Are interim CEOs just caretakers?

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Journal of Corporate Finance journal homepage: www.elsevier.com/locate/jcorpfin

Are interim CEOs just caretakers? Xiaoxiao Hea, , Margaret Rui Zhub ⁎

a

School of Finance, Southwestern University of Finance and Economics, 555, Liutai Avenue, Wenjiang District, Chengdu 611130, Sichuan, PR China College of Business, Department of Economics and Finance, City University of Hong Kong, Tat Chee Avenue, Kowloon, Hong Kong Special Administrative Region

b

ARTICLE INFO

ABSTRACT

Keywords: CEO turnover Interim CEO Testing-ground option

Interim CEOs are often viewed as caretakers during CEO transition periods. However, the caretaker function does not fully explain the increasing trend in the use of interim CEO appointments. Recent studies suggest that firms also use the interim position to test potential CEO candidates. This paper empirically examines this argument using a hand-collected dataset of 1936 CEO successions between 1994 and 2014. We find evidence that firms consider interim positions as a testing ground for CEO candidates. Specifically, we find that candidates with uncertain managerial abilities are more likely to be initially named as interim CEOs rather than permanent CEOs. We also find that interim CEOs are more likely to be promoted to the permanent CEO position when they have better interim-period performance attributable to managerial skills. Consistent with the testing-ground option hypothesis, we find interim CEOs promoted to the permanent position result in superior long-run performance, suggesting better CEO-firm matches.

JEL classification: G34 M51

1. Introduction An important function of boards of directors is succession planning. However, in many cases, boards do not appear to have qualified successors in place and instead appoint interim CEOs. Traditionally, interim CEOs are considered to be caretakers whose primary mandate is to maintain the firms' day-to-day operations while the board and upper management search for a qualified CEO successor. Previous studies of interim CEOs focus primarily on this caretaker function. The evidence to date suggests that firms are more likely to use interim CEOs as caretakers when the incumbent CEO departs suddenly (Mooney et al., 2012) or when a firm forces out a poorly performing CEO before a successor has been identified (Ballinger and Marcel, 2010). However, the caretaker function does not fully explain the increasing trend of using interim CEOs. During our sample period of 1994–2014, the proportion of CEO successions that involve interim CEOs increased from 5.0% in 1994 to 27.0% in 2014, peaking at 31.6% in 2006. Of the 422 interim CEO successions of U.S. listed firms in our sample, only 6.6% occurred after a sudden CEO departure due to death or medical issues, while 46.2% of such appointments followed a forced CEO turnover. The motivations for the remaining 47.2% interim CEO appointments are unclear. Furthermore, 140 (33.2%) of the interim CEOs were subsequently promoted to permanent CEO positions. Other recent work suggests that appointing an interim CEO allows the board to assess potential CEO candidates (Liang et al., 2012; Mooney et al., 2012). When the firm's board does not have full confidence in a candidate's managerial abilities, it can use the interim position as a testing ground to evaluate her. In such circumstances, the interim CEO position offers the board an option-like searching strategy. If the cost of dismissing an interim CEO is lower than the cost of dismissing a permanent CEO, the testing-ground

⁎

Corresponding author. E-mail addresses: [email protected] (X. He), [email protected] (M.R. Zhu).

https://doi.org/10.1016/j.jcorpfin.2018.11.003 Received 4 March 2018; Received in revised form 10 November 2018; Accepted 15 November 2018 0929-1199/ © 2018 Elsevier B.V. All rights reserved.

Please cite this article as: He, X., Journal of Corporate Finance, https://doi.org/10.1016/j.jcorpfin.2018.11.003

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option is valuable.1 In addition, Mooney et al. (2012) suggest that promoting the interim CEO to a permanent position signals a good quality CEO-firm match, as the board has confidence in the candidate's managerial skills. An anecdotal example of a firm using an interim CEO is Bristol-Myers Squibb naming James M. Cornelius interim CEO in September 2006 to replace the previous CEO, Peter R. Dolan. In April 2007, the company named Cornelius as the permanent CEO. At the time, Bristol-Myers-Squibb Board Chair James D. Robinson III commented, “As we conducted an extensive and thorough CEO search, it became increasingly clear that Jim was the ideal person to continue leading our company. He has done a splendid job as CEO, and we couldn't be more pleased that he has agreed to stay in this role.” During the eight-month interim period, Cornelius devoted himself to the companies' strategic review and several innovative partnerships designed to reduce costs and mitigate risks.2 The firm's buy-and-hold abnormal return during the interim period was 22.5%. Despite the increasing reliance on interim CEOs that we document, with the exceptions of Ballinger and Marcel (2010) and Intintoli et al. (2014), few empirical studies directly investigate the testing-ground rationale for their use. Both studies document the fraction of interim CEOs in their samples who are promoted to permanent CEO and focus on firm performance during the interim period.3 To fill this gap in the literature, we use a hand-collected dataset to empirically examine whether there are motivations other than caretaking for using interim CEOs. In addition, we attempt to identify factors associated with the promotion of interim CEOs to permanent CEO positions. We find evidence supporting the testing-ground argument. First, our results show that firms are more likely to name candidates as interim rather than permanent CEOs when the board's uncertainty about the candidates' managerial ability is high. The positive relationship between managerial ability uncertainty and the use of interim CEOs is robust after controlling for the caretaker motivation, firm and CEO characteristics, and year and industry fixed effects, and when using matched samples. We also find that the positive effect of managerial uncertainty on the use of interim positions is more pronounced for firms with better corporate governance and for firms with better previous performance. These results suggest that better-governed firms care more about the potential costs of a CEO-firm mismatch and that better-performing firms can more easily bear the potential short-term deterioration in firm performance related to using the interim appointment as a testing ground for CEO performance. Overall, the evidence supports the hypothesis that firms consider the interim position to test the ability of CEO candidates. Second, we find that an interim CEO is more likely to be promoted to permanent CEO if, during the interim period, the firm performs well in a way that can be attributed to managerial skill.4 This result is robust after controlling for potential earnings manipulation (Chen et al., 2015), firm and CEO characteristics, and year and industry fixed effects, and when using matched samples. We further show that promotion-performance relationship is more pronounced among firms whose candidates have higher uncertainty in their managerial skills. As the purpose of the testing-ground option is to verify candidates' managerial skills. And we also find that promotion-performance sensitivity is more pronounced among firms that do not require caretaker interim CEOs.5 This evidence is also consistent with the testing-ground argument. When no emergency CEO departure takes place that requires a caretaker, the purpose of using interim CEOs is more likely to be to verify managerial ability; in such circumstances, the board is likely to consider more of firm performance during the interim period when deciding whether to retain the interim CEO. Therefore, we observe a high promotion-performance sensitivity. In contrast, when firms suffer sudden CEO departures, the main purpose of using interim CEOs is likely as caretaker to ensure that the firm continues to operate smoothly; thus, the board is less likely to focus on firm performance during the interim period. Third, in the long run, promoted interim CEOs have better firm performance than permanent CEOs who are appointed directly, suggesting a better firm-CEO match. Overall, we find that the long-term performance of firms that use interim CEOs is no worse than firms that directly appoint new permanent CEOs. This paper offers further insight into why firms use interim CEOs by providing direct empirical evidence supporting the testing ground proposition by Liang et al. (2012) and Mooney et al. (2012). We also find the testing ground argument is supplemental to the traditional caretaker view. Our work also relates to the studies examining the relationship between firm performance and interim CEO successions. Previous works report that firms that use interim CEOs experience a deterioration of firm performance during the interim period. Ballinger and Marcel (2010) find that firms that use interim CEOs underperform their peers four quarters throughout the interim period but using interim CEOs is not significantly associated with firm failure in the long-run. They attribute the underperformance to the limited authority of the interim CEOs and the disruption in the top management team. Intintoli et al. (2014) argue that firm underperformance during the interim period only occurs following the voluntary turnover of the prior incumbent. However, a direct comparison of the after-succession period performance between interim CEO succession and permanent CEO succession is not fair. One of the reasons is that interim CEOs have limited CEO authorities than permanent CEO (Ballinger and Marcel, 2010). We first 1 A CEO-firm mismatch will deteriorate long-term firm performance and the firm may not be able to replace a poorly performing permanent CEO quickly due to increasing managerial power (Bebchuk et al., 2002). 2 Bristol-Myers Squibb Co. press release, (April 26, 2007). Retrieved from https://news.bms.com/press-release/james-m-cornelius-elected-bristolmyers-squibb-ceo. 3 Both studies focus on how using interim CEOs could affect firm performance by looking at a post-succession period after interim (permanent) CEO successions. However, neither study distinguishes whether the interim CEO will be promoted or not. 4 We use Fama-French three-factor abnormal returns to proxy for firm performance attributable to skills (BHAR). In additional to BHAR, we also use the residual from the return regression on market, industry and year dummies to proxy for the “skill” of the CEO candidate. 5 Situations that firms require a caretaker are when the previous CEOs have sudden departure due to death of health issues and when firms forced out the incumbent CEO.

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compare the interim period performance among the firms using interim CEOs. After controlling for the type of turnovers of previous permanent CEO, firms that promoted their interim CEOs experience a favorable stock performance during the interim period than firms that do not promote their interim CEOs. We further compare the long-term firm performance after permanent CEO successions between firms that use interim CEOs and firms that directly appoint a permanent CEO. Consistent to the existing literature (Ballinger and Marcel, 2010; Mooney et al., 2012), we find that the firms that use interim CEOs, in general, have no worse firm performance in the long run than firms that appoint permanent CEOs. Furthermore, firms that promote their interim CEOs even have better firm performance than firms that directly appoint their new CEOs. More generally, we contribute to the CEO turnover literature. Previous studies of CEO turnover focus on incumbent CEOs and incoming CEOs. One stream of the literature focuses on the determinants of CEO turnover (Weisbach, 1988; Farrell and Whidbee, 2003; Lehn and Zhao, 2006; Hazarika et al., 2012; Jenter and Kanaan, 2015; Jenter and Lewellen, 2017) and conditions that affect turnover-performance sensitivity (Parrino, 1997; Mikkelson and Partch, 1997; Denis et al., 1997; DeFond and Park, 1999; Huson et al., 2001; Kaplan and Minton, 2012). Another body of work focuses on characteristics that affect incoming CEO appointments (Fee and Hadlock, 2003; Murphy and Zabojnik, 2004; Kini and Williams, 2012; Xu and Yang, 2016; He and Zhu, 2016). Due to a lack of detailed disclosure, it is hard to empirically analyze the candidate search process. We offer a potential solution by studying a specific form of search strategy: use of the interim position. Our results suggest that firms use different strategies in the search process—interim and direct appointment—with each search method potentially affecting long-term firm performance. The rest of the paper is organized as follows. Section 2 develops our empirical hypotheses. Sections 3 and 4 describe the sample and variable construction procedures, respectively. Section 5 presents the empirical results, which are discussed in Section 6. Section 7 summarizes our empirical findings and concludes the paper. 2. Hypothesis development The testing-ground argument suggests that boards use interim CEO appointments to test the abilities of CEO candidates. This option is valuable when boards cannot accurately measure the managerial abilities of potential candidates due to labor market frictions, specifically, information asymmetry between employers and candidates. For instance, a board would have less information or certainty about a candidate's skills if her previous employer displays volatile performance, if she does not have experience as a top executive, if she was previously employed at a private firm (where even firm performance may not be observable), or if her previous tenure was short. When a CEO candidate has more information than the board about her managerial skills and the candidate is confident in those skills, it would be optimal for the board to assign her as the interim CEO and optimal for her to accept the interim position. Interim positions enable firms to closely evaluate CEO candidates' managerial skills during the interim period and then make the permanent appointment decision based on this information. Hypothesis 1. The firm is more likely to appoint an interim CEO rather than a permanent CEO when the board is uncertain about the candidate's managerial abilities. We would expect better-governed firms to have well-designed succession plans. However, if the best available candidate's managerial skills are uncertain or not all board members are convinced that she is the best option, then it is optimal to give the risky candidate an interim position as a test period. If she demonstrates good leadership skills, then the board can promote her to permanent CEO. If she fails the interim period test, the board can go on to other candidates.6 The testing-ground option reduces the probability and the cost of CEO-firm mismatch, so long as replacing an interim CEO is less costly than replacing a permanent CEO. Therefore, we expect that firms with better corporate governance will consider the testing-ground option of interim positions as an essential part of the succession plan and are more likely to appoint interim CEOs whose managerial abilities are more uncertain. In contrast, firms with worse corporate governance are less likely to have a succession plan or consider the testing ground option of interim CEO positions. Therefore, they are more likely to use interim CEOs as caretakers and are less likely to use such positions to test candidates' managerial skills. Hypothesis 1a. Firms with better corporate governance are more likely to use interim CEOs if the board is uncertain about a candidate's managerial ability. Furthermore, letting a candidate with uncertain managerial skills run the firm as interim CEO could risk firm performance, increasing the probability of poor performance during the interim period. Therefore, all else equal, we expect firms with better prior performance to be more able to bear potential short-term losses during the interim period. Hypothesis 1b. The positive effect of managerial ability uncertainty on the use of interim CEO appointments is more pronounced for firms with better previous performance. The testing-ground hypothesis further suggests that an interim CEO is more likely to be promoted to permanent CEO if she demonstrates good managerial skills during the interim period. Assuming that a randomly assigned CEO with the average ability is expected to perform at the level predicted by the factor models or industry average, then interim CEOs who achieve higher than 6 When evaluating interim CEOs' managerial ability during the interim period, firms could also be searching for the next potential candidate. The interim CEO and the other candidate would compete. The existence of the competitor further motivates the interim CEO, making the testing-ground option of the interim positions more efficient in selecting the best candidate.

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predicted abnormal returns could be considered to have stronger managerial skills.7,8 Therefore, an interim CEO is more likely to be retained for the permanent position when her performance is better than the performance of an average CEO. Hypothesis 2. An interim CEO's probability of promotion increases with an increase in the interim-period firm performance attributable to managerial skill. In addition, the purpose of exercising the testing-ground option is to verify managerial ability, so we expect the promotion to be more depending on interim-period firm performance for a candidate with a high uncertainty of managerial skill. Hypothesis 2a. The effect of interim-period firm performance on interim CEOs' promotion probability is more pronounced for candidates whose managerial ability is more uncertain. Moreover, firms are more likely to use the interim CEO as a caretaker rather than as a testing ground if the previous CEO left unexpectedly, such as due to death or medical reasons, or if she is dismissed for unexpectedly poor performance. If a firm views the interim CEO as a caretaker only, we would expect the promotion to be less dependent on the interim period performance. Hypothesis 2b. The positive effect of interim-period firm performance on interim CEO promotion is more significant in circumstances that do not require a caretaker. If firms use interim positions as an option to test candidates' managerial skills, then interim CEOs who are subsequently promoted to permanent CEO should be a better match for the firm. Of course, the quality of the CEO-firm match is not directly observable. However, the outcome of the CEO-firm match can be quantified, as a high-quality CEO-firm match should result in better long-run firm performance. Hypothesis 3. Promoted interim CEOs have better firm performance in the long run than directly appointed CEOs.

3. Sample Information on interim CEO successions is collected from BoardEx. We identify interim CEO positions in all nonfinancial U.S. firms listed on the NYSE, AMEX, and NASDAQ between fiscal years 1994 and 2014.9 An interim CEO position is defined as a position with a description that includes keywords such as “Interim CEO” or “Acting CEO.” Interim positions in subsidiaries, divisions, or regional affiliates are excluded. We limit our sample to situations in which the interim CEO's tenure is completed and a permanent CEO successor is identified by the end of fiscal year (FY) 2014. For observations with multiple interim CEOs, we only keep the last interim CEO whose successor is named as permanent CEO to avoid potential selection bias.10 Stock return data come from the CRSPCompustat Merged (CCM) dataset. The interim period for each observation is required to be within the CCM effective linking period. Information on institutional ownership comes from Thomson Reuters. CEO characteristics and board composition are collected from BoardEx. We require that all observations have non-missing firm fundamentals and CEO characteristics. The final treatment sample comprises 422 interim CEO succession events from FY 1994 to FY 2014. Of the 422 interim CEOs, 140 (33.2%) are promoted to permanent CEO (defined as the promoted group hereafter), and the remaining 282 (66.8%) are replaced (defined as the not-promoted group hereafter). To examine the motivation behind using interim positions, we use CEO successions in which no interim CEO is appointed as the control group. The control sample is collected from the ExecuComp database and comprises 1514 CEO turnovers from FY 1994 to FY 2014. Fig. 1 shows the annual trend in the use of interim positions and the promotion of interim CEOs within the sample period. The proportion of CEO successions that involve the use of interim CEOs increased from 5.0% in 1994 to 27.0% in 2014, peaking at 31.6% in 2006. Table 1 shows the origins of the interim CEOs. Firms in our sample generally appoint current employees or board chairs as interim CEOs. The percentages of previous chairs in the promoted and not promoted groups are 10.0% and 13.5%, respectively. Chairs who become interim CEOs are likely to act as caretakers, as their managerial skills are generally well-known to the board. Among the promoted group, 40.0% of the interim CEOs were previously top managers or other employees of the firm compared to 30.9% for the not-promoted group. The large percentage of top managers and employees suggests that the interim positions may indeed be used as a testing ground of managerial ability; of the interim CEOs in the promoted (not-promoted) group, 35.7% (39.4%) are non-employees. Of these, 72.0% (87.4%) previously served as a director of the hiring firm. The remaining 28.0% (12.6%) are outsiders with no relationship to the hiring firm. Panel B of Table 1 compares the CEO experience of interim CEOs in the promoted group and the not-promoted group. > 40% of interim CEOs in both groups have CEO experience, primarily at other firms. Only 10% of interim CEOs in the promoted group and 12.4% in the not-promoted group have CEO experience with the hiring firm. Interestingly, we do not find a higher promotion rate 7 We use a Fama-French three-factor model to generate the predicted returns and use the buy and hold abnormal returns (BHAR) to measure the interim CEO's performance attributable to managerial ability. Following Jenter and Kanaan (2015), we define an alternative variable, Skill, as the residual of the regression of interim period firm stock returns on market returns, industry returns and year dummies. The corresponding variable, Luck, is defined as the predicted value in the above regressions. 8 Fee and Hadlock (2003) suggest that performance above the industry average can be used to measure managerial talent. 9 Firms with SIC codes of 6000–6999 are excluded from our sample. 10 There are nine such cases in the raw sample.

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100%

35%

90% 30% 80% 25%

70% 60%

20%

50% 15%

40% 30%

10%

20% 5% 10% 0%

0%

Pct. of Interim CEO Promotion-Left

Pct. of Interim CEO Succession-Right

Fig. 1. Annual distribution of interim CEO succession & promotion. This figure plots the annual trend of using interim CEO during CEO succession and the promotion of interim CEO. The line plot shows the annual percentage of CEO successions using interim CEO, using right measures. The bar graph shows the annual percentage of interim CEOs that are being promoted as permanent CEO within the group of interim CEOs, using left measures.

Table 1 Background of Interim CEOs. Variable

Promoted

Not promoted

N. Obs.

Pct.

N. Obs.

Pct.

Panel A: Previous origin Top manager Chair Top manager & chair Other employee Outsider Director Total

56 14 2 18 50 36 140

40.00% 10.00% 1.43% 12.86% 35.71% 25.71% 100.00%

87 38 3 43 111 97 282

30.85% 13.48% 1.06% 15.25% 39.36% 34.40% 100.00%

Panel B: Previous CEO experience CEO experience-others CEO experience-firm CEO experience-both Total

43 6 4 140

30.71% 4.29% 2.86% 100.00%

87 19 8 282

30.85% 6.74% 2.84% 100.00%

This table reports the origins and previous CEO experience of interim CEOs. The sample period is from 1994 to 2014. Panel A reports the backgrounds of interim CEOs. Top Manager indicates that the CEO served as a top manager (including the president and other chief managerial positions) at the firm. Chair indicates that the interim CEO previously served as the firm's chair and zero otherwise. Other Employee indicates that the interim CEO previously worked at the firm in some capacity other than as a top manager or chair. Outsider indicates that the interim CEO was not already an employee of the firm. Director indicates that the interim CEO previously served as the firm's director. Panel B reports previous CEO experience. CEO Experience-Others indicates that the interim CEO has CEO experience at other firms. CEO Experience-Firm indicates the interim CEO has CEO experience at the current employer. CEO Experience-Both indicates the interim CEO has CEO experience at both the current employer and the other firm (s). Promoted refers to the group comprises interim CEOs that are promoted as permanent CEO. Not promoted refers to the group comprises interim CEOs that are promoted as permanent CEO.

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among interim CEOs with previous CEO experience. 4. Variables 4.1. Managerial ability uncertainty Previous studies suggest that employers use firm performance as a measure of managerial performance (Fama, 1980; Baker et al., 1988; Jensen and Murphy, 1990; Fee and Hadlock, 2003). Uncertainty over managerial ability increases with the measurement error of firm performance (Parrino, 1997). Therefore, we use the variable 36-month IVol. to proxy for the uncertainty of managerial ability. For each interim CEO/permanent CEO, the stock returns of a candidate's previous employer in the 36 months leading up to the appointment are regressed on the Fama-French three factors. The 36-month IVol. is calculated as the standard deviation of the residuals of the model. The previous employer is defined as the firm where the candidate was a full-time employee before being appointed (interim) CEO. If the previous employment tenure was < 36 months, we use the full employment tenure as the estimation window. If a candidate only had director positions immediately prior to being appointed (interim) CEO, we use the average level of 36-month IVol. for the firms for which the candidate acted as a director. Moreover, we develop an Uncertainty Index to capture features that increase the uncertainty of a candidate's managerial skill. In the labor market, firms have less information about a job candidate if she previously worked at a private firm, had a shorter tenure with her previous employer, or did not hold a visible position as a top executive. Therefore, the Uncertainty Index is defined as the sum of the following three binary variables: Short Tenure, which is equal to one if a candidate's overall tenure with her previous employer was shorter than 12 months and zero otherwise, Not a Top Manager, which is equal to one if a candidate did not serve as a top manager or CEO at her previous employer and zero otherwise, and Private Firm, which is equal to one if a candidate was previously employed by a private firm and zero otherwise.11 The value of the Uncertainty Index ranges from 0 to 3, with an average of 1.51 over all of the CEO turnovers in our sample. We use the dummy variable Outsider in the regressions to control for whether the candidate works in the current company. Table 2 reports sample descriptive statistics for interim CEO successions and for directly named CEO successions. The 36-month IVol. measure and the Uncertainty Index are significantly different between the two groups. Compared to candidates who are directly named as permanent CEOs, those who are named as interim CEOs, on average, have much higher 36-month IVol. (0.12 vs. 0.09) and Uncertainty Index (1.51 vs. 1.08) scores. Both differences are significant at the 1% level. The summary statistics show that firms are more likely to name an interim CEO when there is more uncertainty about the candidate's managerial skills. The uncertainty measures do not differ significantly between interim CEOs who are promoted to permanent CEO and those who are not (see Table 3 for the summary statistics). 4.2. Interim period performance We use abnormal stock market returns to measure an interim CEO's performance. Abnormal returns better reflect the performance attributable to the CEO's skills than raw returns because they subtract out the market and common factors that affect all stock returns. We do not use operational performance measures because the reporting period for quarterly finance reports is fixed and may not fully cover the interim period.12 The main performance measures we use are interim-period buy and hold abnormal returns (BHAR) based on the Fama-French three-factor model (Fama and French, 1995). The estimation window is [t = − 60, t = − 1] months before the succession event (t = 0). To further test the hypothesis that firms promote interim CEOs based on their skill and not luck (Hypothesis 2), we decompose firms' interim-period stock returns into Skill and Luck following the approach of Jenter and Kanaan (2015). Firms' interim-period stock returns are regressed on the contemporaneous market return, industry return, and year fixed effects using the following equation:

Returnit =

+

1 Market

Returnit +

2 Industry

Returnit + Year Dummyt +

it .

(1)

Skill is defined as the residual εit of the model, which measures the return attributable to managerial skills, eliminating market, industry, and year effects. Luck is defined as the predicted value of Returnit, which measures the return attributable to the windfall effect due to market, industry, and other macroeconomics shocks. Table 3 reports the results of univariate tests of firm performance for the promoted group and the not-promoted group of interim CEOs. Firms in the promoted group outperform firms in the not-promoted groups. The mean value of BHAR for the promoted group is 0.11 (p-value ≤.05) higher than for the not-promoted group. There is also a positive difference in Skill, but the p-value (0.1265) for the two sample t-test is slightly higher than 10%. 11

We do not include “outsider” as part of the Uncertainty Index. The uncertainty of an outsider's managerial skill is not necessarily higher than that of an insider. For both external and internal candidates, the uncertainty of managerial skill will increase if the candidate did not serve as a top manager or if the candidate did not have a long tenure in the current employer. The uncertainty of an external candidate will also increase if she came from a private firm. Instead, we control for “outsider” in the regressions. 12 We compare the quarterly operational performance during the interim period for promoted and not-promoted groups as a robustness test in Table 10. We discuss the interim-period operational performance in detail in Section 6.1. 6

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Table 2 Summary statistics of all CEO successions. Variable

36-Month IVol. Uncertainty index Sudden departure Forced prior Outsider CEO experience Female Age Log(AT) Debt ratio B/M Return(t-1) Institutional ownership Indep. director N. Obs.

(1) With Interim CEO

(2) Without Interim CEO

(1)–(2)

Mean

Std. Dev.

P25

P75

Mean

Std. Dev.

P25

P75

Difference

T-Statistics

0.12 1.51 0.07 0.46 0.38 0.40 0.04 54.91 5.48 0.23 0.61 −0.21 0.39 0.58 422

0.07 1.04 0.25 0.50 0.49 0.49 0.20 9.24 1.96 0.69 0.90 0.66 0.37 0.27

0.07 1.00 0.00 0.00 0.00 0.00 0.00 48.00 4.05 0.00 0.23 −0.54 0.00 0.43

0.17 2.00 0.00 1.00 1.00 1.00 0.00 61.00 6.93 0.26 0.80 0.16 0.70 0.75

0.09 1.08 0.01 0.19 0.27 0.33 0.04 52.41 7.54 0.21 0.52 −0.02 0.56 0.51 1514

0.06 0.98 0.10 0.39 0.44 0.47 0.19 6.65 1.58 0.24 0.61 0.51 0.34 0.25

0.05 0.00 0.00 0.00 0.00 0.00 0.00 48.00 6.44 0.03 0.26 −0.24 0.37 0.33

0.12 2.00 0.00 0.00 1.00 1.00 0.00 57.00 8.61 0.31 0.66 0.26 0.82 0.67

0.03*** 0.44*** 0.06*** 0.28*** 0.11*** 0.07** 0.00 2.49*** −2.06*** 0.02 0.08* −0.19*** −0.18*** 0.08***

[9.09] [7.71] [4.55] [10.50] [4.31] [2.45] [0.43] [5.18] [−19.87] [0.53] [1.80] [−5.54] [−8.87] [5.36]

The table shows summary statistics of all CEO successions. (1) With Interim CEO reports descriptive statistics of CEO successions that use interim CEOs. (2) Without Interim CEO reports descriptive statistics of CEO successions that do not use interim CEOs. (1)–(2) reports the differences in sample means between the two groups. T-statistics of two-sample t-tests are reported in brackets. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively. Variable definitions are given in the Appendix A. Continuous variables are winsorized at the 1% and 99% levels. The sample period is 1994 to 2014. Table 3 Summary statistics of interim CEO successions. Variable

BHAR Skill Luck Sudden departure Forced Prior 36-Month IVol. Uncertainty index Discretionary accruals Outsider CEO experience Age Female Log(AT) B/M Debt ratio Return(t-1) Institutional ownership Indep. director N. Obs.

(1) Promoted

(2) Not promoted

(1)–(2)

Mean

Std. Dev.

P25

P75

Mean

Std. Dev.

P25

P75

Difference

T-Statistics

−0.06 −0.06 −0.02 0.10 0.41 0.12 1.46 0.14 0.36 0.38 53.34 0.04 5.34 0.57 0.22 −0.25 0.39 0.57 140

0.47 0.37 0.24 0.30 0.49 0.07 1.06 0.61 0.48 0.49 8.87 0.19 1.98 0.62 0.88 0.72 0.36 0.28

−0.30 −0.23 −0.09 0.00 0.00 0.07 1.00 0.00 0.00 0.00 46.00 0.00 3.76 0.28 0.00 −0.55 0.00 0.40

0.17 0.14 0.11 0.00 1.00 0.17 2.00 0.02 1.00 1.00 60.00 0.00 6.78 0.77 0.25 0.18 0.70 0.78

−0.17 −0.12 −0.05 0.05 0.49 0.12 1.54 0.11 0.39 0.40 55.68 0.04 5.55 0.63 0.24 −0.19 0.38 0.59 282

0.45 0.37 0.24 0.22 0.50 0.07 1.03 0.45 0.49 0.49 9.33 0.20 1.95 1.01 0.58 0.63 0.38 0.27

−0.40 −0.33 −0.13 0.00 0.00 0.08 1.00 0.00 0.00 0.00 48.00 0.00 4.15 0.21 0.00 −0.54 0.00 0.44

0.08 0.08 0.09 0.00 1.00 0.16 2.00 0.03 1.00 1.00 62.00 0.00 7.02 0.81 0.28 0.15 0.70 0.75

0.11** 0.06 0.03 0.05* −0.08 0.01 −0.08 0.03 −0.04 −0.03 −2.34** −0.01 −0.20 −0.06 −0.01 −0.07 0.01 −0.02

[2.33] [1.53] [1.29] [1.76] [−1.54] [0.77] [−0.75] [0.52] [−0.73] [−0.51] [−2.51] [−0.35] [−1.00] [−0.74] [−0.18] [−0.92] [0.26] [−0.72]

The table shows summary statistics of all interim CEO successions. (1) Promoted reports descriptive statistics of CEO successions in which the interim CEO is subsequently promoted to the permanent CEO position. (2) Not Promoted reports descriptive statistics for successions in which the interim CEOs are not promoted to the permanent CEO position. (1)–(2) reports the differences in sample means between the two groups. T-statistics of twosample t-tests are reported in brackets. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively. Variable definitions are in the Appendix A. Continuous variables are winsorized at the 1% and 99% levels. The sample period is from 1994 to 2014.

4.3. Control variables 4.3.1. Other motivations for using interim CEOs We use two variables to proxy for the two most common circumstances under which prior research has found that firms tend to use interim CEOs: when the previous CEO departs suddenly or unexpectedly (Mooney et al., 2012) and when a firm forces out a poorly performing CEO without having a suitable successor lined up (Ballinger and Marcel, 2010). We search public media and SEC 8-K filings for announcements of sudden CEO departures. Sudden Departure is a dummy variable that equals one when the previous 7

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CEO's departure is due to death or medical issues and zero otherwise.13 Following Parrino (1997), we use the dummy variable Forced Prior, which equals one if the previous CEO was fired or forced to resign and zero otherwise.14 Consistent with the previous literature, the results in Table 2 show that firms that had a sudden or forced CEO departure are more likely to use interim CEOs. The difference in Sudden Departure between successions that use interim and successions that directly appoint CEOs is 0.06 (p-value ≤.01), and the difference in Forced Prior is 0.28 (p-value ≤.01). Overall, the two circumstances account for approximately 53% of the interim CEO appointments in our sample. 4.3.2. Candidate characteristics We control for candidate's prior employer, previous CEO experience, age, and gender in our empirical tests. Table 2 displays the summary statistics for candidate characteristics, broken down by firms that use interim positions and firms that do not. The CEO successors tend to be employees from the current firm, regardless of whether the firm uses an interim CEO. Specifically, 62% of interim CEOs are promoted from within the firm (henceforth “insiders”) and 73% of directly named CEOs are insiders. 40% of interim CEOs and 33% of directly appointed CEOs tend to have CEO experience. The difference in CEO Experience is positive (0.07 months) and significant at the 1% level (Table 2). Interim CEOs tend to be older than directly named CEOs (54.9 years vs. 52.4 years, respectively). In both groups of firms, those that use an interim CEO and those that name CEOs directly without an interim period, only 4% of the appointees are female. Table 3 reports the characteristics of the interim CEOs who are promoted after the interim period relative to those who are not promoted. We find no significant difference in a candidate's employment origins between interim CEOs who do or do not become permanent CEOs. Interim CEOs who are promoted are slightly younger than those who are not promoted (53.34 years vs. 55.68 years), a statically significant difference (p-value ≤ 01). There is no significant difference in gender between these groups. 4.3.3. Firm characteristics We control for the following firm-level characteristics in the multivariate analyses in Sections 5 and 6: the logarithm of total assets (Log(AT)); the book-to-market ratio (B/M); the Debt Ratio, which is the sum of long-term debt and debt in current liabilities scaled by lagged total assets; the previous fiscal year's stock return compounded monthly (Return(t-1)); the fraction of shares held by institutional investors (Institutional Ownership); and the proportion of independent directors (Indep. Director). All control variables are measured at time t − 1. Table 2 reports firm characteristics for our sample of CEO successions, broken down by whether firms use interim CEOs or directly appoint permanent CEOs. Generally, firms that use interim CEOs are smaller and show poorer performance prior to the succession, which is consistent with the high forced turnover rate in the treatment group. Institutional ownership is lower, but board independence is higher among the firms that choose to use an interim CEO. Table 3 reports the same firm characteristics, conditioned on whether the interim CEO is subsequently promoted to a permanent position. We find no significant differences in firm fundamentals between firms that promote interim CEOs and those that do not. 5. Empirical results 5.1. Determinants of using interim CEOs We use probit models to test Hypothesis 1, which posits that candidates whose managerial ability is uncertain are more likely to be named interim CEOs. The dependent variable is the dummy Interim, which equals one if the candidate is named interim CEO and zero if the candidate is named permanent CEO. We use two variables to measure managerial uncertainty: 36-month IVol. and the Uncertainty Index. Positive values on these two variables would lend support to Hypothesis 1, indicating that interim CEOs are more common when managerial uncertainty is high. Table 4 reports the propensity of using interim CEOs. Model 1, which controls for firm and CEO characteristics, shows our baseline results. The coefficient of 36-month IVol. is 2.84 and its marginal effect is 0.51, significant at the 1% level. The Uncertainty Index also has a significant positive effect on a firm's likelihood of using an interim CEO, with a marginal effect of 0.03. The positive relationship between the probability of using interim CEO and uncertainty of managerial skill is also economically significant. Holding other variables at the mean level, the results indicate that the probability of using an interim CEO will increase by 3.05% when the 36-month IVol. increases from the 50th percentile to the 75th percentile and 3.37% when the Uncertainty Index increases from 1 to 2, respectively.15 These results support the hypothesis that candidates whose managerial ability is more uncertain are more likely to be named interim CEOs rather than directly appointed as permanent CEOs. Consistent with the univariate results in Table 2, Model 1 of Table 4 also shows that firms that use interim CEOs and firms that do not differ substantially. Firms that use interim CEOs tend to be slightly smaller and have lower pre-turnover stock returns than those that directly appoint new CEOs. Their institutional ownership is relatively low, and their boards tend to be more independent. Further, interim CEOs are more likely to be insiders and are relatively older than CEOs who are appointed directly. We also control 13

Although we would like to include scandals that forced CEOs to suddenly leave their positions, such data are tricky to define and collect. We thank Dirk Jenter, Florian Peters, and Alexander Wagner for providing their turnover data. For details about these data, please see Jenter and Kanaan (2015) and Peters and Wagner (2014). 15 Hereafter, we refer to this as the change in implied probability. 14

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Table 4 Determinants of using interim CEOs. Variable

36-Month IVol. Uncertainty Index Sudden departure Forced prior Outsider Female Age Log(AT) Debt ratio B/M CEO experience Return(t-1) Institutional ownership Indep. director Constant Year FE. Industry FE N. Obs. Pseudo R2

Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

Model 7

Model 8

Raw sample

Matched sample

High Board indep.

Low Board indep.

Low E-index

High E-index

High return

Low return

2.84*** (3.75) 0.16*** (2.98) 1.49*** (6.27) 0.70*** (7.43) −0.56*** (−4.45) 0.25 (1.28) 0.03*** (5.55) −0.38*** (−11.20) 0.54** (2.49) 0.17 (1.54) 0.02 (0.17) −0.20** (−2.12) −0.52*** (−4.09) 0.46*** (2.72) −1.64 (−1.58) Yes Yes 1910 0.39

5.28*** (4.34) 0.27*** (2.82) 1.93*** (4.55) 0.80*** (5.49) −0.85*** (−4.00) −0.23 (−0.79) 0.04*** (3.79) 0.13** (2.48) 0.01 (0.03) −0.11 (−0.61) 0.24* (1.72) −0.35** (−2.20) −0.07 (−0.36) 0.54* (1.76) −1.45 (−0.99) Yes Yes 522 0.26

4.30*** (3.99) 0.14* (1.83) 2.05*** (6.08) 0.69*** (5.60) −0.85*** (−4.76) 0.35 (1.43) 0.04*** (5.02) −0.34*** (−7.75) 0.71** (2.46) 0.15 (0.98) −0.01 (−0.10) −0.23* (−1.75) −0.45*** (−2.66) 1.06*** (3.22) −1.33 (−1.42) Yes Yes 982 0.42

1.06 (0.83) 0.18** (2.05) 1.02*** (2.77) 0.77*** (4.78) −0.31 (−1.62) 0.10 (0.29) 0.04*** (4.12) −0.49*** (−8.52) 0.33 (0.92) 0.05 (0.26) 0.10 (0.69) −0.21 (−1.35) −0.78*** (−3.79) 0.08 (0.22) 0.90 (0.75) Yes Yes 861 0.44

7.12*** (3.31) 0.31** (2.20) 1.33* (1.68) 1.38*** (6.18) −1.07*** (−3.22) 0.52 (1.52) 0.03 (1.60) −0.15** (−2.12) 1.04* (1.93) 0.32 (0.94) 0.24 (0.97) −0.46** (−2.08) −0.12 (−0.40) 0.92* (1.89) −1.91 (−1.41) Yes Yes 417 0.38

2.73*** (2.77) 0.07 (0.89) 1.53*** (4.80) 0.48*** (3.80) −0.50*** (−2.74) −0.06 (−0.20) 0.04*** (5.51) −0.49*** (−9.60) 0.53* (1.77) 0.34** (2.37) 0.01 (0.09) −0.09 (−0.78) −0.49*** (−2.64) 0.35 (1.53) −0.59 (−0.45) Yes Yes 944 0.43

5.60*** (2.86) 0.41*** (2.94) 1.48*** (2.67) 0.86*** (3.43) −0.91*** (−2.92) 0.45 (1.05) 0.03** (2.42) −0.47*** (−5.97) 0.79* (1.69) 0.24 (0.76) 0.18 (0.75) −0.20 (−0.67) −0.75*** (−2.78) −0.07 (−0.19) −0.79 (−0.65) Yes Yes 417 0.46

3.10** (1.96) 0.17 (1.38) 2.57*** (3.50) 0.44** (2.42) −0.81*** (−3.01) 0.93** (2.57) 0.05*** (3.57) −0.49*** (−7.07) 0.51 (1.03) −0.12 (−0.62) −0.07 (−0.35) −0.60*** (−2.74) −0.49* (−1.78) 0.33 (0.99) 0.81 (0.62) Yes Yes 473 0.45

This table reports the estimation results of probit models. The dependent variable is Interim CEO, which equals one if the candidate is named interim CEO and zero if the candidate is directly named permanent CEO without an interim period. 36-Month IVol. is the standard deviation of the previous 36 months' idiosyncratic risk of the candidate's previous employer. The Uncertainty Index is the sum of the following three binary variables: Short Tenure, Not a Top Manager, and No Employment Record. Sudden Departure is a dummy variable that equals one if the turnover is due to the sudden death or medical problems of the previous CEO and zero otherwise. Forced Prior is a dummy variable that equals one if the previous CEO is fired or forced to resign and zero otherwise. Model2 reports the results using a matched sample. Models 3 to 8 report subsample analyses. High Board Indep. and Low Board Indep. represent the groups whose proportion of independent directors on the board is larger or smaller than the fiscal year and industry sample mean, respectively. Low E-index represents the group whose E-index≤2. High E-index represents the group whose E-index ≥4. High Return represents the group whose Return(t-1) is larger than the 75th percentile of Return(t-1) sorted by fiscal year and industry. Low Return represents the group whose Return(t-1) is less than the 25th percentile of Return(t-1) sorted by fiscal year and industry. Detailed variables definitions are in the Appendix A. All continuous variables are winsorized at the 1% and 99% levels. Standard errors are clustered at the firm level. Chi-statistics are reported in parentheses. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively.

for the caretaker function of interim CEOs in our probit regressions by including the variables Sudden Departure and Forced Prior. The results are broadly consistent with the previous literature: Firms use interim CEOs when the prior CEO departs suddenly. After controlling for the caretaker rationale for using interim positions, managerial uncertainty is still significantly positively related to the likelihood of using interim positions, suggesting that the testing-ground option is also one of the motivations of appointing interim CEOs. To address the potential heterogeneity of firm characteristics between the two groups, we construct a matched sample. Each interim CEO succession (treated) is matched with one permanent CEO succession (control) occurring in the same calendar year using a propensity score matching approach based on a firm's total assets, debt ratio, and book-to-market ratio in the previous fiscal year. The results using this matched sample are reported in Model 2 of Table 4. After matching on firm characteristics, the implied probability of 36-month IVol. increases by 8.36% and the implied probability of the Uncertainty Index increases by 10.62% in Model 2. We next conduct subsample analyses to test Hypotheses 1a and 1b, which postulate that the likelihood of using interim CEOs to test managerial ability is higher for firms with better corporate governance and better previous firm performance. First, we separate firms into good corporate governance and bad corporate governance groups based on board independence and the E-index (Bebchuk et al., 2008). For a given fiscal year, firms whose proportion of independent directors is larger (smaller) than the industry mean in our 9

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sample are classified as having good (bad) corporate governance. Models 3 and 4 in Table 4 present the results of probit regressions using these two subsamples. Consistent with Hypothesis 1a, the positive effects of 36-month IVol. are more substantial for firms with greater board independence. The implied probability of 36-month IVol. in Model 3 is 5.17% for firms with highly independent boards, compared to 0.89% in Model 4 for firms whose boards have low independence. We detect no significant difference in the marginal effect of the Uncertainty Index between firms with higher versus lower board independence. Models 5 and 6 in Table 4 use the E-index as another proxy for corporate governance. Firms with an E-index score less than or equal to 2 are categorized as having good corporate governance, and firms with an E-index score greater than or equal to 4 are categorized as having bad corporate governance. The marginal effect (implied probability) of the 36-month IVol. is 0.99 (4.69%) for well-governed firms, compared to 0.55 (3.96%) for poorly governed firms. The marginal effect of the Uncertainty Index is 0.04 for well-governed firms, compared to a statistically insignificant 0.01 for poorly governed firms. These results suggest that the wellgoverned firms are 4.60% more likely to use an interim CEO if the Uncertainty Index score increases from 1 to 2. However, for poorly governed firms, the increased probability is 1.98%. Overall, these results indicate that firms with better governance are more likely to use interim CEOs when the managerial ability of the candidate is more uncertain, supporting Hypothesis 1a. Second, we sort firms' stock returns of the previous fiscal-year by industry and year within the sample. Firms with stock returns above the 75% quartile are categorized as the high return group, and firms with stock returns below the 25% quartile are categorized as the low return group. Models 7 and 8 report the subsample analyses. Consistent with Hypothesis 1b, the relationship between the use of interim CEO and the uncertainty of managerial ability are more pronounced for firms in the high return group. These results imply that the well-performing firms are 4.86% more likely to use an interim CEO if the 36-month IVol. increases from the 50th to the 75th percentile, compared to 3.66% for poorly performing firms. When the Uncertainty Index increases from 1 to 2, firms in the high return group are 7.56% more likely to use an interim CEO compared to an insignificant 4.19% for poorly performing firms. These findings support Hypothesis 1b, which posits that firms with good previous performance can bear the potential firm value deterioration associated with using interim CEOs. 5.2. Determinants of interim CEO promotion Under the testing-ground option, the outcome of the test depends on the interim CEO's performance. In this section, we use probit models to investigate whether the decision to promote an interim CEO to the formal position is affected by the interim-period stock performance attributable to managerial skill. The dependent variable is the dummy Promoted, which equals one if the interim CEO is promoted to permanent CEO and zero otherwise. Table 5 reports the probit regression estimates for interim CEO promotions. After controlling for managerial ability uncertainty, circumstances requiring the caretakers, and other firm and CEO characteristics, firms that experience better interim-period abnormal stock performance are more likely to promote their interim CEOs. The coefficient of BHAR is 0.50 (p-value≤.01) in Model 1 of Table 5 with a marginal effect of 0.16, implying that the interim CEO is 3.24% more likely to be promoted to permanent CEO if the buy and hold abnormal returns increase from 50th to 75th percentile. We find no significant differences in firm and CEO characteristics between the promoted and not-promoted groups except for candidate age and board independence. Chen et al. (2015) find that interim CEOs manage firms' earnings to enhance their probability of promotion. We use the absolute value of discrete accruals (Discretionary Accruals) to measure the level of earnings management during a firm's interim period. Discretionary accruals are constructed using the modified Jones (1991) model, following Chen et al. (2015). We collect firms' financial information for the first and last quarter within the interim period. All fiscal-quarters within the first and last quarter are counted as the fiscal-quarters under the management of interim CEOs. As the beginnings and ends of interim periods are random and the periods are relatively short, we assume interim CEOs are not capable of conducting earnings management for successions that do not contain a completed fiscal-quarter and set Discretionary Accruals equal to 0 for these observations. Model 2 in Table 5 controls for Discretionary Accruals. The coefficient and the implied probability of BHAR decreases slightly to 0.49 and to 3.12% but still have significant explanatory power. Model 3 in Table 5 uses a hazard model as an alternative method to analyze interim CEO promotion. Model 4 in Table 5 replicates the Model 2 baseline results using a matched sample, following the matching procedure described in Section 5.1. The positive relationship between BHAR and promotion probability remains statistically and economically significant after controlling for heterogeneity and when using these alternative empirical methods. To further test the hypothesis that firms only promote interim CEOs with better managerial skills and not those who are simply lucky, we decompose the interim-period stock return into skill and luck components. The empirical results are reported in. Table 6. The probability of promotion depends mainly on the managerial skills of interim CEOs, supporting Hypothesis 2. The coefficients of Skill range from 0.29 to 0.53 for the various models and specifications. The explanatory power of Skill remains significant except for that in Model 4. The coefficients of Luck range from −0.33 to 0.11 and are not statistically significant. For instance, in Model 2 of Table 6, the results imply that the probability of getting promoted to permanent CEO increases by 3.42% if the interim CEO has higher Skill, compared to an insignificant 0.37% for higher Luck.16 If firms use interim positions as an option to test the managerial skill of CEO candidates, we would expect firms to be more sensitive to firm performance during the interim period for candidates whose managerial ability is less certain (Hypothesis 2a) and in circumstances that do not require a caretaker (Hypothesis 2b). To test Hypothesis 2a, we sort interim CEO successions by year and 16

Higher Skill or Luck is measured from 50th to 75th percentile change. 10

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Table 5 Determinants of interim CEOs' promotion. Variable

BHAR 36-Month IVol. Uncertainty index Sudden departure Forced prior Outsider CEO experience Age Female Discretionary accruals Log(AT) B/M Debt Ratio Return(t-1) Institutional ownership Indep. director Constant Year FE Industry FE N. Obs. Pseudo R2

Model 1

Model 2

Model 3

Model 4

Raw Sample

Raw Sample

Hazard Model

Matched Sample

0.50*** (2.90) 2.48* (1.95) 0.10 (0.93) 0.27 (0.79) −0.23 (−1.46) −0.22 (−0.92) 0.09 (0.50) −0.02* (−1.81) 0.02 (0.07)

0.49*** (2.76) 2.43* (1.91) 0.10 (0.96) 0.27 (0.80) −0.24 (−1.49) −0.23 (−0.94) 0.09 (0.50) −0.02* (−1.85) 0.04 (0.10) 0.09 (0.64) −0.07 (−1.41) −0.10 (−1.16) −0.02 (−0.17) −0.17 (−1.18) 0.23 (1.05) −0.56* (−1.85) 2.34** (2.03) Yes Yes 384 0.13

0.39* (1.89) 2.94* (1.71) 0.11 (0.69) −0.07 (−0.17) −0.42* (−1.80) −0.16 (−0.49) 0.02 (0.07) −0.02* (−1.96) −0.18 (−0.43) −0.22 (−1.37) −0.15* (−1.80) −0.08 (−0.61) 0.14 (1.07) −0.06 (−0.28) 0.61* (1.87) −0.25 (−0.69)

0.42* (1.78) 2.40 (1.26) 0.20 (1.46) 0.52 (1.07) −0.20 (−0.98) −0.33 (−1.15) 0.10 (0.46) −0.02** (−2.09) −0.27 (−0.65) 0.11 (0.66) −0.07 (−0.98) 0.03 (0.15) 0.05 (0.42) −0.10 (−0.59) 0.21 (0.71) −0.27 (−0.71) 2.31** (2.07) Yes Yes 242 0.11

−0.07 (−1.43) −0.10 (−1.17) 0.00 (0.01) −0.17 (−1.13) 0.24 (1.07) −0.56* (−1.88) 2.40** (2.05) Yes Yes 384 0.13

Yes Yes 422 0.07

This table reports the results of multivariate analyses of the determinants of interim CEO promotion. The dependent variable is Promoted, which equals one if the interim CEO is subsequently promoted to the permanent CEO position and zero otherwise. Interim-period performance is measured using BHAR, which is the interim-period buy and hold abnormal returns. Models 1 and Model 2 report estimation results of probit regressions. Model 3 reports the estimation results of the Cox proportional hazard model. Model 4 reports estimation results of a probit regression using a matched sample. Detailed variable definitions are reported in the Appendix A. All continuous variables are winsorized at the 1% and 99% levels. Standard errors are clustered at the firm level. Chi-statistics are reported in parentheses. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively

separate the sample into a high and low group based on whether their 36-Month IVol. is greater than or lower than the mean value. Models 1 and 2 in Table 7 report the subsample analyses. The coefficient of BHAR is 0.69 with an implied probability of 4.43% for interim CEOs with a high 36-Month IVol. from their previous employer. Models 3 and 4 repeat these analyses but instead use subsamples based on high and low Uncertainty Index scores. The coefficient of BHAR 0.92 with an implied probability of 4.93% among the group with high Uncertainty Index scores. The coefficients of BHAR are not significant for interim CEOs in the low 36Month IVol. or low Uncertainty Index groups, consistent with Hypothesis 2a. Hypothesis 2b posits that when interim CEOs act as caretakers, interim-period firm performance is less likely to be a factor in promotion to permanent CEO. To test this hypothesis, we divide the full sample into two subsamples: a Non-Caretaker group of interim CEO successions (Sudden Departure = 0 and Forced Prior = 0 for the prior permanent CEO), and a Caretaker group of interim CEO successions (Sudden Departure = 1 or Forced Prior = 1 for the prior permanent CEO). The results are reported in. Table 7, Models 5 and 6. The positive effect of BHAR remains significant in both models, but their magnitudes are economically distinct. The marginal effects of BHAR are 0.34 and 0.14 in Models 5 and 6, respectively. The results suggest that the promotionperformance sensitivity is 6.44% for the Non-caretaker group and 3.20% for Caretaker group.17 Therefore, the relationship between 17

The number is measured when BHAR increases from 50th to 75th percentile. 11

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Table 6 Determinants of interim CEOs' Promotion: alternative measures. Variable

Skill Luck 36-month IVol. Uncertainty index Sudden departure Forced prior Outsider CEO experience Age Female Discretionary accruals Log(AT) B/M Debt ratio Return(t-1) Institutional ownership Indep. director Constant Year FE Industry FE N. Obs. Pseudo R2

Model 1

Model 2

Model 3

Model 4

Raw sample

Raw sample

Hazard model

Matched sample

0.53*** (2.61) 0.07 (0.16) 2.37* (1.87) 0.10 (0.93) 0.27 (0.82) −0.23 (−1.46) −0.23 (−0.98) 0.10 (0.58) −0.02** (−1.98) 0.01 (0.03)

0.51** (2.47) 0.11 (0.27) 2.32* (1.83) 0.10 (0.97) 0.28 (0.83) −0.24 (−1.48) −0.24 (−1.02) 0.10 (0.59) −0.02** (−2.02) 0.02 (0.07) 0.10 (0.72) −0.08 (−1.56) −0.10 (−1.10) −0.01 (−0.12) −0.21 (−1.47) 0.19 (0.83) −0.54* (−1.81) 2.39** (2.18) Yes Yes 384 0.13

0.37* (1.83) −0.33 (−0.68) 2.66 (1.57) 0.10 (0.65) −0.08 (−0.19) −0.40* (−1.72) −0.16 (−0.49) 0.03 (0.13) −0.02** (−2.10) −0.18 (−0.43) −0.24 (−1.40) −0.18** (−2.12) −0.07 (−0.58) 0.15 (1.28) −0.12 (−0.58) 0.55* (1.68) −0.27 (−0.73)

0.29 (1.07) 0.05 (0.08) 1.96 (1.06) 0.20 (1.54) 0.52 (1.08) −0.21 (−1.06) −0.33 (−1.15) 0.09 (0.41) −0.03** (−2.24) −0.32 (−0.77) 0.12 (0.75) −0.08 (−1.09) 0.04 (0.17) 0.05 (0.45) −0.13 (−0.74) 0.20 (0.66) −0.25 (−0.67) 2.35** (2.15) Yes Yes 242 0.10

−0.08 (−1.59) −0.10 (−1.11) 0.01 (0.08) −0.21 (−1.43) 0.19 (0.84) −0.56* (−1.84) 2.46** (2.23) Yes Yes 384 0.13

Yes Yes 422 0.07

This table reports the results of multivariate analyses of the determinants of interim CEO promotion. The dependent variable is Promoted, which equals one if the interim CEO is subsequently promoted to permanent CEO and zero otherwise. Interim-period performance is measured using Skill and Luck, which are constructed using the following regression model: Returnit = α + β1Market Returnit + β2Industry Returnit + Year Dummyt + εit. Skill is defined as the residual εit of the model, which measures the return attributable to managerial skills. Luck is defined as the predicted value of Returnit , which measures the return attributed to windfall effects due to market movements, industry movements, and other macroeconomic shocks. Models 1 and 2 report estimation results of probit regressions. Model 3 reports the estimation results of the Cox proportional hazard model. Model 4 reports estimation results using a matched sample. Detailed variable definitions are reported in the Appendix A. All continuous variables are winsorized at the 1% and 99% levels. Standard errors are clustered at the firm level. Chi-statistics are reported in parentheses. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively.

promotion probability and interim period firm performance is stronger when there is no need for a caretaker interim CEO, supporting Hypothesis 2b. In Table 8, we repeat the subsample analyses using Skill and Luck as alternative measurements of managerial skills. Empirical results in Model 1 to Model 4 suggests that a firm performing better in a way that is attributable to managerial skills leads to a significantly greater probability of an interim CEO with uncertain management skills being promoted, consistent with Hypothesis 2a. The results are the opposite when firm performance is attributable to luck. Models 5 and 6 of Table 8 report similar results as that in Model 5 and 6 of Table 7. Among non-caretakers, Skill has a coefficient of 0.85 and is significant at the 5% level but has a smaller and insignificant coefficient for the caretaker group, consistent with Hypothesis 2b.

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Table 7 Determinants of interim CEOs' promotion: subsample analysis. Variable

BHAR 36-month IVol. Uncertainty index Sudden departure Forced prior Outsider CEO Experience Age Female Discretionary accruals Log(AT) B/M Debt ratio Return(t-1) Institutional ownership Indep. director Constant Year FE Industry FE N. Obs. Pseudo R2

Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

High IVol.

Low IVol.

High index

Low index

Non-caretaker

Caretaker

0.69*** (2.80) −0.21 (−0.05) 0.43** (2.56) −0.35 (−0.84) −0.30 (−1.32) −0.54 (−1.33) −0.20 (−0.77) −0.03* (−1.73) −0.66 (−1.10) 0.09 (0.52) −0.14 (−1.62) −0.18* (−1.83) 0.10 (0.90) −0.46** (−2.48) 0.35 (1.00) −0.39 (−0.83) −0.01 (−0.01) Yes Yes 206 0.23

0.50 (1.27) 3.95 (0.94) −0.33 (−1.32) 1.64** (2.53) −0.49 (−1.33) −0.25 (−0.48) 0.41 (1.11) −0.01 (−0.73) −0.07 (−0.09) −0.34 (−0.89) −0.04 (−0.39) −0.23 (−0.63) −0.43 (−0.50) 0.49 (1.19) 0.34 (0.82) −0.80 (−1.25) 2.46 (1.54) Yes Yes 125 0.30

0.92*** (2.94) 6.55** (2.07) 0.06 (0.19) −1.68** (−2.04) −0.21 (−0.81) −0.35 (−0.80) 0.14 (0.47) −0.01 (−0.80) −0.29 (−0.56) −0.01 (−0.05) −0.17* (−1.65) −0.46* (−1.69) −0.26 (−0.97) −0.37 (−1.54) 0.17 (0.39) −0.82 (−1.53) 1.54 (1.00) Yes Yes 173 0.28

−0.01 (−0.04) 3.34* (1.69) 0.27 (0.94) 0.71 (1.31) −0.38 (−1.41) −1.06* (−1.76) 0.53* (1.73) −0.02 (−1.19) 0.36 (0.60) 0.35 (1.59) −0.03 (−0.45) 0.02 (0.09) −0.00 (−0.01) −0.29 (−1.22) 0.00 (0.02) −0.74 (−1.58) 0.59 (0.39) Yes Yes 185 0.25

1.20*** (3.45) 1.69 (0.79) −0.27 (−1.52)

0.50** (2.03) 1.42 (0.71) 0.24 (1.29)

0.40 (1.00) 0.11 (0.35) −0.02 (−1.05) 0.79 (1.37) 0.20 (0.90) −0.18* (−1.96) −0.32 (−1.35) 0.01 (0.04) −0.53** (−2.05) 0.80** (2.04) −1.62*** (−3.04) 2.80** (2.16) Yes Yes 171 0.22

−0.35 (−0.79) 0.04 (0.17) −0.01 (−0.78) −0.84 (−1.08) −0.12 (−0.44) −0.03 (−0.47) 0.01 (0.03) −0.35 (−0.91) 0.09 (0.35) 0.10 (0.27) −1.00** (−2.08) 2.65** (2.14) Yes Yes 174 0.23

This table reports subsample analyses of the determinants of interim CEO promotion using probit models. BHAR is used as the interim-period performance measure. High IVol. (Low IVol.) is the group of interim CEO successions whose 36-Month IVol. is greater (lower) than the mean value in the corresponding calendar year. High Index (Low Index) is the group of interim CEO succession whose Uncertainty Index is greater (lower) than the mean value in the corresponding calendar year. Non-Caretaker is the group of interim CEO successions without sudden departures or forced turnovers of the previous CEO. Caretaker is the group of interim CEO succession with sudden departures or forced turnovers of the previous CEO. Variables are defined in the Appendix A. All continuous variables are winsorized at the 1% and 99% levels. Standard errors are clustered at the firm level. Chi-statistics are reported in parentheses. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively.

6. Further discussion 6.1. The effectiveness of the testing-ground option One purpose of the testing-ground option is to motivate interim CEOs to demonstrate their managerial ability. If this test is effective, interim CEOs will make operational decisions designed to enhance their promotion prospects. To explore whether this option effectively motivates CEO candidates, we study the quarterly changes in operational activities and firm performance that are under the influence of interim CEOs. Changes in quarterly operational activities and firm performance during the interim period are defined as

Cik =

1 n

n

[Ci (t + j)

Ci (t

j) ]

(2)

j=1

ΔCik is the mean value of the quarterly change in the ith operational activity or performance measure for group k. Group k is either the promoted group or the not-promoted group. t + j is the jth quarter after the interim CEO succession at time t, and t-j is the corresponding quarter before the interim CEO succession. To be included in the test, quarter t + j must be fully included within the interim 13

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Table 8 Determinants of interim CEOs' promotion: subsample analysis using alternative measures. Variable

Skill Luck 36-month IVol. Uncertainty index Sudden departure Forced prior Outsider CEO experience Age Female Discretionary accruals Log(AT) B/M Debt ratio Return(t-1) Institutional ownership Indep. director Constant Year FE Industry FE N. Obs. Pseudo R2

Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

High IVol.

Low IVol.

High index

Low index

Non-caretaker

Caretaker

0.54* (1.89) −0.29 (−0.47) −0.35 (−0.09) 0.41** (2.44) −0.39 (−0.91) −0.30 (−1.31) −0.54 (−1.33) −0.17 (−0.67) −0.02 (−1.56) −0.55 (−0.94) 0.11 (0.62) −0.16* (−1.73) −0.16* (−1.65) 0.09 (0.84) −0.47** (−2.49) 0.28 (0.78) −0.34 (−0.73) 0.08 (0.07) Yes Yes 206 0.22

0.24 (0.48) 2.70** (2.16) 2.82 (0.69) −0.27 (−1.06) 1.89*** (3.13) −0.46 (−1.22) −0.67 (−1.39) 0.45 (1.22) −0.01 (−0.50) −0.08 (−0.11) −0.35 (−0.85) −0.06 (−0.61) 0.10 (0.27) −0.54 (−0.60) 0.44 (1.10) 0.22 (0.50) −0.69 (−1.08) 2.46 (1.57) Yes Yes 125 0.33

1.05*** (2.77) 1.15* (1.65) 7.11** (2.21) 0.09 (0.27) −1.33* (−1.87) −0.14 (−0.56) −0.61 (−1.38) 0.18 (0.61) −0.02 (−0.88) −0.28 (−0.53) 0.10 (0.34) −0.17* (−1.67) −0.42* (−1.68) −0.17 (−0.67) −0.44* (−1.88) 0.11 (0.24) −0.66 (−1.27) 1.69 (1.11) Yes Yes 173 0.28

−0.09 (−0.28) −2.00** (−2.36) 2.95 (1.48) 0.29 (1.04) 0.70 (1.29) −0.34 (−1.26) −0.92 (−1.46) 0.51 (1.62) −0.02 (−1.14) 0.27 (0.40) 0.33 (1.51) −0.01 (−0.09) −0.00 (−0.00) −0.05 (−0.44) −0.32 (−1.29) 0.07 (0.21) −0.82* (−1.67) 0.27 (0.18) Yes Yes 185 0.28

0.85** (2.13) 0.68 (1.00) 1.46 (0.71) −0.21 (−1.21)

0.31 (1.00) −0.34 (−0.51) 1.08 (0.55) 0.24 (1.27)

0.21 (0.54) 0.13 (0.45) −0.01 (−0.81) 0.65 (1.11) 0.26 (1.07) −0.18** (−2.10) −0.25 (−1.07) 0.01 (0.11) −0.48* (−1.94) 0.56 (1.47) −1.19** (−2.45) 2.42* (1.80) Yes Yes 171 0.20

−0.37 (−0.84) 0.06 (0.25) −0.01 (−0.88) −0.81 (−1.08) −0.09 (−0.31) −0.04 (−0.58) 0.05 (0.23) −0.38 (−0.92) 0.06 (0.23) 0.05 (0.13) −0.99** (−2.08) 2.82** (2.24) Yes Yes 174 0.22

This table reports subsample analyses of the determinants of interim CEO promotion using probit models. Skill and Luck are used as interim-period performance measures. High IVol. (Low IVol.) is the group of interim CEO succession whose 36-Month IVol. is greater (lower) than the mean value in the corresponding calendar year. High Index (Low Index) is the group of interim CEO succession whose Uncertainty Index is greater (lower) than the mean value in the corresponding calendar year. Non-Caretaker is the group of interim CEO successions without sudden departures or forced turnovers of the previous CEO. Caretaker is the group of interim CEO successions with sudden departures or forced turnovers of the previous CEO. Variables are defined in the Appendix A. All continuous variables are winsorized at the 1% and 99% levels. Standard errors are clustered at the firm level. Chi-statistics are reported in parentheses. *, **, and *** indicate significance at the 10%, 5%, 1% levels, respectively.

period. Operational activities are measured using, equity issuance, debt issuance, capital expenditure, and inventory turnover rate. Firm performance is measured using asset growth, ROA, and EPS. Table 9 reports the t-test results for ΔCik. Panel A compares changes in firm performance during the interim period for interim CEOs who are subsequently promoted versus those who are not promoted. Firms in the promoted group see a significant improvement in EPS and an insignificant increase in asset growth and ROA. For firms in the not-promoted group, asset growth, ROA, and EPS all decrease significantly. Panel B reports the quarterly changes in operational activities. Firms in both the promoted and notpromoted groups, on average, experience a significant increase in their external financing levels through debt and equity issuance. The mean values of the change of capital expenditure and the change of the inventory ratio for the promoted group are also significantly different than zero. Table 10 investigates the determinants of interim CEOs' promotion to permanent CEO by including the quarterly changes in firm performance and operational activities. Controlling for the interim-period buy and hold abnormal returns, firm fundamentals, and interim CEO characteristics, firms in the promoted group, on average, see significant increases in ROA (0.90, p ≤.05) and EPS (0.11, p≤ .1), consistent with the marked stock performance of the promoted group in Table 5. With the exception of the change in equity issuance (0.07, (p ≤0.1), we find no significant differences in quarterly changes in operational activities. 14

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Table 9 Managerial efforts during the interim period: univariate analysis. Variable

(1) Promoted

(2) Not Promoted

Mean

T-Statistics

Mean

T-Statistics

Panel A: Firm performance ΔROA ΔEPS ΔAsset growth ΔSales growth

0.02 0.16* 0.00 0.05

[1.66] [1.81] [0.22] [0.81]

−0.01* −0.12** −0.02** 0.01

[−1.88] [−2.30] [−2.19] [0.32]

Panel B: Operational activities ΔEquity issuance ΔDebt issuance ΔCapital expenditure ΔInventory turnover N. Obs

0.46*** 0.92*** −0.00 1.64* 69

[4.10] [3.34] [−0.07] [1.77]

0.33*** 0.70*** −0.01*** 0.21 161

[3.85] [4.78] [−3.37] [0.43]

This table reports t-test results of quarterly changes in operational activities and firm performance during the interim period. The prefix Δ indicates the average change in the specified characteristic of a firm. Panel A reports t-test results of quarterly changes in firm performance during the interim period. ROA is income before extraordinary items divided by lagged total assets. EPS is earning per share excluding extraordinary items. Asset growth is the logarithm of total assets divided by lagged total assets. Sales growth is the logarithm of total sales divided by lagged total sales. Panel B reports the t-test results of quarterly changes in operational activities during the interim period. Equity Issuance is the logarithm of the sales of common and preferred shares. Debt issuance is the logarithm of long-term debt issuance. Capital Expenditure is capital expenditure divided by lagged total assets. Inventory Turnover is sales divided by inventory. T-statistics are given in brackets. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively. All continuous variables are winsorized at the 1% and 99% levels. Table 10 Managerial efforts during the interim period: multivariate analysis. Variable

Model 1

ΔROA

0.90** (2.00)

ΔEPS ΔAsset growth

Model 2

0.11*** (2.75)

ΔSales growth

Model 3

Model 4

0.13 (0.50)

0.11 (1.10)

ΔEquity issuance ΔDebt issuance

Model 5

0.07* (1.86)

ΔCAPX

Model 6

0.01 (0.40)

ΔInventory turnover Constant Control Year FE Industry FE N. Obs. Adj. R2

0.14** (2.05) Yes Yes Yes 231 0.18

0.13* (1.97) Yes Yes Yes 231 0.19

0.16** (2.34) Yes Yes Yes 231 0.16

0.18** (2.59) Yes Yes Yes 223 0.18

0.14* (1.85) Yes Yes Yes 188 0.21

0.12 (1.36) Yes Yes Yes 183 0.12

Model 7

0.21 (0.20) 0.16** (2.29) Yes Yes Yes 228 0.16

Model 8

0.01 (1.12) 0.23*** (2.76) Yes Yes Yes 171 0.15

This table reports the results of probit regressions of quarterly changes in operational activities and firm performance. ΔROA is the average change in quarterly ROA during the interim period. ΔEPS is the average change in quarterly EPS during the interim period. ΔAsset Growth is the average change in quarterly asset growth during the interim period. ΔSales Growth is the average change in quarterly sales growth during the interim period. ΔEquity Issuance is the average change in quarterly equity issuance during the interim period. ΔDebt Issuance is the average change in quarterly debt issuance during the interim period. ΔCAPX is the average change in quarterly capital expenditures during the interim period. ΔInventory Turnover is the average change in quarterly inventory turnover during the interim period. Other control variables are similar to those in Table 5. Variables are defined in the Appendix A. T-statistics are given in brackets. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively. All continuous variables are winsorized at the 1% and 99% levels.

Overall, we find that interim CEOs in both the promoted and not-promoted groups make operational changes during the interim period. Firms that subsequently promote their interim CEOs experience better operational firm performance, on average, which is consistent with the better interim-period stock performance of firms in that group that we observe.

15

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Table 11 Long-term firm performance after CEO succession. Variable

Treat × Post Treat Post Forced Prior Outsider Retiring Age Female Log(AT) B/M Debt Ratio Return(t-1) Institutional ownership Indep. director Constant Year FE Industry FE N. Obs. Adj R2

All interim

Promoted

Not promoted

Model 1

Model 2

Model 3

Model 4

Model 5

Model 6

Model 7

Model 8

Model 9

[−1,1]

[−3.3]

[−5,5]

[−1,1]

[−3.3]

[−5,5]

[−1,1]

[−3.3]

[−5,5]

0.65 −1.08 −0.04 (−0.11) −0.08 (−0.32) −0.41 (−1.22) −0.07 (−0.28) −0.11 (−0.15) −0.37 (−0.56) −0.16** (−2.13) −1.34*** (−3.90) −0.35 (−0.47) 0.21 −0.76 0.24 −0.63 −0.51 (−1.10) 6.32*** −5.77 Yes Yes 3068 0.51

0.5 −0.93 −0.12 (−0.38) −0.18 (−1.01) −0.53** (−2.13) −0.29 (−1.47) 0.14 −0.25 −0.2 (−0.46) −0.18*** (−3.13) −1.35*** (−4.94) −0.67 (−1.24) 0.35* −1.69 0.1 −0.42 −0.16 (−0.49) 6.82*** −6.46 Yes Yes 7450 0.5

1.07** −2.09 −0.47 (−1.64) −0.26* (−1.67) −0.34 (−1.53) −0.16 (−0.92) −0.24 (−0.53) −0.58 (−1.43) −0.16*** (−3.34) −1.43*** (−5.79) −0.77 (−1.62) 0.37** −2.04 0.01 −0.06 −0.19 (−0.62) 7.05*** −6.42 Yes Yes 10,042 0.49

1.53* −1.78 −0.4 (−0.67) −0.11 (−0.44) −0.44 (−1.20) −0.05 (−0.18) −0.19 (−0.24) −0.12 (−0.18) −0.16** (−2.08) −1.34*** (−3.58) −0.63 (−0.78) 0.1 −0.33 0.33 −0.76 −0.6 (−1.20) 6.62*** −5.52 Yes Yes 2754 0.51

1.76** −1.97 −0.67 (−1.45) −0.19 (−1.10) −0.55** (−2.02) −0.33 (−1.55) 0.17 −0.33 −0.04 (−0.09) −0.19*** (−3.09) −1.24*** (−4.27) −0.81 (−1.41) 0.46** −2.1 0.12 −0.46 −0.11 (−0.31) 6.83*** −6.3 Yes Yes 6780 0.5

2.02** −2.26 −0.91** (−2.10) −0.25 (−1.60) −0.36 (−1.47) −0.16 (−0.89) −0.19 (−0.43) −0.47 (−1.17) −0.19*** (−3.56) −1.31*** (−4.93) −0.89* (−1.78) 0.44** −2.3 0.01 −0.05 −0.14 (−0.44) 7.13*** −6.38 Yes Yes 9226 0.49

0.26 −0.35 0.04 −0.08 −0.07 (−0.27) −0.41 (−1.15) 0.01 −0.04 0.02 −0.02 −0.36 (−0.51) −0.16** (−1.99) −1.40*** (−3.73) −0.29 (−0.38) 0.22 −0.72 0.32 −0.79 −0.49 (−1.01) 7.89*** −6.71 Yes Yes 2914 0.5

−0.02 (−0.04) 0.02 −0.05 −0.16 (−0.89) −0.51* (−1.93) −0.23 (−1.09) 0.34 −0.59 −0.24 (−0.54) −0.19*** (−3.21) −1.48*** (−5.27) −0.68 (−1.23) 0.29 −1.35 0.09 −0.34 −0.13 (−0.40) 7.61*** −6.57 Yes Yes 7160 0.49

0.7 −1.21 −0.37 (−1.10) −0.24 (−1.51) −0.29 (−1.25) −0.11 (−0.60) −0.12 (−0.27) −0.65 (−1.58) −0.17*** (−3.39) −1.55*** (−6.14) −0.8 (−1.64) 0.33* −1.82 0.01 −0.03 −0.11 (−0.35) 7.68*** −6.56 Yes Yes 9696 0.48

This table reports the estimation results of OLS regressions. The dependent variable is the Market-to-Book Ratio adjusted by the industry mean in the corresponding fiscal year. Treat is a dummy variable equal to one if the observation is in the treatment group and zero otherwise. The control group in all models is CEO successions that do not use interim CEOs. The treatment group in Models 1 to 3 comprises CEO successions that use interim CEOs. The treatment group in Models 4 to 6 comprises CEO successions in which the interim CEO is subsequently promoted to the permanent CEO position. The treatment group in Models 7 to 9 comprises CEO successions in which the interim CEO is not promoted to the permanent CEO position. Post is a dummy variable equal to one in the periods after the CEO succession and zero in periods before the CEO succession. All continuous variables are winsorized at the 1% and 99% levels. Standard errors are clustered at the firm level. Wald chi-square statistics are reported in parentheses. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively.

6.2. Long-term managerial performance of promoted interim CEOs Mooney et al. (2012) suggest that promoting the interim CEO to a permanent position signals a good quality CEO-firm match. We use a difference-in-difference approach to compare the long-term performance of firms that promote (does not promote) their interim CEOs to that of firms that directly name a permanent CEO. We use the industry-adjusted market-to-book ratio to proxy for firm performance. Interim period is excluded from the pre-succession period, and for each interval, all observations must have both a presuccession and post-succession period. The results of the OLS regressions are reported in Table 11. Besides lagged firm characteristic, we also control the characteristic of the succeeded formal CEO. Previous studies suggest that firms forced out their prior permanent CEOs suffers a deterioration of presuccession firm performance. A binary variable named Forced Prior is used to proxy whether the prior permanent CEO suffered a forced turnover or not. Outsider is a dummy variable indicating whether the succeed permanent CEO is an outsider or not. Retiring Age is a dummy variable with one if the CEO's is between 62 and 64 years old and zero otherwise. Female is a binary variable indicating whether the CEO is a female or not. The control group in all models is CEO successions that do not use interim CEOs. The treatment group in Models 1 to 3 comprise CEO successions that use interim CEOs. The results in Models 1 to 3 show that firms that use interim CEOs do not have worse long-term performance. Rather, these CEOs, on average, perform slightly better in the [−5 FY, +5 FY] window. The treatment group in Models 4 to 6 comprise CEO successions in which the interim CEO is subsequently promoted to permanent CEO. The coefficients of the interaction term Treat × Post are positive and significant in all event windows. The treatment group in Models 7 to 9 comprise CEO successions in which firms use interim CEOs but subsequently appoint a different candidate to 16

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Table 12 Interim CEO turnover after promotion. Variable

Model 1

Model 2

Interim

1.03*** (5.70)

0.72*** (2.88) −0.99** (−2.19)

Interim × Forced prior Promoted Not promoted Promoted × Forced prior

Model 3

Model 4

0.17 (0.49) 1.35*** (7.12)

−0.37 (−0.77) 1.23*** (5.07) −0.34 (−0.49) −1.37*** (−2.94) 1.67*** (4.77) −0.06* (−1.75) 0.12 (0.49) −0.82* (−1.75) −0.70*** (−6.36) −0.22 (−0.47) −0.43*** (−3.72) −0.39** (−2.39) 1.11*** (4.57) −2.02*** (−5.60) −0.19* (−1.70) −0.91*** (−4.00) Yes Yes 11,735 0.08

Not promoted × Forced prior Forced prior Log(AT) Debt ratio Adj. ROA(t-1) Adj. return(t-1) Adj. ROA(t-2) Adj. return(t-2) Institutional ownership Female Retiring age Outsider Indep. director Year FE Industry FE N. Obs. Pseudo R2

1.65*** (4.71) −0.07* (−1.84) 0.20 (0.83) −0.72 (−1.44) −0.70*** (−6.17) −0.20 (−0.41) −0.41*** (−3.56) −0.39** (−2.35) 1.09*** (4.28) −2.01*** (−5.60) −0.09 (−0.86) −0.91*** (−4.02) Yes Yes 11,735 0.08

−0.06 (−1.52) 0.19 (0.77) −0.70 (−1.39) −0.71*** (−6.27) −0.17 (−0.35) −0.42*** (−3.61) −0.38** (−2.26) 1.05*** (3.91) −2.03*** (−5.65) −0.05 (−0.49) −0.90*** (−3.96) Yes Yes 11,735 0.07

−0.06 (−1.50) 0.11 (0.43) −0.79* (−1.67) −0.72*** (−6.45) −0.19 (−0.40) −0.43*** (−3.76) −0.38** (−2.30) 1.07*** (4.36) −2.03*** (−5.63) −0.17 (−1.49) −0.89*** (−3.91) Yes Yes 11,735 0.08

This table reports the estimation results of Cox proportional hazard regressions. Forced turnover is set as the event, and the CEO tenure of voluntary turnover is right censored. Interim is a dummy variable indicating CEO successions that involved an interim period. Promoted is a dummy variable indicating that an interim CEO is subsequently promoted to permanent CEO. Not Promoted is a dummy variable indicating the permanent CEO successor of a not-promoted interim CEO. Forced Prior is a dummy variable that equals one of the previous permanent CEO was fired or forced to resign. All continuous variables are winsorized at the 1% and 99% levels. Standard errors are clustered at the firm level. Wald chi-square statistics are reported in parentheses. *, **, and *** indicate significance at the 10%, 5%, and 1% levels, respectively.

the permanent CEO position. The coefficients of the interaction term Treat × Post are insignificant in all event windows. Overall, these results support the argument that firms use interim positions as a testing-ground and that only candidates with better managerial skills (or that are better matched to the firm) are promoted to permanent CEO, leading to better performance in the long run. In addition, we find that using interim CEOs does not cause long-term deterioration in firm performance in general. As firms' operations are affected by factors other than CEOs' managerial skills, we compare the forced turnover rate of promoted interim CEOs to that of other permanent CEOs to further investigate the quality of the CEO-firm match. Because firms use relative firm performance to evaluate managerial performance, poorly performing CEOs are more likely to be forced out. Based on our succession sample, we create a CEO-firm-year panel dataset for fiscal years 1994 to 2014 to investigate the turnover of permanent CEOs. There are two types of permanent CEOs in our sample. First, directly named permanent CEOs. Second, permanent CEOs who replace an interim CEO. Directly named permanent CEOs are treated as the control group. We use a dummy variable named Interim to indicate whether a permanent CEO has succeeded an interim CEO or not. For permanent CEOs who replace an interim CEO, we further classify them into two groups namely permanent CEOs who are promoted from an interim CEO position, and permanent CEOs who replace a not-promoted interim CEO. Two dummy variables, Promoted and Not Promoted, are used to identify these two groups. We use Cox proportional hazard models to study the forced turnover rate. Forced turnovers are the events, and the CEO tenure (in months) of voluntary turnovers is right censored. Table 12 reports the empirical results of the hazard models. Models 1 to 4 control for lagged performance measurements and other 17

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firm and CEO characteristics. Adj. ROA(t-1) and Adj. ROA(t-2) are the once- and twice-lagged fiscal year industry-adjusted return on assets, respectively, calculated as the raw ROA minus the industry average ROA in the same fiscal year. Adj. Return(t-1) and Adj. Return(t-2) are the once- and twice-lagged fiscal year industry-adjusted stock returns, calculated as the raw return minus the industry average return in the same fiscal year.18 Model 1 compares the hazard rate of forced turnovers between CEOs in firms with interim periods and firms without interim periods. Our results show that permanent CEOs in firms with interim periods have higher forced turnover rates. The coefficient of Interim in Model 1 is 1.03 (p-value≤0.01), suggesting that the expected hazard rate is 2.8 times higher for permanent CEOs succeeding an interim CEO than permanent CEOs that are directly named. Model 2 controls for the turnover type of the previous permanent CEO. The coefficient of Interim × Forced Prior is negative and significant. Models 3 and 4 decompose interim CEO cases into a Promoted and a Not Promoted group. The coefficient of Promoted is not significant, suggesting that the forced turnover rate of promoted interim CEOs is not greater than their peers. The coefficient of Promoted is still insignificant after controlling for the turnover type of the previous permanent CEO; however, the forced turnover rate of the next permanent CEO in the not-promoted group is higher than that of their peers. Overall, our results support Mooney et al.'s (2012) argument that the promotion of an interim CEO indicates that she has passed the due diligence test, signaling a high-quality CEO-firm match. 7. Conclusion In our sample from 1994 to 2014, we find that there is an increasing trend of using interim CEO during CEO succession and about one-third of these CEOs were subsequently promoted to permanent CEO. The traditional view of interim CEOs as caretakers does not fully explain these trends. Using a hand-collected dataset of 1936 CEO turnovers from 1994 to 2014, we empirically examine whether interim CEO use is driven by motivations other than the caretaker function as well as the factors that influence the promotion of interim CEOs to permanent CEO positions. We find that, in addition to the traditional caretaker motivation for using interim CEOs, firms also use the interim CEO position to test potential CEO candidates. Specifically, candidates whose managerial skills are not known are more likely to be named as interim CEOs rather than directly as permanent CEOs. We also find that interim CEOs are more likely to be promoted to the permanent CEO position if their firms perform well during the interim period. Finally, we find that the testing-ground option induces effort from interim CEOs. Firms that promote the interim CEO to the permanent position tend to have better performance in the long run, suggesting that the outcome of the testing process signals a good CEO-firm match. Acknowledgments The authors acknowledge valuable comments from Stuart Gillan, anonymous reviewers, Qianqian Huang, Yaxuan Qi, Jie Cao, seminar participants in the Department of Economics and Finance at City University of Hong Kong, and conference participants at the 29th Asian Financial Associate Annual Conference, the 2017 China Annual Financial Meeting, the 2017 Australasian Finance & Banking Conference, and the 2017 Auckland Financial Meeting. Appendix A. Variable definitions Variable

Definition

Data Source

Panel A: Motivation for using interim CEO Sudden deparDummy variable equal to one when the CEO turnover is due to the sudden death or medical ture problems of the previous CEO and zero otherwise. Forced prior Dummy variable equal to one when the previous was fired or forced to resign and zero otherwise. The classification of forced turnovers follows the methodology of Parrino (1997). 36-month IVol. The standard deviation of the idiosyncratic risk of the candidate's previous employer. For each interim CEO/permanent CEO, their previous employer's excessive returns are regressed on the Fama-French three factors leading up to the month of the CEO appointment. The estimation window is 36 months or candidates' employment tenure if the tenure is shorter than 36 months. Uncertainty in- Sum of the following three binary variables: Short Tenure, which equals one if the candidate's overall dex tenure with her previous employer was shorter than 12 months and zero otherwise; Not a Top Manager, which equals one if a candidate did not serve as a top manager or CEO at her previous employer and zero otherwise; and Private Firm, which equals one if a candidate was previously employed by a private firm and zero otherwise.

Factiva Factiva & CEO turnover data provided by Jenter, Peters, and Wagner BoardEx, CRSP & Fama-French data library BoardEx

Panel B: Interim Period Performance BHAR Buy and hold abnormal returns during the interim period, calculated as the holding-period return CRSP & Fama-French data library compounded monthly minus the Fama-French three-factor model predicted return. The estimation window is 60 months before the succession event. Skill Interim period firm stock returns regressed on market returns, industry returns, and year dummies. CRSP & Fama-French data library Skill is defined as the residual of the regression model.

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ROA is defined as EBIT divided by beginning-of-year total assets. 18

Journal of Corporate Finance xxx (xxxx) xxx–xxx

X. He, M.R. Zhu Luck Panel C: Interim Age CEO experience Female Outsider Retiring age

Interim period firm stock returns regressed on market returns, industry returns, and year dummies. CRSP & Fama-French data library Luck is defined as the predicted value of the regression model. CEO characteristics (Interim) CEO age in a given fiscal year Previous CEO tenure in months Dummy variable equal to one if the (interim) CEO is female and zero otherwise. Dummy variable equal to one if the (interim) CEO is an outsider relative to the firm and zero otherwise. Dummy variable equal to one if the (interim) CEO's age is between 62 and 64 years old.

Panel E: Firm characteristics Asset growth The growth rate of total assets. B/M Book-to-Market ratio CAPX Capital expenditure scaled by beginning-of-year total assets. Debt issuance The logarithm of the long-term debt issuance. Debt ratio Sum of long-term debt scaled by beginning-of-year total assets. Discretionary The absolute value of firms' discretionary accruals at the end of each fiscal year. The discretionary accruals accrual is calculated based on the modified Jones (1991) model. EPS Earnings per share (basic) - excluding extraordinary items. Equity issuance The logarithm of the sales of common and preferred shares. Inventory turn- Sales scaled by inventory. over Log(AT) The logarithm of total assets. Return(t-1) Previous fiscal year return compounded monthly, ROA Return on assets, defined as income before extraordinary items scaled by beginning-of-year total assets. Sale growth The logarithm of the quotient of current sales and lagged sales. Panel F: Corporate governance characteristics E-index Entrenchment Index. For details, please refers to Bebchuk et al. (2008) Indep. director Percentage of independent directors on the board. Institutional o- Percentage of institutional holding. wnership

BoardEx BoardEx BoardEx BoardEx BoardEx Compustat Compustat Compustat Compustat Compustat Compustat Compustat Compustat Compustat Compustat CRSP Compustat Compustat Institutional Shareholder Services BoardEx Thomson-Reuters

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