unitary

leadership as the case when the CEO and Chairman of the Board titles are vested in one

individual. We define dual leadership as the case where the two positions are held by different

individuals. Note that there is some confusion in the literature over these terms. Some authors

have used dual to refer to the case where the CEO holds both titles, while others have used the

term unitary. We think that using unitary leadership to refer to a single CEO/Chairman and dual

5

leadership to refer to two leaders is most descriptive.

II. The Benefits and Costs of Separating the CEO and Chairman Titles

A. Benefits of Dual Leadership

The modem large corporation is characterized by the absence of the classical

entrepreneurial decision maker. Instead, in order to reap the benefits of risk sharing, the

company's residual claims are diffused among many agents, who generally vest their decision

control rights in the board of directors and the CEO's office. This delegation leads to agency

problems between decision agents and residual claimants and creates agency costs, which Jensen

and Meckling (1976) define to be the sum of the costs of designing, implementing, and

maintaining appropriate incentive and control systems and the residual loss resulting from not

solving these problems completely.

Fama and Jensen (1983) argue that agency costs in large organizations are reduced by

institutional arrangements that separate decision management from decision control. Decision

management refers to the rights to initiate and implement recommendations for resource

allocation, while decision control refers to the rights to ratify and to monitor the implementation

of resource commitments.

The apex of the decision control system of large corporations is the board of directors,

which generally has the power to hire, fire, and reward top operating managers, and to ratify

and monitor important decisions. As Fama and Jensen point out, "the board is not an effective

device for decision control unless it limits the decision discretion of individual top managers."

This argument seems to imply that combining the CEO and chairman titles contradicts their

separation theory (a point which they partially concede).

6

Extending this logic, Jensen (1993) in his Presidential Address to the American Finance

Association recommends that companies separate the two titles. In this speech (page 36), Jensen

articulates the potential benefits of separation:

"The function of the chairman is to run board meetings and oversee the process of hiring,firing, evaluating, and compensating the CEO. Clearly the CEO cannot perform thisfunction apart from his or her personal interest. Without the direction of an independentleader, it is much more difficult for the board to perform its critical function. Therefore,for the board to be effective, it is important to separate the CEO and Chairman positions.The independent chairman should, at a minimum, be given the rights to initiate boardappointments, board committee assignments, and (joint with the CEO) the setting of theboard's agenda. "

B. Costs of Dual Leadership

Aeency costs. Curiously, the discussion of separating the titles has completely ignored

the critical issue of the incentives of the non-CEO chairman. Appointing an outside director

chairman of the board (the head decision control agent in a large organization) might reduce the

agency costs of controlling the CEO's behavior, but it introduces the agency costs of controlling

the behavior of the non-CEO chairman. Granting an outside chairman increased decision rights

over such things as firing the CEO and agenda setting, can give the individual enormous power

to extract rents from the firm. Thus, shareholders must be concerned about the chairman's

perquisite taking, effort level and investment preferences. In the spirit of Alchian and Demsetz

(1972), "who monitors the monitor?" If the chairman is a large residual claimant, then the

problem is solved as it is in the classical model of the entrepreneurial owner. But, in the large

complex company, it is generally the case that no one on the board has greater reputational and

financial capital at risk in the future performance of the organization than does the CEO.

Infonnation costs. Presumably, CEOs have unparalleled specialized knowledge

regarding the strategic challenges and opportunities facing the firm. If one accepts the

7

apparently reasonable assumption that the CEO possesses, as a natural byproduct of his firm­

specific experience, considerable specialized knowledge valuable to the chairman's job, then

separating the CEO and the chairman titles necessitates the costly and generally incomplete

transfer of critical information between the CEO and the chairman. One way to reduce this

problem is to have the old CEO stay on as chairman indefinitely (depending on age and health).

However, keeping the old CEO on the board for an extended time period might restrict the new

CEO in making changes in the organization (see, Sonnenfeld (1988».

Costs of changing the succession process. Another important concern relates to the

succession process of CEOs. Vancil (1987) provides detailed studies of the succession processes

used by about a dozen firms. These case studies suggest that a common succession process is

what Vancil calls "passing the baton." This process has the former CEO, who recently

relinquished the CEO title to the heir apparent (passed the baton), retain the chairman title

during a probationary period in order to allow the board to monitor the new CEO in action. The

probationary period also provides an opportunity for the old CEO to pass on relevant information

to the new CEO. The new CEO generally has an additional operating title such as President or

Chief Operating Officer. If the new CEO passes this test, then typically the new CEO earns the

additional title of chairman, and the old chairman resigns from the board," At this point, the

'A classic example of passing the baton is the recently completed succession at Merrill Lynch. In June 1993,Daniel Tully became chairman--he had been the CEO since February 1992, when he succeeded William Schreyer.Tully had been named President and COO in 1985. William Schreyer, who was non-CEO/chairman from 1992-93,during Tully's "probation, W resigned form the board concurrently with Tully's promotion to chairman. Anotherrecent example where the new CEO was a controversial choice, is Harvey Golub's succession of James Robinsonill at American Express Co. Robinson was removed as CEO/chairman by a disgruntled board, and an outsidedirector Mr. Furlaud, was instituted as chairman. Moreover, the board set up an executive committee to monitorMr. Golub's performance during his probation period. Having passed this five-month test, the board promoted Mr.Golub to chairman, dismantled the executive committee, and allowed Mr. Golub to appoint his choice as president.See Steven Lipin, "Golub Solidifies Hold at American Express, Begins to Change Firm", Wall Street Journal, June30, 1993, page AI.

8

CEO often holds three titles, such as Chairman, CEO and President. After a few years, the

CEO hands off the operating title to an heir apparent and the process continues. Vancil

concludes that the transition period, during which time the CEO and chairman titles are separate,

is deliberately structured to allow the board to readily oust the new CEO, should he or she "drop

the baton" .8 The process also eases the transition from active duty to retirement for an aging

CEO and thus makes it less likely that the CEO will attempt to hold on to his position too long.

If this succession process is widely used (as Vancil's case studies suggest), regulations to

separate the titles would force many firms to change their basic succession process." The costs

of forcing this change have not been considered in regulatory debates. For instance, the

prospect of being promoted to the chairmanship potentially provides important incentives to new

CEOs. These incentives are lost if the firm maintains an independent chairman.

Othercosts. While they are hardly impartial, it is still interesting to note the objections

of top management of U.S. companies to combining titles. They claim that splitting titles would

dilute their power to provide effective leadership, create the potential for rivalry between the

separate title holders, and that having two public spokespersons could well lead to confusion and

even to opportunistic behavior by outsiders [see Lorsch and Lipton (1993)]. Also dual

leadership makes it more difficult to pinpoint the blame for bad corporate performance.

Similarly, some outside analysts oppose separate titles because of the possible confusion both

!Recent examples of new CEOs who "dropped the baton" and were removed before they could earn theadditional title of chairman include Vaughn Bryson of Eli Lilly & Co., Richard Markham of Merck & Co., andJames Paul of Coastal Corporation.

9V'ancil (1987) claims that this process is widespread based on some large-sample data that he has collected butnot fully analyzed.

9

inside and outside the company about who is really in charge could harm the company. 10

These arguments receive support from the research on social choice theory which demonstrates

how significant inconsistencies can arise in decision making when authority is divided among

more than one person [see, Arrow (1963) and Sen (1970)]. Another potential cost of dual

leadership is the extra compensation for the chairman. For instance, General Motors paid John

Smale $300,000 for his services as chairman in 1993.

Interestingly, our discussion of the costs of dual leadership is reminiscent of the

arguments made years ago by Alexander Hamilton in his support of a single chief executive

officer in government. In the Federalist (1788), Hamilton argues that dual executives increase

the likelihood of agency problems, the potential for costly disputes, the difficulty in pinpointing

blame, etc. Hamilton summarizes his position as follows:

"I rarely met with an intelligent man from any of the States, who did not admit, as theresult of experience, that the UNITY of the executive in this State (New York) was oneof the best of the distinguishing features of our constitution."

c. Further Discussion

Contrary to the allegations of reformers, combining the CEO and chairman titles does

not necessarily violate the principle of separation of decision management and decision control.

Indeed, the extreme case of no separation exists only when the "board" has the CEO as its only

member. The modern corporate board with combined titles delegates important decision

functions to committees, such as compensation and auditing. Moreover, the board also retains

the right to hire and fire senior management, although it is potentially more difficult for the

board to oust the CEO/chairman than it is to oust the CEO/non-chairman. Indeed, several

IOSee the New York Times, November 15, 1992, page 4.

10

boards of large U.S. companies have ousted CEO/chairman in recent years, including Eastman

Kodak (Kay Whitmore), General Motors (Robert Stempel), IBM (John Ackers), American

Express (James D. Robinson II!), and Westinghouse (paul Lego). Critics, however, argue that

these dismissals would have happened sooner, had the boards been more independent.

Fama and Jensen (1983) recognize that the danger of shareholder harm from combined

titles can be counter-balanced by effective independent outside directors who "have incentives

to carry out their tasks and do not collude with managers to expropriate residual claims"."

Generalizing from their insight, the agency costs of unitary leadership can be mitigated by a

variety of institutional mechanisms that help to align the incentives of the CEO with

shareholders. Such mechanisms include large CEO stockholdings or options, a well-functioning

takeover market, effective monitoring by an independent board, or effective oversight by large

blockholders or institutional shareholders. 12

In conclusion, it is not theoretically obvious whether dual or unitary leadership is

optimal. Rather both forms of leadership involve potential costs, as well as benefits. Separating

the titles is efficient for shareholders only if the reduced agency costs of controlling the CEO's

behavior are not outweighed by the sum of the agency, information, and other costs associated

with the change. Since the costs and benefits of different leadership structures can vary across

"There is a significant body of empirical evidence that outside directors impose important constraints onmanagerial behavior. See Brickley, Coles and Terry (1994), Brickley and James (1987), Byrd and Hickman (1992),Mayers, Shivdasani, and Smith (1993), Rosenstein and Wyatt (1990) and Weisbach (1988).

l2Evidence indicates that typical CEO's wealth is significantly related to the value of his firm's common stock[Murphy (1985)], although some commentators argue the relation is relatively small [Jensen and Murphy (1990)].There is also evidence that institutional investors and other blockholders help to control managerial behavior throughvoting and lobbying. See Brickley, Lease and Smith (1988, 1994) and Van Nuys (1993). Numerous studies suggestthat the takeover market imposes constraints on managers. See Jarrell, Brickley and Netter (1988) and Jensen andRuback (1983) for reviews of this literature.

11

firms it is also unlikely that all firms should have the same leadership structure.

Proponents of dual leadership might concede these arguments, but assert that the facts

indicate that the benefits of dual leadership are larger than the costs for most firms. For

instance, existing studies suggest that 20-25% of U. S. firms have separate titles and that these

firms outperform firms with combined titles. Our subsequent empirical analysis, however,

suggests that the conventional interpretation of the data is wrong.

We divide the empirical analysis into four major subsections. First, we present a detailed

description of the leadership structures of large U. S. firms. Our data present a much different

picture of American leadership structures than is commonly portrayed in the financial press.

The data also suggest that the agency and information costs of dual leadership are important

determinants of leadership structure. Second, we document that a significant fraction of

American firms use the passing-the-baton succession process. Our evidence also suggests that

these firms use the title of chairman as a reward for CEOs, who perform well. Third, we

examine whether the correlation between leadership structure and accounting returns, found in

previous studies, is present in our data. It is not. Finally, we document the stock-market

reactions to changes in leadership structure. Consistent with our results using accounting

returns, we find no systematic stock-market reaction to leadership changes. Ifanything, we find

results that are opposite conventional wisdom.

ID. Empirical Results

A. Leadership Structures of U. S. Firms

We begin our empirical analysis by providing a detailed characterization of the leadership

structures of large U. S. firms. For this analysis, we use a sample of firms from the 1989

12

Forbes survey of executive compensation." This survey contains information on compensation

and other variables for the CEOs of 737 firms for the 1988 fiscal year. We consulted Dunn &

Bradstreet's, Reference Book of Corporate Managements, to obtain the exact title of each CEO

in the Forbes survey at year-end 1988.14 If the CEO was not the chairman, we also recorded

the identity and employment background of the chairman. We were able to find the relevant

information for 661 firms.

Table 1 classifies the sample by whether the CEO holds the title of chairman. In slightly

over 80% of the firms, the CEO holds the chairman title. About 5% of the firms do not have

a chairman. In the remaining 14% of the cases there is a non-CEO chairman of the board.

As Table 1 also indicates, for the 93 firms in our sample with separate chairs, 76

(81.72 %) have chairmen who are either former CEOs, founders, or other top officers of the

company or an affiliate. Only 17 firms have independent chairmen (chairmen who are not

current or former employees of the company). These firms represent 18.28% of the firms with

separate chairmen and only 2.57% ofthe overall sample. Eleven of the 17 firms are from the

financial sector, while only six are nonfinancial firms. The firms tend to be among the smaller

fmns in our data base. For example, the median firm in this subsample has assets of $2.24

billion, compared to $4.24 billion for the other 644 firms in the sample. These values are

significantly different with a p-value of .036 for the Wilcoxon rank-sum test.

Table 2 presents data on the chairman's stock ownership and tenure on the board for the

13We are grateful to Kevin J. Murphy for providing us with a computer-readable version of this data base.

14.rhis reference source does not always report changes in titles in a timely fashion. Thus for some firms, wemay not have the exact title held by the person at year-end 1988. For instance, we might have the title held in1987. The potential for some misclassifications of this type does not have a material effect on our analysis.

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Table 1

The relation between the CEO and Chairman of the Board at year end 1988for a sample of 661 flrms contained in Forbes Executive CompensationSurvey.

Panel A: Full sample

Number Percent

Same person holds both 535 80.94titles

Different people hold the 93 14.07two titles

No person holds title of 33 4.99Chairman of the Board

Panel B: Classification of 93 cases of dual leadership

Number Percent

Only Affiliation (past or 17 18.3present) with Company is

Chair Position (andpossibly boardmembership)

Former CEO or President 61 65.6

Former officer in an 10 10.8Affiliate (subsidiary,merger partner, etc.)

CEO of Parent Company 1 1.1

Former Lower-Level 1 1.1Officer

Founder 3 3.2

11 financial firms with independent chairmen. The average stock ownership is 2.72 %. In eight

out of 11 firms, the chairman's stock ownership is greater than the CEO's. Average tenure on

the board is 17.5 years, ranging from 0 to 41 years. These data suggest that the potential

information and agency problems associated with separate titles are mitigated in these firms by

the chairman's stock ownership and long tenure with the firm.

Table 3 presents related information for the six nonfinancial firms with independent

chairmen. Again the chairmen tend to hold reasonably large amounts of stock (except in the

case of Engelhard). In addition, the firms tend to be special cases. For example, the chairman

or his family is a major blockholder, the chairman has been with the firm since inception (fore

example, as a venture capitalist), or the firm was recently acquired in a merger.

We were able to obtain information on the leadership structures of 14 of the 17 firms

(with outside chairmen in 1988) for 1994. All, but one, of these firms still had dual leadership

five years later. Thus, for these firms, having separate people in the two top positions appears

to be a stable leadership structure.

The data in Tables 2 and 3 suggest that no major firm in 1988 had a leadership structure

where an independent outside director without special ties to the firm held the chairman position

(for example, General Motor's new structure with John Smale as chairman). This finding

implies that if the popular arguments for having outside directors as chairmen are correct, almost

all major firms had suboptimal board structures in 1988. While this possibility exits, such a

sweeping assertion of inefficiency should not be embraced without a cogent explanation for how

such an important corporate-control practice can be wealth-decreasing and still survive in the

competitive marketplace for so long across so many companies. Firms compete along many

14

Table 2Beneficial stock ownership and years on the board as of 1988 for thechairman of the board of 11 financial companies where the chairman was nota former or current top operating officer of the company or an affiliate. Thesubsample of 11 firms meets the relevant criteria from a total sample of 661firms contained in the Forbes survey of executive compensation for 1988.

ay

COMPANY CHAIRMAN: CHAIRMAN: CHAIRMAN:% STOCK YEARS ON OWNERSHIP >

OWNERSHIP BOARD CEOOWNERSHIP?

AMERICAN 1.23- 28 YESNATIONAL INS.

ATLANTIC 0.63 6 NOFINANCIAL

BANK SOUTH 0.63 19 YES

FARM & HOME 3.07 20 YESSAVINGS

FIRST COMMERCE 7.80 5 YESCORP.

NATIONAL 4.33 41 YESCOMMUNITY BANK

PROGRESSIVE 10.00 0 YES

SECURITY 0.60 25 NOBANCORP

SECURITY CAPITAL 0.37 - NO

SUNWEST 0.37 13 YESFINANCIAL

VALLEY FEDERAL 0.85 18 YESS&L

AVERAGE 2.72 17.5 8/11

"The chairman or American National Insurance IS a member of a famil that ownssubstantial interest in the company.

Table 3

Beneficial stock ownership and commentary for the chairman of the boardas of 1988 of 6 nonflnanclal companies where the chairman was not a formeror current top operating officer of the company or an affiliate. Thesubsample of 6 firms meets the relevant criteria from a total sample of 661flrms contained in the Forbes survey of executive compensation for 1988.

COMPANY CHAIRMAN: % STOCK NOTESOWNERSHIP

COMPAQ COMPUTER 0.80 Chairman has been withthe company since

inception.

ENGELHARD 0.01 Chairman is on the boardof a foreign company thatowns 30.2 percent of the

stock.

REXENE 28.71 Company involved in arecent merger.

SPIEGEL 97.5- The chairman controlsthe voting stock of the

company. He owns littleof the nonvoting stock.

TANDEM COMPUTERS 1.1 Chairman has been with .company since inception.

WHEELING- 34.2 Family is the largestPITTSBURG STEEL shareholder in the

company.

-Ownership for class-B stock (the voting stock). The chairman disclaims beneficialownership of some of the stock.

dimensions including organizational design. The competitive process selects which firms survive

much like the process of natural selection in the theory of evolution -- the strong survive. If

separating the titles produces more profits, competitive pressures would presumably motivate

firms to split the titles (firms that combine titles would be forced out of business by those that

do not - see Alchian (1950».

One concern is that our data are over 5 years old. For instance, it is possible that

increased foreign competition has motivated firms to change their leadership structures in the

last few years. To address this concern, we examine the 1994 leadership structures of the

largest 100 firms in our sample. We find that only General Motors has an outside director as

chairman. The leadership structures for the remaining 99 firms are as follows: 89 have unitary

leadership, 2 are no longer independent firms, 7 have dual leadership with former CEOs serving

as chairmen, 1 (Digital Equipment) has no chairman. Thus, our characterization of American

leadership structures continues to hold with more recent data.

The data in tables 2 and 3 suggest that the potential information and agency problems

associated with dual leadership are important considerations in the choice of leadership structure.

In particular, there is essentially no firm in the data base that has an outside chairman who does

not have significant experience with the firm -- either as a former officer or as a long-time board

member. In addition, outside chairmen tend to own significant amounts of stock. Indeed, John

Smale has been on the General Motors board since 1982, and as of the beginning of 1994 owned

about $440,000 in company stock. Thus, whenever separate chairman are used, additional

mechanisms or circumstances are observed that help to control information and agency problems.

Holmstrom and Milgrom (1994) argue that this type of evidence provides important support for

15

agency-related explanations for organizational structure. In their analysis, the chairman title,

his stock ownership, and years with the firm would be viewed as complements (increasing one

of these variables, increases the benefits from increasing the other variables).

B. Evidence on Passing the Baton

Table 4 compares the net sales, CEO tenure, and other selected variables of firms that

separate the titles of CEO and chairman with those firms that do not. For this and the

subsequent analysis, we eliminate the 33 firms that do not have a chairman. Firms with separate

chairman tend to be somewhat smaller; they have younger CEOs that have less tenure, own less

stock, and receive lower compensation levels compared with the CEO/chairman of the other

firms. This description, together with the fact that most of the separate chairmen are former

CEOs, appears quite consistent with the pass-the-baton (or relay) pattern of CEO succession

identified by Vancil. Under the Vancil scenario, in the cross section we would expect firms to

be at different stages of their succession process, with firms having CEOs with limited tenure

being more likely to be in the transition phase.

Recall that in the passing-the-baton process, the CEO starts with the title CEO and

President (or some other operating title). After completing the probationary period, he holds

three titles (chairman, CEO and president). After a few years, he passes the operating title to

an heir apparent. Table 5 reports tenure statistics that are consistent with this pattern. CEOs

who are not also the chairman have relatively short mean tenure of 4.2 years. CEOs who also

possess the chairman title and an operating title have significantly longer mean tenure of 7.3

years. Finally, CEOs who are chairman but do not possess an operating title have the longest

mean tenure of 10.4 years. The F-test allows rejection of the null hypothesis of equal means

16

Table 4

Descriptive statistics for a sample of 628 firms contained in Forbes survey ofexecutive compensation (data for 1988) classified by whether there is a separateChairman of the Board,"

Median for the 93 Median for the p-value of test forfirms with separate 535 firms where difference

CEO and the CEO is also (ANOVAIChairman the Chairman WILCOXON

Rank-Sum Test)

Net Sales of Firm ($ 1,939.60 2,250.21 ANOVA p= .038millions) Wilcoxon p= .012

CEO age 53.17 58.50 .000/.000

Tenure as CEO (years) 2.92 6.92 .000/.000

CEO's prior experience 15.00 15.74 .761/.683with firm (years)

CEO stock ownership 0.13 0.18 .070/.096(percent of firm)

Value of CEO stock 1.20 2.70 .231/.001ownership ($ millions)

Salary & Bonus 571.00 785.00 .001/.000Compensation of CEO

($ thousands)

Total Compensation of 675.00 985.00 .060/.000CEO ($ thousands)

-rhis table eliminates 33 firms from the original sample of 661 where there is no Chairman of theBoard. Some calculations are based on slightly smaller subsamples due to missing values on theCompustat Tapes.

Table 5

Distribution of tenure as CEO by title of CEO for a sample of 628 firms at year end1988 for a sample of 628 firms contained in Forbes survey of executivecompensation.·

Title Sample Size Average tenure Median Tenure(years)b (years)"

CEO does not hold the title of 93 4.22 2.92Chairman of the Board (there is a

separate Chairman)

CEO is Chairman of the Board 186 7.36 4.92and has an additional operatingtitle (e.g., Chairman, CEO and

President).

CEO is also Chairman of the 348 10.39 7.92Board but does not have anadditional operating title.

'This table eliminates 33 firms from the original sample of 661 where there is no Chairman of theBoard.

bAn F-statistic of 30.73 allows rejection of equal mean years of tenure across titles at the .0001 levelof significance.

CA chi-squared of 75.28 allows rejection of equal median years of tenure across titles at the .0001level of significance.

across the three groups at the .Ollevel of significance. The medians show basically the same

pattern as the means, and both serve as additional evidence of Vancil's relay succession process.

The Kruskal-Wallis test rejects the null hypothesis of equal medians across the three categories

at p=.OOOl.

An indication of the frequency of firms that use this succession process can be obtained

by examining the titles of newly-appointed CEOs. Our sample includes 53 CEOs with less than

one year of tenure. Among these CEOs, 64% hold the title of chairman. Presumably, most of

these CEOs were appointed chair and CEO at the same time. Thus, roughly one-third of the

firms in our sample appear to use the baton process (assuming that most of the other firms use

the baton process). A similar frequency can be inferred from the composition of the sample in

Baliga, Moyer and Rao (1994).

While our data suggest that a significant number of firms use the relay process, an

alternative interpretation of the data in Table 2 is managerial entrenchment. In particular,

combined titles might imply that the CEO is not accountable to shareholders and is seldom fired

for poor performance. In this case, the average age and tenure would be higher in a sample of

firms with unitary leadership than in a sample of dual-leadership firms, where the managers

turnover more frequently.

Evidence on which of these alternatives best explains the data is provided by examining

the relation between prior firm performance and the leadership structure. Under the relay

process, CEOs are presumably promoted to chairmen after completing a successful probationary

period. If the CEO's performance is substandard the probationary period is prolonged or in

extreme cases the CEO is dismissed. This process implies that holding the number of years as

17

CEO constant, the likelihood of being chairman increases with prior firm performance. In

contrast, the entrenchment argument makes no such prediction. Table 6 presents three

regressions. In each case, the dependent variable is a dummy variable equal to one if the titles

are combined and zero if the positions are separate. Explanatory variables include measures of

prior firm performance and controls for firm size and years as CEO.IS The question of interest

is whether the likelihood of having combined titles increases with prior performance. We use

three different measures of firm performance in the prior fiscal year: return on capital, change

in return on capital (from fiscal year -2 to fiscal year -1) and the stock return." Return on

capital measures the level of financial performance for the year, while the other two measures

are more likely to capture performance that was unanticipated by the market at the start of the

prior year. The coefficient on return of capital is positive and highly significant, which is

consistent with the arguments about the existence of a probationary period. The coefficients for

the other two performance measures are not significant. We have estimated similar models

where we measure performance over the entire tenure of the CEO and find similar results.

Both the size and tenure variables add significant explanatory power to the model. The

tenure variable presumably reflects the passing-the-baton phenomenon. The positive coefficient

for size potentially reflects that large firms are more likely to give a new CEO the title of

chairman than small firms (that is, they are less likely to use the baton process). Vancil's work

I~e report linear probability models because the coefficients have straight-forward interpretations. We obtainsimilar results when we estimate legit models. We have also estimate models where we add additional controls forgrowth opportunities (Tobin' s Q). prior experience of the CEO with the firm, regulatory status, and stock ownershipof the managers. The results are insensitive to these control variables and none provide significant explanatorypower.

16we eliminate observations from this analysis, where the current CEO was not in office over the priorperformance period. We obtain similar results using return on equity, rather than return on capital.

18

Table 6

Regression of a dummy variable with value equal to 1 if the titles of CEO andChairman of the Board are held by one person (0 if held by two separateindividuals) on variables measuring firm size, years as CEO of current CEO, andprior CEOlfirm performance. Sample of 628 firms is derived from Forbes surveyof executive compensation (data for 1988). (t-statistics in parentheses.)"

IndependentVariable:

Intercept 0.43- 0.61- 0.52-(2.89) (4.70) (5.09)

lnsales ($ millions) 0.04· 0.02 0.04-(2.31) (1.47) (2.94)

Years as CEO of 0.01- 0.01- 0.01-Current CEO (4.36) (4.10) (5.11)

Prior Return on 0.24-Capital" (2.59)

Change in Prior 0.06Return on Capital, (0.26)

Prior Stock Return, -0.06(-1.53)

R-squared 0.07- 0.0S- 0.07-

arrhis table eliminates 33 firms from the original sample of 661 where there is no Chairman of theBoard. Some calculations are based on slightly smaller subsamples due to missing values on theCompustat Tapes.

bIncomebefore extraordinary items and discontinued operations plus interest and minority interest(income account) all divided by invested capital (total) in prior fiscal year.

cChange in return on capital from fiscal year -2 to fiscal year -1.

ttStock return for the prior fiscal year.

-Significant at p= .01.

·Significant at p= .05.

suggests that firms sometimes use a "horse race" process for succession, where several

candidates for the CEO job are identified and compete against each other for the top slot. The

winner is awarded the title of CEO and Chairman. An example of a horse race is General

Electric's selection of Jack Welch as CEO/Chairman over several internal competitors. It is

plausible that large firms are more likely to run horse races than small firms because they have

larger and more well-developed internal labor markets. Also, large firms are more likely to

have lower-level managers with general management experience (e.g., being divisional

managers). Managers in small firms, in contrast, are more likely to come from particular

functional areas, such as finance or marketing (since these firms tend to organize around

functions rather than divisions).. Thus, it might be more important in small firms for the old

CEO to stay on the board to help train the new CEO in general management. Also, a horse race

might cause dysfunctional competition among functional managers, who ideally should work

together as a team to manage the firm. 17

While the results in Table 6 are consistent with the Vancil scenario, the analysis is

subject to potential criticisms. For example, the analysis treats CEO tenure as exogenous, while

it might be more appropriate to treat it as endogenous (as a function of performance)." In

general, having data for only one year limits what we can infer about changes in titles over time.

To provide additional evidence on the succession process, we present a time series analysis of

17Horse races are rank-order tournaments, as analyzed by Lazear and Rosen (1981). Gibbons and Murphy(1990) discuss the dysfunctional behavior these relative-performance evaluation schemes can cause. One of thepotential problems is sabotage and/or noncooperation.

180ne might argue that it is reasonable to treat CEO tenure as exogenous as a first approximation. Forexample, Jensen and Murphy (1990) argue that while there is a negative relation between firm performance andCEO turnover, the relation is very small.

19

the titles of the 50 CEOs in our sample, who have less than three years of tenure in 1988 and

do not hold the chairman title. Since we want to focus on the baton process, we restrict our

attention to firms where the chairman is either a former CEO, officer or founder of the

company. Table 7 reports the status of these individuals in 1993 and stock-returns for fisca1­

year 1989 and for the period 1989-1991 (similar results hold using accounting measures of

performance). The table indicates that 21 of the CEOs hold both titles in 1993,5 are still CEO

but are not chairmen, 5 are not CEO but are on the board of directors, 10 are not CEO and are

not on the board, and 9 are missing from the sample due to an acquisition of the firm. A closer

look at the data reveals that for most firms the probationary period of the CEO results in an "up

or out" decision. The 5 cases where the person is still CEO, but does not have the chair title,

are all special cases where the chairman is a founder, co-founder or long-time officer of the firm

(since the 1950s) with substantial stock ownership (ranging from 1.6% to 9.4%). Three of the

5 people, who are no longer CEO in 1993 but are on the board, were CEO/Chairman but

subsequently retired (they are farther along in the baton process). Interestingly, the performance

of the firms where the CEO is "promoted" to CEO/Chairman is substantially better than for the

firms where the CEO is no longer with the firm (as CEO or on the board). For instance, the .

median performance of the promotion subsample over the period 1989-1991 is 7.8% compared

to -14.7% for the "departure" subsample. These returns are significantly different at the 5%

level using the Wilcoxon rank sum test. The median age of the CEOs in 1993 for the departure

subsample is 58, suggesting that most of these departures are not ordinary retirements. These

results are consistent with the findings in Table 6, which suggest that some firms use the title

of chairman (along with retention) as a reward for CEOs, who perform well during their

20

Table 7

The status of 50 CEOs in 1993, who have less than 3 years of tenure and do not hold thechairman title in 1988. The table also presents the stock-price performance for their firmsfor fiscal-year 1989 and for the period fiscal-year 1989-1991.

1993 Status # % Median Stock Median AnnualReturn FY 89 Stock Return for

FY 89-91

Is CEO and Chair 21 42 25.7 7.8(promotion subsample)

Is CEO but is not Chair 5- 10 43.0 22.7

Is not CEO but is on the ~ 10 19.6 23.6Board

Is not CEO and is not on 10 20 -12.1 -14.7the Board (departure

subsample)

Is not in Sample Due to 9 18 - -an Acquisition

Hypothesis Tests: The p-value for the test that the median return for the promotion subsample(category 1) for 1989 is equal to the median return for the departure subsample (category 4) is .086,based on the Wilcoxon rank sum test. The p-value for the test that the median annual return forthese two subsamples is the same for the period 1989-1991 is .015.

-These five firms are all firms where the chairman is a founder, co-founder, or long-time officer ofthe firm (with the firm since the 19SOS) with substantial stock ownership ranging from 1.6% to9.4%.

bIn three of the these five firms, the CEO was CEO/Chairman, but subsequently retired in hismiddle sixties (they are farther along in the baton process).

probationary periods.

Collectively, the evidence provides rather strong support for the proposition that a

reasonable fraction of firms in the U.S. use the passing-the-baton process, suggested by Vancil's

case studies. In addition, our evidence suggests that these firms use the chairman title as a

reward to CEOs for good performance. These findings suggest that officials, considering

requirements to combine the titles, should be careful to evaluate the potential costs of forcing

these firms to change their succession processes and incentive systems.

Our results also call into question the interpretation of studies that compare the

performance of firms based on leadership structure. For instance, Pi and Timme's (1993)

sample includes any bank that had the same leadership structure for a two-year period. Our data

suggests that many of the banks classified as having dual leadership are likely to have the same

long-run leadership structures as many other banks, but they are simply at different stages in the

same basic succession process. Thus, the study may be picking up differences in accounting

performance over the life cycle of CEOs, rather than differences in performance across

leadership structures." One potential defense of this work, however, is a follows. Firms can

be categorized into three types of leadership structures. Those that maintain dual leadership,

those that maintain unitary leadership, and those that switch leadership structures through the

baton process. Banks observed with dual leadership at a point in time either are firms that are

passing the baton or firms that maintain dual leadership. In contrast, banks that are observed

with unitary leadership either are firms that use the baton process or that maintain unitary

19Murphy and Zimmerman (1993) provide evidence on the possible existence of systematic patterns inaccounting returns over the tenure of the typical CEO.

21

leadership. If maintaining unitary leadership is the worst structure, Pi and Timme would expect

to find better performance for the firms that are observed to have dual leadership structures.

Indeed, Baliga, Moyer and Rao (1994) find that firms that switch their leadership structures

(which are likely to be firms passing the baton) have better long-term performance than firms

that maintain unitary leadership. Rechner and Dalton (1991) avoid these issues by concentrating

on firms that have the same leadership structure for a six-year period. Our analysis, however,

indicates that there are very few large firms that have dual leadership and that meet this

criterion. Thus, their analysis must concentrate on relatively small firms. In contrast, the

financial press and regulators focus their attention on large firms.

c. Leadership Structure and Accounting Performance

This discussion suggests that differences in accounting returns across subsamples with

alternative leadership structures are hard to interpret. Nevertheless, it is interesting to see if the

association between returns and leadership structure documented in previous work is present in

our data.

In the spirit of previous work on this topic, we compare the accounting performance for

the two subsamples for fiscal year 1988 and beyond." Return on capital in 1988 was 13.8

percent for firms with separated positions and 15.6 percent for firms that combine the positions.

These returns are significantly different based on the standard F-test (p = .020) and the

Wilcoxon rank-sum test (p = .044). Over the period 1989-1991, unitary firms earned 12.5

percent on capital as compared to 11.7 percent for dual firms, though the difference in

2Grhis analysis is very preliminary. We are in the process of computing industry-adjusted returns, compilingtables, etc.

22

performance is not statistically-significant. These results are interesting because, in contrast to

previous studies, they suggest that firms with dual leadership do not necessarily have lower

accounting returns than firms with unitary leadership. If anything, our results suggest the

opposite results. As an additional check, we compare the performance of the 17 firms with

outside chairmen with other firms in the sample. Again we find no significant difference in the

post-1988 period. Similar results hold when we control for differences in firm size.

D. Event Study

Previous authors argue that firms with dual leadership have systematically higher cash

flows than firms with unitary leadership structures. If this argument is correct then, under the

following conditions, the stock market would be expected to react positively to firms that split

the titles and negatively to firms that combine the titles: (1) the market thinks that dual titles are

associated with systematically higher cash flows, (2) the market does not perfectly anticipate the

announcement of the leadership change, and (3) the board's decision to change the leadership

structure does not reveal offsetting information that causes the stock-price to move in the

opposite direction (for example, a board might only split the titles when it has private

information that the firm is in serious financial trouble).

In this section, we provide evidence on this prediction by examining the stock-market

reactions to changes in leadership structure. It is important to note that tests of this prediction

are tests of the joint hypothesis about the effects of leadership structure on cash flows and the

assumed information structure. Rejecting this joint hypothesis either implies that split titles do

not have systematically higher cash flows and/or that the three conditions, listed above, are not

met. This problem arises in interpreting the results of most event studies. Nevertheless, the

23

stock-market reactions to these events are interesting to document.21

Sample. To collect a sample of firms that announce changes in leadership structure, we

conduct a key-word search of the Dow Jones News Retrieval Service over the period 1984-1991.

Initially, we select any Wall Street Journal article containing the words "chief executive officer"

and "chairman" and a verb such as "choose, appoint, name or select." This search yielded over

2,000 articles. A firm is included in the sample if it changes its leadership structure from dual

to unitary or the reverse and is listed on the CRSP tape (which contains the stock-return data).

Our final sample consists of 264 firms -- 102 firms announce they are splitting the CEO and

chairman titles (the positions were formerly held by one person) and 162 firms announce they

are giving one individual both titles.

Statistical Tests. We focus our analysis on the stock-market return over the two-day

period during which the plan to change leadership structure becomes public. The announcement

period consists of the date that the financial press reports the change in leadership structure (day

0) and the prior trading day (day ·1). Accordingly, CRSP returns data are collected for the day

of the WSJ announcement, the day before, as well as over a prior benchmark estimation period.

Benchmark returns are computed over the period t = -190 to t = -21 using the standard market

model and the CRSP equally-weighted index with dividends. Unless otherwise indicated, we

conduct statistical tests using standardized prediction errors. Refer to the appendix of Dodd and

Warner (1983) for specific details on calculating standardized prediction errors and the

21In a contemporaneous working paper, Baliga, Moyer and Rao (1994) present similar event-study evidence.Our analysis differs from their analysis in three significant ways: (1) Our sample size is much larger. (2) Weconduct a more detailed analysis of subsamples containing different types of leadership changes. (3) We examineboth our total sample of events, as well as subsamples that are purged of other contemporaneous newannouncements. Baliga, Moyer and Rao restrict their attention to their total sample.

24

associated Z-statistics.

For each announcement of a change in leadership structure, we check the Wall Street

Journal Index for potentially-confounding news items. A potentially-confounding news item is

any story appearing during the two-day event window in the Wall Street Journal that contains

news unrelated to the change in leadership structure. Examples of such news items in our

sample include, but are not limited to, dividend announcements, earnings announcements,

merger news, tender offers, restructurings, stock splits, recapitalizations and LBOs, spin-offs,

earnings and sales forecasts, new product announcements, charter amendments to prevent

takeovers, internal disputes, general strife, and increases in authorized common shares. Of the

102 announcements of splitting thepositions, 61 have noassociated potentially-confounding news

announcement, while of the 162 announcements of combining the positions, 118 are "clean."

We perform all tests for both the total and clean subsamples.

Splittina the Titles. Table 8 presents the results for those firms announcing a title split.

The most common event, about three-quarters of the announcements, is a split where the

chairman keeps the chair but appoints a new CEO.22 The other two general kinds of

announcements are lesscommon. Appointing a new chairman but keeping the same CEO occurs

only five times, while appointing two new people occurs 21 times in the sample of 102. In the

relatively routine case of thechairman keeping the chairbut appointing a new CEO, the average

age of the chairman is 63.5 years, suggesting retirement is near. In contrast, for less-routine

22Qne example is "Charles R. Shoemate, president of CPC International Inc. was elected to the added post ofchief executive officer, succeeding James R. Eiszner, who will continue as chairman of the board. Mr. Eiszner,who is 62 years old and has been undergoing cancer treatment, said the change is part of the food productcompany's 'succession plan and is being made at this time to continue the orderly transition of the company'sleadership.' - ~, 8/30/90, p. B8.]

25

Table 8

Two-day announcement-period abnormal returns (CAR) for a sample of firmsannouncing that they were splitting the positions of Chairman of the Board andChief Executive Officer (sample period: 1984-1991)

FULL SAMPLE

Sample Average Z-Statistic Median %Size CAR (%) CAR (%) Positive

All Observations 102 0.72 -1.30 0.04 50.00

Same Chairman & 76 1.00 -0.90 0.20 53.94New CEO

New Chairman & 5 -1.14 0.15 -1.65 20.00Same CEO

New Chairman & 21 0.14 -1.23 -0.69 42.86New CEO

CLEAN SUBSAMPLE

Sample Average Z-Statistic Median %Size CAR (%) CAR (%) Positive

All Observations 61 -0.71 -2.7S- -0.22 47.54

Same Chairman & 47 -0.75 -2.31· -0.22 48.94New CEO

New Chairman & 2 -6.29 -2.10 -6.29 00.00Same CEO

New Chairman & 12 0.41 -0.75 0.04 50.00New CEO

"Signlflcant at p=.01.·Significant at p= .05.

title-splitting events, the average age of the chairman is 54.4 years, which is significantly lower

at the one percent level. For the full sample, the two-day announcement-period returns for the

entire sample and for each of the three subsamples are not significantly different from zero.

This evidence suggest that announcements of moves from unitary to dual leadership do not

systematically affect shareholder wealth.

In contrast, in the clean subsample the announcement of splitting the positions appears

to be associated with a negative market reaction that is statistically-significant based on the

parametric test. These results are not consistent with the conventional wisdom that splitting the

positions will generate improved performance. The sample sizes, however, are substantially

smaller than in the full sample, so we perform both the Fisher sign test (for the proportion of

returns greater than zero) and the Wilcoxon signed-rank test (for medians). None of the

nonparametric tests rejects the null hypothesis of zero abnormal returns.

Combinine the Titles. Table 9 presents the results for the 162 firms announcing the

combining of the titles. The most common type of announcement (83% of the cases) is that the

CEO is adding the position of chairman of the board." Thus, as in the case of splitting the

positions, the distribution of the events suggests the Vancil relay pattern. The average CAR for

the entire sample is not significantly different from zero, though the CAR is significant, on the

basis of the parametric test, for two subsamples. First, for the 10 cases in which a new person

assumed both positions, the average CAR is a significantly positive 2.43 percent (Z = 2.08, P

= 0.038). This result is confirmed in the clean subsample (Z = 2.28, P = 0.023). Second,

for the 17 announcements where the chairman takes the title of CEO, the average CAR is a

DOne example is "Thomas W. Field, Jr., 54-year old president and chief executive officer, was named theadditional post of chairman succeeding Neil A. Harlan, 67, who remains a director." ~, 7/28/88]

26

Table 9

Two-day announcement-period abnormal returns (CAR) for a sample of firmsannouncing that they were giving the positions of Chairman of the Board and ChiefExecutive Officer to one person. Previously the positions were held by twoindividuals (sample period: 1984-1991).

FULL SAMPLE

Sample Average Z-Statistic Median %Size CAR (%) CAR (%) Positive

All Observations 162 0.14 0.45 -0.01 50.00

CEO Adds Chair 134 0.27 0.73 0.10 51.49Title

Chair Adds Title of 18 -2.08 -2.20· -1.16 38.89CEO

New Person 10 2.43 2.08· 0.67 50.00Assumes Both

Titles (formerlyheld by two people)

CLEAN SUBSAMPLE

Sample Average Z-Statistic Median %Size CAR (%) CAR (%) Positive

All Observations 118 0.24 0.28 -0.24 46.61

CEO Adds Chair 98 0.20 -0.03 -0.25 46.94Title

Chair Adds Title of 12 -1.23 -0.89 -0.78 41.67CEO

New Person 8 2.87 2.28· 1.10 50.00Assumes Both

Titles (formerlyheld by two people)

"Significant at p= .01.·Significant at p= .05.

significant -2.08 percent (Z = -2.20, p = .028). This subsample corresponds to the case where

the CEO "drops the baton" and the former CEO takes back the CEO title. One explanation for

this negative return is that the announcement conveys negative information to the stock market

about the board's assessment of the future prospects for the firm. Another explanation is that

the market views the event as a power play by an old and outdated CEO to regain power [see,

Sonnenfeld (1988)]. Note, however, that in both the full and clean samples none of the

nonparametric tests rejects the null hypothesis of zero abnormal returns.

In comparison to the case where the titles are combined by the CEO also assuming the

chairman position, one might expect the "take-back" cases to be associated with relatively poor

prior performance. To some extent, this prediction is confirmed in the data. We calculated

market performance over the trading days -300 to -21 (day 0 is the announcement day) net of

the CRSP equal-weighted index for each firm that combined the positions either by the CEO

assuming the chairman position or by the chairman taking back the CEO position. When the

CEO assumes the chairman position prior return net of the market is -9.90 percent on average,

while in the take-back subsample prior return net of the market is -41.0 percent. These figures

differ significantly according to the standard F-test (p = .016) and the Wilcoxon rank-sum test

(p = .009). In contrast, return on capital for the fiscal year prior to the announcement does not

differ across the two subsamples.

Anticipation Effects. Overall, our results suggest that announcements of changes in

leadership structure do not have systematic effects on shareholder wealth. While some of the

parametric tests are significant, the results tend to be driven by outliers. In any case, the results

do not appear to not support the claims of reformers that dual leadership results in higher cash

27

flows -- if anything the results suggest the opposite. One possible explanation for not finding

stronger stock-market reactions, however, is that the events in our sample are well anticipated

by the stock market and therefore do not affect the stock price even though the events are

important (recall the three conditions in our joint hypothesis). To address this issue, we examine

two specific subsamples in which the market is unlikely to completely anticipate the joining of

the titles: 1) the CEO is appointed to a chair position that has been vacant for at least one year;

and 2) the CEO is appointed to the chair position that was previously held by a person whose

age is less than 59 years (i.e., someone who is not obviously near to retirement). For the first

subsample, the average and median abnormal returns are both -0.08 percent. For the second

subsample, the mean and median are 0.83 and 0.85 percent. None of these returns is

significantly different form zero.

Secondary Infonnation Effects. It is important to note that changes in leadership

structure might convey information to the market about cash flows even if the structure itself

does not affect performance. For example, boards might announce leadership changes when

they have private information about the firm's investment opportunities or future cash flows.

In this case, the market might react to changes in leadership structure because it implies this

information. The potential for these types of secondary information effects confounds the

interpretation of our results. For example, it is possible that leadership changes affect

shareholder wealth. However, we are unable to detect these effects in the data because they are

systematically offset by other information effects. Given this possibility, we view our evidence

as providing some support for the hypothesis that shareholder wealth is unaffected when the

typical firm changes its leadership structure.

28

IV. Conclusions

A common view on corporate leadership structure (among regulators, financial reporters

and certain academics) is as follows: (1) It is obviously better to split the titles of CEO and

Chairman than to combine them. (2) About 10-25% of U. S. firms have separate titles and the

frequency of split titles might be increasing. (3) Firms with split titles outperform firms with

combined titles. (4) Firms with combined titles would increase their values by separating the

titles. This paper provides arguments and evidence that challenge this conventional wisdom.

First, we discuss some costs of separating the titles that have been overlooked by

proponents of dual leadership. These costs include agency costs of controlling the behavior of

the chairman, information costs, costs of having firms change their succession processes, and

other costs (such as inconsistent decision making with shared authority). Thus, in contrast, to

the conventional arguments, it is not theoretically obvious which leadership structure is best.

Indeed, the optimal structure might vary across firms.

Our empirical evidence is generally inconsistent with commonly-stated statistics and

evidence. First, we find that almost no major firm in the U.S. in 1988 had the type of

leadership structure that is commonly recommended by shareholders activists and regulators -­

an independent outsider as chairman. Rather, in almost all cases the chairman is either the

former or current CEO or a person with special ties to the firm. These data suggest that if the

popular arguments for having outside chairman are correct, then almost all major firms in the

United States have inefficient board structures. Although this conclusion may be accurate, we

know of no cogent explanation for how such an important corporate-control practice can be

wealth-decreasing and still survive in the competitive marketplace for so long across so many

29

..

companies.

Second, we find that when firms separate the titles, the chairmen are almost always

people with detailed knowledge of the company and relatively high stock ownership. In fact,

the few chairmen who are not former officers of the company tend to own more stock than the

CEO and have longer affiliations with the firm. This observation is consistent with the

hypothesis that the potential agency and information costs associated with separate titles are

important determinants of leadership structure -- the titles are separated only when these

information and agency costs are low.

Third, we find that a significant number of firms use the titles of chairman, CEO and

president as part of their succession plans for CEOs. A common practice is what Vancil (1987)

calls, in reference to a relay race, "passing the baton." Our evidence suggests that firms, which

use this process, employ the title of chairman as a reward for CEOs who perform well during

a probationary period. The widespread use of the baton succession process has two important

implications. First, a regulatory requirement to have separate titles would force many firms to

develop different transition patterns and incentive schemes for top management. Second, the

prevalent use of this process confounds the interpretation of studies that compare the

performance of firms with different leadership structures.

Fourth, in contrast to previous studies, we find no systematic association between

leadership structure and accounting returns. In addition, we find that changes in leadership

structures have no systematic effects on stock-prices. If anything, the evidence suggests that

dual leadership is associated with systematically lower cash flows and value -- not higher cash

flows and value, as reformers claim.

30

We tentatively advance the argument that the widespread practice of combining the titles

of CEO and chairman is indeed efficient and generally consistent with shareholders' interests for

the typical large U.S. company and that legislative reforms forcing separate titles are misguided.

Clearly, however, more detailed estimates of the costs and benefits of alternative leadership

structures are required before more definitive conclusions can be reached.

31

"

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