Elsevier

Journal of Corporate Finance

Volume 47, December 2017, Pages 88-109
Journal of Corporate Finance

Career concerns and the busy life of the young CEO

https://doi.org/10.1016/j.jcorpfin.2017.09.006Get rights and content

Highlights

  • Younger CEOs are more likely to enter new lines of businesses and exit from existing ones.

  • Younger CEOs undertake bolder expansions and divestments, which lead to significant changes to firm asset base.

  • Younger CEOs prefer to grow through acquisitions than de novo investments.

  • Younger CEOs do not to hurt firm efficiency.

Abstract

We examine how real investment decisions of firms are affected by their CEOs' career concerns. Relative to their older counterparts, younger CEOs are more likely to enter new lines of businesses and exit from existing ones. Younger CEOs undertake bolder expansions and divestments, which lead to significant increases and decreases in firm size, respectively. Younger CEOs also prefer to grow through acquisitions than de novo investments. However, such busier investment style of the younger CEOs appears not to hurt firm efficiency. Additional results also shed light on how CEO favoritism distorts capital allocation within firms.

Introduction

In this paper, we examine how career concerns affect the investment activities of younger Chief Executive Officers (CEOs) compared with older CEOs. Career concerns matter because managers are expected to deliberately adjust their investment behavior to influence the labor market's perception of their abilities, and hence their reputation and future prospects. Extant literature, such as Gibbons and Murphy (1992), points out that career concerns are stronger when managers are further away from retirement as the increase in returns from influencing the market's belief about their abilities is higher. Therefore the investment decisions of younger CEOs are expected to be more affected by their career concerns than those of older CEOs.

Consistent with the idea that career concerns affect real investment decisions, we find that relative to older CEOs, younger CEOs are more likely to undertake restructuring activities. Prior literature has argued that younger CEOs acquire more due to compensation benefits associated with firm size increases. However, we show that not only are younger CEOs more likely to undertake restructuring activities that increase firm size, they are also more likely to exit from existing business lines which reduces firm size. Therefore, younger CEOs are not only motivated by explicit financial incentives, they are also motivated by the implicit goal of influencing labor market's perception of their abilities. Our use of plant-level data from the U.S. Census Bureau allows us to further examine the characteristics of the restructuring activities and also differentiate between internal and external investments. We find that younger CEOs undertake bolder investment decisions and prefer to grow aggressively through acquisitions.

Indeed, the theoretical literature has long recognized that a firm's investment decisions are contaminated by its managers' career concerns (see, e.g., Holmstrom and Ricart i Costa, 1986, Prendergast and Stole, 1996, and Holmstrom (1999)). The empirical evidence on career concerns from specialized labor markets, such as mutual fund managers (Chevalier and Ellison, 1999), security analysts (Hong et al., 2000), and macroeconomic forecasters (Lamont, 2002) finds that younger decision makers, with a long prospective career ahead, avoid bold decisions that can lead to negative outcomes and adversely affect the labor market's perception about their abilities. Therefore, the Market Learning Hypothesis generally predicts that younger decision-makers will behave conservatively and underinvest. However, there are reasons to question whether the results of other specialized labor markets apply to the CEO labor market as well.

The serious downside, forced terminations, is relatively rare for CEOs compared to that for other managers in the specialized labor markets (see e.g., Jenter and Kanaan, 2015, Kaplan and Minton, 2011). Even in extreme circumstances of firm bankruptcies, many departing CEOs find full-time employment within one year with little change in compensation (Eckbo et al., 2016). In contrast, there is significant upside potential for younger CEOs who successfully signal superior ability. For example, Gudell (2010) reports that there is a sizeable market for serial CEOs, along with large increases in compensation across jobs. With their long career horizons to reap benefits, younger CEOs are predicted to have stronger incentives to boldly signal ability by adopting a more active and possibly riskier investment strategy (Prendergast and Stole, 1996). Such career concerns are captured through the Managerial Signaling Hypothesis.

Using comprehensive data from the U.S. Census Bureau, we study real investment activities across all sectors of the economy and address questions dealing with the impact of career concerns on three salient aspects of investment behavior: the extent and type of investment activities, the associated productive efficiency, and the favored internal capital allocations.

The plant-level data from the U.S. Census Bureau allow us to characterize investments broadly to include all firm activities that alter the composition of a firm's asset base. In particular, we make use of plant-level information from the Longitudinal Business Database (LBD), which covers every U.S. private non-farm sector establishment (not just manufacturing sector), to construct a complete profile of all the plants and industry segments in which a firm operates. We then construct real investment variables based on the year-to-year change in the composition of the firm's asset structure. We show that a CEO's age has first order effects on a firm's investment decisions. In particular, we find that younger CEOs lead a “busy life.” Younger CEOs are more likely to alter a firm's current asset base by both entering new business segments and withdrawing entirely from existing business segments. In contrast, as CEOs get older, they seem to prefer a “quiet life” by refraining from churning their firms' existing business portfolios. Other things equal, firms with CEOs under 50 years of age are 5.9 percentage points less likely to keep the firm's business profile the same as last year, compared to firms with CEOs aged 60 and above. In contrast, firms with CEOs younger than 50 are 2.6 percentage points more likely to enter a new business segment and 3.7 percentage points more likely to exit from an existing business segment, relative to firms with CEOs aged 60 and above. These findings are statistically significant and economically relevant, even against a backdrop of fairly dynamic ongoing restructuring among our firms. We further find that external governance mechanisms such as stronger shareholder rights, rather than compensation contracts, can partially attenuate the distortion in investment policies caused by a CEO's career concerns.

We have shown that younger CEOs restructure more, consistent with the Managerial Signaling Hypothesis. Under this model, it is also predicted that younger CEOs will undertake bolder and riskier investments in a bid to signal their superior ability. They tend to overweight their own information and magnify their investment decisions in order to try and persuade the market of their superior talents (Prendergast and Stole, 1996, Serfling, 2014). Indeed we find that younger CEOs are more likely to undertake more aggressive restructuring activities; the net firm size effects of the restructuring activities are more pronounced for younger CEOs. In particular, when younger CEOs expand into new segments, they bring more job growth; when younger CEOs divest existing segments, they also shed more jobs, compared with older CEOs. Younger CEOs are also associated with increased research and development (R&D) expenditures, a type of investment that is often considered very risky (Coles et al., 2006). A CEO can initiate a new project by either building a de novo plant or by acquiring a plant from another firm. The latter is often thought of as a riskier strategy due to the significantly higher upfront, irreversible cost and also the information asymmetry between the acquirer and target (see e.g., Lee and Lieberman, 2010). Between the two ways of initiating a plant, we find that younger CEOs favor acquiring a plant from another firm over building a plant from scratch, consistent with our predictions.

We argue that the age-investment relation is driven by CEO career concerns. Several compelling alternative explanations are potentially viable and may explain the negative relation between CEO age and restructuring propensity. First, the age effects may be due to confounding firm characteristics or other known factors that determine the matching between firms and specific types of CEOs. Second, the age effects are simply picking up the effects of CEO tenure. Third, the age-investment relations are due to other CEO personal traits, such as education and overconfidence, and CEO compensation incentives. Finally, the age-investment relation may be driven by industry-specific waves.

We perform a battery of tests to deal with the first alternative explanation – confounding firm characteristics. First, we conduct a propensity score matching analysis. The idea is to compare the restructuring decisions made by two groups of firms with otherwise similar observable characteristics except for CEO's age. The age-investment relations continue to hold in this alternative specification. Second, young CEOs are more likely to manage young and focused firms and so we perform sub-sample analysis and find that the results continue to hold in various subsamples segregated based on number of business segments and firm size. Third, the age-investment relations may reflect the selection of young CEOs by firms that need more restructuring. To the extent that restructuring needs are firm-specific, we control for firm fixed effects and our results continue to hold. Fourth, a firm's restructuring needs may change with time and a firm hires a young CEO when it is about to undergo restructuring. To address this inherent selection bias, we delete the newly-hired CEOs and the results continue to hold in the subsample of long-tenured CEOs. This last test also addresses the second alternative hypothesis that our results are due to CEO age picking up the effects of CEO tenure. Given that the age-investment results continue to hold in the subsample of long-tenured CEOs, it is unlikely that we are picking up the effects of new and younger CEOs taking a big bath upon becoming CEOs (Weisbach, 1995, Pan et al., 2016).

To deal with the third explanation that CEO age is picking up other CEO personal traits, we include CEO fixed effects to control for time-invariant, unobservable CEO characteristics such as cohort effects and education (Bertrand and Schoar, 2003). We find that the effects of age on investments are robust to the inclusion of CEO fixed effects. Next, given that certain CEO characteristics may covary with age and also affect CEO restructuring propensity, we control for the most obvious candidate – CEO overconfidence – and find that the results remain robust to this control. Our results also continue to hold after controlling for CEO incentives arising from their compensation and portfolio of own firm's stock and stock options (Gibbons and Murphy, 1992). Finally, our results are also robust to controlling for industry-year fixed effects, assuring us that our results are not spuriously picking up the effects of merger waves (Harford, 2005).

Finally, we examine the impact of CEOs' investment activities on plant-level efficiency. We have shown that young CEOs restructure more due to their career concerns. Under the Managerial Signaling Hypothesis, it is unclear how such career concerns affect the efficiency of the investment decisions. On the one hand, Narayanan (1985) shows that a manager hoping to enhance his reputation earlier will tend to make inefficient investment decisions. On the other hand, to the extent that effort and ability are substitutes, a young manager may exert more effort when making investment decisions, leading to potentially more efficient decisions (Holmstrom, 1999). Using total factor productivity (TFP) and value-added per worker as metrics, we cannot reject the hypothesis that, on average, younger CEOs are associated with plants of equal efficiency as older CEOs. In a second test, we examine changes to a plant's productivity after an acquisition. We do not find any evidence that plants acquired by younger CEOs are associated with a decrease in productivity post-acquisition. Acquisitions made by younger CEOs experience at least as great an improvement as those made by older CEOs.

We further analyze the impact of career concerns on the allocation of capital across plants within a firm. Career concerns may lead managers to hang on to underperforming projects, causing an escalation of commitment problem (Boot, 1992). To this end, we distinguish between plants that are “inherited” by the CEO, versus plants that are not. A “not-inherited” plant is either built from scratch or acquired from other firms during the current CEO's tenure. We find that managers tilt incremental capital expenditures towards plants that they themselves initiated. This type of managerial favoritism is, however, not affected by CEO age as older CEOs and younger CEOs are equally prone to such favoritism.

This paper highlights the important role that a CEO's career concerns play in shaping a firm's investment policies. Our paper is part of a growing body of research that shows that heterogeneity in CEO characteristics and personal traits matter for corporate policies. In particular, recent empirical work has shown that CEO characteristics matter for firm investments: e.g., firm investment and acquisition decisions are affected by CEO styles (Bertrand and Schoar, 2003), CEO overconfidence (Malmendier and Tate, 2005, Malmendier and Tate, 2008), managerial attitude (Graham et al., 2013), and managerial miscalibration (Ben-David et al., 2013).

Recent papers have also started to examine the impact of CEO age on acquisition policies (Yim, 2013), firm risk (Serfling, 2014 and Gormley and Matsa, 2016), stock price crash risk (Andreou et al., 2016), and willingness of acquisition targets' CEOs to agree to a takeover (Jenter and Lewellen, 2015). Our paper is most closely related to Yim (2013) who shows that younger CEOs are more likely to undertake acquisitions because of the compensation benefits derived from managing bigger firms. Our paper distinguishes from hers as we show that not only do younger CEOs make more investments, they also make more divestitures which decrease firm size. Such divestments are likely not motivated by compensation considerations as Bebchuk and Grinstein (2005) show that firm size increases, and not decreases, are associated with higher compensation. Thus, career concerns effects do not only derive from explicit compensation incentives but also from implicit benefits of influencing the market's perception of one's abilities. Our findings that younger CEOs take on bigger and bolder investment decisions complement Serfling (2014) who finds that CEOs take fewer risks as they age. In particular, he shows that firms managed by older CEOs are more diversified across business segments, invest less in R&D, and conditional on making acquisitions, older CEOs make more diversifying acquisitions. We not only show that younger CEOs take on risker investment decisions, but because of the detailed plant-level data, our results also shed light on the characteristics and performance implications of these investment policies. We are able to contrast the decision to invest internally versus external acquisitions and also examine capital allocation across different investment projects, issues not examined by previous literature. Finally, we show that external governance mechanisms rather than incentive compensation can partially attenuate the effects of career concerns on investment policies.

The rest of the paper is structured as follows: In Section 2, we review the theoretical and empirical literature on how career concerns distort the behavior of decision makers and propose several testable hypotheses. We describe our data and key variables in Section 3. Section 4 analyzes the relation between CEO age and investment activities and also addresses several alternative hypotheses. Section 5 provides additional results by examining the types and profitability of investment activities undertaken by young CEOs. Section 6 concludes.

Section snippets

Literature review and hypothesis development

Fama (1980) is the seminal work advancing the notion that career concerns can influence corporate performance. He argues that managers are disciplined by an efficient managerial labor market where poor performance by a manager can lead to lower future wages and early dismissal. However, Holmstrom (1999) points out that there are circumstances where career concerns can distort managers' actions instead. In his model, Holmstrom analyzes the nature of career concerns where the market is learning

Data and variables

In this section, we discuss our sample, sources of data, and methodology to test the above hypotheses. We first describe how we classify various plant-level activities using data from the U.S. Census Bureau.

The effect of CEO age on investment

Both the Market Learning and Managerial Signaling Hypotheses predict that CEO career concerns affect firm investment activities. Following the literature on career concerns (Gibbons and Murphy, 1992 and Chevalier and Ellison, 1999), we proxy for the degree of career concerns faced by a CEO with his age: a younger CEO has greater career concerns.

Impact of governance and compensation

In Table 5, we examine whether better governance and compensation mechanisms can reduce the impact of career concerns on firm investment activities. Panel A shows results where we divide the firms into two groups based on the sample median Governance index (G-index) of Gompers et al. (2003). We find that the impact of CEO age on firm restructuring activities are mostly concentrated among worse-governed firms, i.e., firms with above median G-index. We do not find a significant impact of CEO age

Conclusions

Younger managers have greater concerns over their future careers. In this paper, we examine how real corporate investment decisions are affected by CEOs' career concerns. We characterize a firm's investment policy to encompass the acquisitions and sales of assets, as well as plant openings and closings. We document that a firm's propensity for investment activities is decreasing in the age of the CEO. Younger CEOs lead a busy life as they are more likely to alter a firm's existing business

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  • Cited by (0)

    We thank Long Chen, Amy Dittmar, Stephen Ferris, David Hirshleifer, Jennifer Huang, Amiyatosh Purnanandam, Jun (QJ) Qian, Uday Rajan, Fatma Sonmez, René Stulz, Jan Svejnar, Mike Weisbach, and Uri Ben Zion for helpful comments. This research was conducted when the authors were Special Sworn Status researchers at the U.S. Census Bureau, Michigan Research Data Center. Any opinions and conclusions expressed herein are those of the authors and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed. We acknowledge the generous support from the ICPSR. Support for this research at the Michigan RDC from NSF (ITR-0427889) is also gratefully acknowledged. All errors are our own.

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