our Accu none 3 (99 95-105, Nort ond AN ANALYSIS OF STOCK PRICE REACTION TO MANAGEMENT (CHANGE IN DISTRESSED FIRMS ‘Karl-Adam BONNIER and Rober F, BRUNER* sent 9 rg Charts VA 28 USA Peeve At son eid ay 198 ‘hs say ames exes cts 1 shale of mance age ey ‘tap’ eos! hos cn arr ae Spay te eich sen le ‘Setntonal carr culpa meen asin Fe ean ‘Set and sit utc at dpe af ss ce wer a Sei ies Gr pannus br ons st sa 1 tntroducion iting and fring of top managers by the board of directors is one of the ‘most important ~ and posbly benefal- internal mechanisms of corporate ‘control [Manne (1965), Alchian and Dense (1972), and Fam (1980). Yet ‘empirical research gves colicin results about the posible benefits of such intemal control, Warner, Wats, and Wruck (1988) fd a sgnieant associ: tion between poor stock perormance and the frequency of management tumover but nd oo signfeant excess returns wo shareholders at thea ‘ouncement of management change, Reinganum (1985) and Borstadt (1985) also find none except in specific cueamstanes relate to execite ti, fmt Size, of origin of successor. Beaty and Zajac (1985) fd an isipiicant negative ceturn at management change announcement. Furtado and Rezell (0987) and Weisbach (1988) report significantly postive returns atthe ma sgement-hange announcement ‘We submit that this inconsistency in resus aes from a confounding information effect associated withthe announcement of management change. ‘As Wamer eal, (1988) and Jensen and Warner (1988) note the abnormal ‘elam at announcement ofa management change isthe sum of an information eth Mele, Cary Seba, Raker Lamy, Way Ma, Ro Wats seca Ne rs ee rt eet Bn Ce 165.0199 5300198, Eee See Pb BY (Nora)fect and a el efet. The information effet could be negative if the change suggests tha the firm's performance was worse thin the market had realized. “The real effect would be postive if the change iin shareholder interest. The ‘combination of real and information eff would produce a wide range of results depending onthe magnitude ofthe individu eects. ‘Our purpose in this study isto isolate and estimate the rel effect of management change by using sample of fms for whom bad peeformance had already been recognized. We hope to reduce the negative information ‘component and focus onthe exe o which the ral component ws postive, ‘Other researchers sopgest tht the performance content is important in testing for the Benes of internal control” If there are benefits to sarees from management change, then the ell ofthis research design shouldbe to reve higher postive abnormal returns tan presested in other studies ‘We used jointly to eit oideay underperforming hms: 3) negative ‘earings and () dividend omision prio o management change. The negative information content of dividend omission announcements is welldocumented {Benesh, Keown, and Pinkerton (1984) and Dielman and Oppeaheimes (1984). (Our earnings ritrion shuld eliminate fom the sample any cares of healthy fem that omit dividends Tn the following section, we discus our sampling methodology in detail and the procedure for estimating shareholder retuas. Secon 3 presents the empirical results. A summary and synthesis of results ae given in seton & 2 Sample and empirical methodology 2. Sample of management changes ‘We initially examined all fms Usted on the New York or American stock ‘exchanges fom 1969 to 1983. From this population, we selected ll ms that financially underperformed aod then had a management change, We defined nancial underperformance 1s nepative cvnigs in the lst quarelyseport bofore the management change, accompanied by the elimination ofa dividend no caler than 24 months before the managemeat change, with no reinstate tent of the dividend before the change. The event was tented a the date the Wall Street Jourol cased the announcement of management change Poe to the dividend elimination, the fm had to have paid east four siceesive dividends, The Standard & Poor's Sect Owner's Stack Guide "tae 9) gi da mean font teen en he ner coming Ware tr ond Wink (in) and Cua tnd Sst (0) dpa ‘Sinton btn ep aegis emo chan ser ‘ae ore tht fe ath tpt prank pet manent et ES Sp Ninna heKA. Bernd RF re, Sek pe oo magne hanes ” ‘was sed to confirm the earings rule. Thos criteria resulted ina sample of 70 rms making a total of 87 management changes over the period. ‘We defined management change to include any personnel turnover inthe postions of chairman, chief exerulive ofcee (CEO), of president and in Positions having combinations of tose tiles. Our entre sample consisted of Instances in which only one individual departed atthe announcement, 2.2, The returns geerting adel “The test of gains to sharcholders from management change announcements was structured ae an event study of diy excss rears. These returns were ‘penerated using the standard market mods! of security returns [disused in Fama (1976): R= a4 (Rag) Eur a where ey ~ excess retums to shareholders of firm J at time ¢ relative to the ‘management-change announcement, {Ry ~ total daily ceturns to shareholders of frm (adjusted for dividends and stock splits and = tla daily returos on the equally-veghted market porto. Eg, (1) was estimated? by ordinary least-squares regression over 100 tang days (from day ~200 10 day ~101) before the management-change event. Daily returos oa cach seeuity were obtained from the daily returns database produced by the Center for Research in Scouts Prices, University of Chicago. “The returns were averaged across the observations according to A= Bey ° “yo mun rd a tt ee ares Eisen aaa oe Tareas meagre et ‘tena mua Thee cet se sgn th 3 le fovae isa Sees‘These average daily retms were tested for significance according to tan ARIS ° where S,,= [var AR,)} with var estimated over the 10 days, ~200 vo ~101, In addition, cumulative average exces returns (CARS) were caleulated over various holding periods from day K today L: ARG, = EAR, o ‘These CARS were tested for statistical sgnieance wing the following [eee back (198) fetta ™ AR /SI(CAR, 1) 6) where S(CARy,,) = [T* vu AR) +217 1)eo¥{AR, AR, And cov estimated over the 100 days ~200 to ~101, abd T 3. Empeeal ess 1°, ih, var een LU, Excess etrs at management change event ‘Table 1 presents de excess returns around the announcement day forthe sample of $7 eases. The returas at the event itself are significantly positive. On day “1 the average excess turn is 15668 (median = O48) witha rstatiic of 379, The average return for day 0 is 09138 (median = 078) with a ‘statistic of 221. The signicanly positive eventday returns contrat wit the Insignificant retirns reported by Borsadt (985), Reiganum (198), and ‘Warner etal. (1987) and withthe negative returns of Beatty and Zajac (1987), Furtado and Revel (1988) report postive two-day returns of 0.958 (r= 2.78), ile Weisbach (1988) reports to-day return for is entire sample of 028% (( 1.7), These later two stds compare with 8 woday return for this sample of 2.479% (1= 439). Generally, the five-day CARs before the event are small and insignificant, ‘whichis consistent with Warner eal, who report an insignifeant excess Tetum over the €© days preceding the announcement. The prepondersace of negative exces returns Before the announcement may eet the financially Aistesed condition of the sample rms For days 4 through , the cumulative rewen is clavely large and signifeant (3.518%, 1402) This doesnot appest to be the result of cuits the median value 1508.5as eu harder oun magnet ge onan eat Pind est oi (oman ie Fae = ar com Tau = cord 1s oaass 08, 003-0382 i tl in ee ep wo TOT Fe ody am ws "caso ee Steer a ket 412, Crnsesetonal pater Sarcholdes of distesed fms appear to gain from a change in senior ‘manages. We hypothesize that thre factors could explain cross-sectional ‘ration inthe event day etanns org ofthe sucesso, tile othe pasion snd frm size" tt pou aan of cts ai his ape ef of he smut mats o's nad sce tamencemen Ip eee far he em ican" cana ts (St ef mw Iomaion so poo ‘signs a puede wanna cary. forngh, ged) Cas te a (0) ape ep Caan ie pe aes he dae eta the den co tet Chef na eng) dolar ‘etomidate32L. Origin of seceor Previous studies have suggested thatthe origin of the successor is a etc variable in explaining a firm's performance after executive change’ In general, the appointment of an outsider is hypothesized to have a negaie effect on performance because (a) inside successions ae less dsruptive than ouside Suceessions; () outsides have none of the firm-specific human exp” of insiders; () the board of deters knows insides better than outsiders (and Thence may be les likely to make a bad appointment; () internal promotion fives incentives to junior executives, wheres ouside appointments may e- duce these incentives; and (@) the appointment of an cusider may signal negative information: thatthe current situation ofthe company isso Bad that {more qualild manager had tobe brought in from outside te Bt. ‘The alternative hypothesis about the appointment of outsiders is that it has 1 posltve eect. Because outsiders may not be commited to the Hn past polices, they may be the agents of change, altering the mision, objectives, Investment/prodacton strtegy, and interal organization, This altemative hypothesis may be especially relevant fr eur sample of nzncaly dsvesed ems? 4122, Tite and power ‘Some senior management postion have nore power than others to led the fm and effect change thvoogh mechanisms of internal conto, Job tie may be a proty for this power. Therefore cosistent with the internal corral hypothesis, we anticipate an asccntion between changes in more powerful titles and the benefits from management change. This ansipation is implicit in the studies of Warner et al, Reinganum, and Borsa, who partion event returns by various tes, It also implicit inthe exclusive focus on CEO Changes in the studies of Beaty and Zajc (1987, Coughlan and Schmid (0985), Weisbach (1988), and Labathn etal. 1586). ‘Thetis no stghtoeward theory about whih tiles ate associtad with treater power. Inthe spirit ofthe erior research, we partition the sample by ‘shether or not the te contained the designation chef executive ofr and {sume that this ile proxies for reter power to exercise Inter contol No ‘Much of is Beat uaa Retin 98a Taine, 985) Al, ‘santero te tem prose nce ner anced nF ad Re 9 "Sac maps oman cata weld egret is reson congenial bs ee vgn "Feds wes new toon’ agent a casing is fg of Maher sets seein hel arp ne yet ig Tak ‘Seavoncnent nt He acted that hs exe pevlomans may hive bre oe fe ‘ony th rd of Dic red onsenA Rater and RE Ba, Sk pe nd manent changer 2, liference between returns forthe CEO and aon-CEO categories would eject, the hypothesis that he power of the positon i ssocated withthe magaitude cof event returns. Lower returns forthe CEO category would be consistent with, ‘Warmer et al’s information content hypothess tht the positon is more povtecful than the others and that change here signals thatthe company ‘must be performing more poorly than previously perceived. Higher returns ‘would be associated with the CEO category ifthe postion is more powerful than the others, nd personnel changes inthis category were peresived by investors to represent more material and postive reiecion ofthe frm than "epresented by change in non-CEO positns 423, Firm se ‘Reinganum suggests that smal rms may have less complex contol sve tures than large firms and that therefore the fect of change in. one ‘management postion willbe more measingfl in a small im than 8 large fr. If this true for our sample of distressed fms and if there are benefits to management change, then the announcement day excess returns should be inversely related to fim se 4.24, Interaction effete ‘The posible interaction among origin, is, and te eects has drava the cation of previous researcher An interaction effect would exist where the ‘sociation between announcement retumne snd one independent variable ‘depends on the level of another independent variable, (© Orig and Sze. Furtado and Rozelf hypothesized that externa hiring sll be more beneficial as frm size detines. They argued tht maintaining ‘a internal Iabor markt is costly and uneconomic n small ems (i) Origin and Tite. Reinganum presented evidence suggesting this interac- tion" For our sample af disesed firms, we hypothesize that change in ‘CEOs wil be more beneficial if an otsde i appointed since the outer ‘would represent amore sigaifcant break wih the polis that le the fem into dite, (i) Tie and Size. Following Reinganum, as described above under main effets, 2 change in CEOs would be more beneficial im smaller fms, al reported ut atemnps hd dftenal pate cnbnatons of pots es eciReginam' io nonsense td ‘hsemantp ed by cama ppitonn IOK = 25 er mone fe oe or ‘sbpecps ae tem gue a1. Bar RE Bee Sk rnd napa where one new and wellpostioned individual could have a ratively larger effect However, in a study focusing on CEOs, Lubathin eta {ound that CEO change was asocated with more sgiicanty positive returns where the fem was lage rather than small. This would be consistent wih the existence of systems of monitoring and corporate ‘control in large fms which sere to heighten the efectivenss ofthe leader 33. Crosssetonl analysis ‘A hierarchical multiple regression was employed to examine both the direct, as well a5 ineacive elects of size, le, and origin on excess eur Hierarchical regression provides sgifcance tests ofthe increments in vai= ance accounted for st by all main effects and then by any interaction elects Inthe present study, the frst set of variables entered incided the main eects of size, tile and origin; he second Set incldad in addition the te two-way lnterctions as cared by the product term (sire tile, size origi, and rgin xt, For completeness, the three-way interaction (size % tile ‘igi was aio examined. In ation to variance accounted for, the betas blained via hierarchical muitiple regression provide an indication of the ‘rection of the effect of interest ‘The fullest equation estimated was BR, + B45) + 8T,) +60) + BST) + B45 20)) +H (O9T) + By(5209T) +6 © where ER, = excess return fr fm j over days —1 and 0 5, = relative sizeof firm fas measured by the Sales ofthe largest fim ia the sample T, = dummy variable taking the valve of 1 if the ste included “Chit Exectie Offer, and tera others, (0, ~ the origin ofthe incoming executive as measured by a dummy variable taking the value Tithe new appoints came fom ouside the Bem, and zero otherwise io of frm 1s sles to the ‘Steamer weld be anced management tn, Henao al ena ston oats ase ul aon (eye con, cn ane od ‘Seal sur ac ilmon she fiw nd aay fear he ‘man. Wide froma oa mee fe 0 sian tase tome Sen es rsa may mae io "the ges fn inte sled ssf 120i,es ‘te a % is ae Byaton FLT, d= Sip 2025, — A rene step?=019(9< 0000) ore rd ‘Sip =025(7 £005) Rinse p= 00090) Beaten F376 a= 77 coger Foot, IIL ss a pis on ke tal ra eo gett rosie ge ea, ry ean aang ae Rie cree deanna SSeS 34, Ress oferasseional nasi ‘Table 2 presents the resus ftom the hierarchical multiple represion, At step 1, the main eflets of siz, origin, and tile entered the equation. The ‘overall? btined om this step obtains no signicant increase fom 2e0- However, examination of the individual eta weights suggest that when the ffets of Size and erigin are partaled from excess returns, tile eains Signicant positive fect on returns (#= 202). Changs in CBOs ae ssoi- ated with 2 signicanly higher tum by 24% (3.643% for CEOs versus 12328 for other sence oles). The appoininent of outsiders ress in a return higher by 199% (2486% for outsider vermis 194% for insiders).Executive changes ia lage fms are asscinted with turns higher by 752% (2.5608 for ems larger than the median versus 1747 fr ae sealer than the median). At Bist the statistical isignieance of the origin effect seme anomalous, since the origin eet has a trend snr tothe le elec whic is sgnifcant). But inspection of the interaction effects revels tht ths origin effect is actualy driven by an interaction withthe tl effect. [At sep 2, the thre two-way interactions were allowed to enter the rees- sion. The ells presented i table 2 nda that a significant increse in the ‘overall was obtained on this tp. Spell, the postive betas associated With the origin x te and the sie tle interstons oh stain signi ance atthe 1% level. In both cass, tb association between CEO and exces returns varies mately by the level of sze or origin. TE the now appointee comes from within the im, the returns associated with (CEO stats ae 0.59% lower than the returns associated with non-CEO tes ‘But when the new appoint comes from outside the fm, the diference in returns associated with the two tle categories is large an excess return of 53958 is associated with appintments of outsides to CEO positions vers (0.266% associated with appointments of outsiders Yo other senior positions. ‘Among small firms, the efect of tie is not material (L778 for CEOs versus 1.794% for athe senior tiles). But among the lager firms in the sample, the effect of tei large. CEO changes in large firms ae associated wih an snouncement day reture of 4984%, while change in other tiles in large firms are associated witha reum of "14548, ‘These tet results support the tle hypothesis and reject the direct hypothe: ses about frm size and orga of the new appoints our sample, sve and ‘ngin seem to matter oaly in interaction with tte The benefits of changing (CEOs in distesed time are postvely ampliied by the appointment of ‘outsiders and by lane rm size 4. Discusion and conlasions (Our research results must be interpreted in light of the most important Aifference between his study and previous studies: we used a sample of ‘manifestly distressed rms in an effort to mininize the information component ofthe abnormal stock tetuns and instead focus onthe real component ‘The returns forthe entre sample are interesting because of tht ares: an average abnormal return of 2479% over the days ~1 and 0(¢= 4.39). The ‘ext highest return ported in research on this subject was 0.95% (1=2 78) 8, tiven by Furtado and Rove The difeence between our results and those of Furtado and Roza is consistent with Warner etal’ hypothesied negative Information content of managemeat change announcements, hat manage ‘ment change is in shareholder interest but tht i conveys bad news about theKA. Baral RF Bre Se prc antmonpeent ngs 18 firm's performance. Our rests provide tongs evidence about the rel ects of management change. ‘Second the power ofthe postion being fled (as measured by our proxy, ‘he CEO ‘ile has a large postive signifeant eect on the announcement returns. This contrasts with Reinganum snd Warner eta, who give evidence fof no mai effect asocated with diferent tiles, and with Beatty and Zac, ‘who id focus on CEO changes but found insignificantly negative returns, “Third, we find thatthe eects of sie and origin are postive and significant ‘bot only in interaction with the le eect The size result contrasts ith Furtado and Rozell's finding ofa signicant negative dec eet. The origin cffect contrasts with Reingnom and Warner et, who report a postive and Significant dlrecr effet associated with the appeinueat of outsiders ~ ire- Sspocsive of the positon being filed, Our results also suggest that cgi is ‘important but da its importance depends on the postion beng fled ‘We id two postive and sgaicant interaction eet: (a ie and origin and (b) te and size Through these interaction effects, ile emerges even ore powerfully as an explanation of cross-sectional variation in reas. The positive interaction between size and ie fs consent with te exitnce of ‘ystems of internal conto in large firms which serve to heighten the efee- Uveness ofthe CEO. The postive interaction betwen origin and tile suggests ‘hat an outside appeintment to CEO amplifies the benefits from a break with the fn’ past policies, ‘We conclude that these findings are consistent with hypothesized benefits fuom internal mechanisms of eorporate control in management change. More research onthe determinant of shareholder benefits from managemeat change ‘i warranted, New insighis may drive from focusing as we di on a sample ‘where intemal contol may be presumed to be at work and the information effects are seduced, and from employing cross-sectional analysis, References am 4A ud Dt 7, nant vr iin ‘eye RE tnd Ea TF. CEO chimes fm phones i nrpeaon: ‘Sate fr sd nae fs, eae Manet oral HSH ‘cisely ded yo, owt ot Pascal Ress SLT rin a pon oan gs Cpl apes compe A ant RO Si 5, ae capt ape tad Did TE ad Opener i ue cen ang un ef Pata snd Guana Aca 1 97106 Ke, Read rr Sock prion mapa hat Fas, EE, 16 Fondo of ae (Boas, New Ye NY "Fo 9 Ay toned yt Su oi ony ur FM 1, Tos of guy ame st fcc ino te eons An "cpa ot, Emer 3381 ol EFOD ml NE Rk Th eth is of mp tel mune aie fee cement aces alee loon ot ame Boom pe sb Wis RE Mage. Rapa sd HLA Newman 8S Amana of et i natin ahs cunt Sth, own Amst oem 111-1 aici a'dne Re Rep nf Owey, Tt of eine cen ‘vhs weft Cran es Ppa Peeing a cee Mae ‘mat ouma Soo a wale STB medical C0 ee no es am