In 2001, Michael Ruettgers exited the CEO position at EMC, a leading information storage firm. He remained as chairman of the board while Joseph Tucci, former CEO of Wang Laboratories, took the reigns as CEO. Publicly, Mr. Tucci described Mr. Ruettgers as “a great friend and a great mentor,” and after the transition of power, Mr. Ruettgers indicated he would be less involved in routine EMC operations1. However, after several months, Mr. Ruettgers remained a fixture at weekly EMC operations meetings and required Mr. Tucci to consult him on key decisions. Further, former EMC executives were telling reporters and stock analysts that Mr. Tucci sought to move fast to cut costs, make acquisitions, and introduce new software but Mr. Ruettgers had slowed the pace of change. When asked by a reporter to evaluate Mr. Tucci’s job performance, Mr. Ruettgers rated Mr. Tucci’s performance in the press as “A” for innovation but “F” for financial management and stock price performance2. There were rumors that Mr. Tucci’s job was in jeopardy. Ultimately, the board intervened; they supported Mr. Tucci, who remains CEO of EMC, yet Mr. Ruettgers served as board chairman until January 2006, five years after departing the CEO position.
In today’s boardroom, there are contrasting points of view regarding the decision to retain a departing CEO on the board for an extended period of time. Together with my colleagues (John H. Evans, III and Nandu J. Nagarajan of the Joseph M. Katz Graduate School of Business, University of Pittsburgh), we examined this issue in our paper entitled, “CEO Turnover and Retention Light: Retaining Former CEOs on the Board”, which is forthcoming in the Journal of Accounting Research3. My colleagues and I refer to this decision as “Retention Light”. On the one hand, the firm is likely to benefit from the former CEO’s human capital, particularly the CEO’s unique monitoring and advisory ability, because the firm continues to retain the former CEO’s ability for an extended period of time, but now as a board member rather than as chief executive4. There is little question that Mr. Ruettgers knew more about EMC than any other top executive in the firm, and having this knowledge simply walk out the door could create anxiety among board members. Further, Retention Light potentially provides desirable incentive effects for the CEO during the final stages of his or her career. Research shows that retaining former CEOs on the board can help mitigate the exiting CEOs’ incentives to increase short term earnings at the expense of longer-term projects, such as cutting investments in research and development to boost current-period earnings performance5. Thus, Retention Light can create positive incentives for departing CEOs to work hard which, in turn, may increase shareholder value.
Notwithstanding these positive features, another widely-held perspective regarding Retention Light argues that the firm can experience unfavorable consequences if the former CEO exploits his or her board position for personal benefit, inhibiting value-maximizing strategies. A large survey of U.S. company directors concluded that “…it is very difficult to discuss steps that may reverse a course of action with a board that includes the person who made the original decision and which is comprised substantially of directors whom that individual has appointed.”6 This view is consistent with the conflict between Mr. Tucci and Mr. Ruettgers. For example, in an effort to reduce costs, Mr. Tucci sought to streamline EMC’s new product testing procedures, which entailed 28 days of quality checks. However, Mr. Ruettgers strongly backed the testing process and required Mr. Tucci to demonstrate that it could be effectively streamlined. After six months of delay, Mr. Tucci finally won approval and the streamlined process reduced product testing costs in half7. Similarly, others argue that “[former CEOs] could dominate the board agenda and decisions… many, if not all, inside directors may owe their jobs to the old CEO, and would be reluctant to contradict his views out of a sense of loyalty and/or fear.”8
We examined whether the board’s decision to retain the departing CEO on the board is more consistent with the positive or negative benefits of continued board service. We collected details surrounding over 350 CEO turnovers in S&P 1500 firms from 1998 through 2001, and tracked whether or not the departing CEO remained on the board, the length of his or her board service, the characteristics of the incoming CEO, and the firm’s subsequent stock price performance. The analysis indicates that Retention Light frequently involves powerful, aging CEOs who have achieved a less distinguished record of pre-turnover financial performance compared to CEOs who remain in their position. In addition, Retention Light has important consequences for board decisions and post-turnover financial performance.
Retention Light occurs rather frequently. We documented that former CEOs remain on the board for at least two years in 130 of 358 turnovers, or 36 percent of turnovers. Of these 130 cases of Retention Light, the CEOs remained on their boards as of the end of 2008 in 37 cases, while the remaining 93 Retention Light CEOs, one of whom was Mr. Ruettgers, served on the board for approximately five years after leaving the CEO position. These numbers suggest that Retention Light CEOs remain on the board for long enough duration to exert influence over both the incoming CEO and future board decisions. Detailed analysis also highlights how Retention Light is a complex phenomenon and not simply a standard outcome of reaching retirement age or exiting the CEO position voluntarily. Thus, understanding the causes and consequences of Retention Light necessitates analyzing more than just CEOs who have reached retirement age.
With respect to the causes of Retention Light, the analysis indicates that Retention Light CEOs deliver relatively better pre-turnover stock returns compared with those CEOs who severed all ties with the firm, but relatively lower stock returns compared with CEOs who retain the chief executive positions. Assuming that CEOs who deliver better stock returns to shareholders possess an ability to provide quality advice to his or her successor, this evidence would suggest that Retention Light may retain a skilled director on the board. However, we also find that better stock returns becomes less important for CEOs who have reached retirement age. Instead, attributes of powerful CEOsâ€•defined by owning a larger fraction of the firm’s stock, jointly holding the CEO and board Chairman positions, and whether the firm reported in its proxy filings an interlocking relationship among its board membersâ€•influences the board’s Retention Light decision. Hence, candidates for the Retention Light position also appear to be powerful, aging CEOs who have achieved a relatively less distinguished record of pre-turnover financial performance.
Retention Light could be a benign event. In fact, the retained CEO may be satisfied to continue interacting with his or her long-time colleagues a few times each year during board meetings and executive retreats. However, this is not necessarily the case, as we find that Retention Light is associated with important board decisions. We examined the characteristics of successor CEOs and found that compared to instances in which the departing CEO severs all ties with the firm, Retention Light firms are more likely to select a new CEO who is a younger insider without prior CEO experience and may have family ties to the former CEO. This evidence suggests that Retention Light is associated with the board’s executive succession decision in a way that enables the former CEO to retain a relatively powerful bargaining position within the firm. In addition, it appears that the board’s Retention Light decision and choice of successor CEO are linked, with the former CEO wielding sufficient power to influence board decisions.
Board’s that retain a powerful, aging CEO who has achieved a relatively less distinguished record of pre-turnover financial performance, who then influences the choice of successor CEO could certainly experience negative consequences. Given this situation, the perspective of one anonymous CEO seems quite appropriate, “… having the retired CEO remain on the board was a major pain… How could it not loom over every aspect of strategy discussion and decision making? Every time you change direction, it’s like a slap in the face to the old CEO, who is still seated across the board table from you!”9 In addition, it is understandable why some firms and incoming CEOs explicitly acknowledge the potential problems that can arise from retaining a former CEO on the board. For example, the governance guidelines outlined in Qwest’s 2007 proxy state, “Our CEO must resign as a director when he ceases to be CEO.” Jeffrey Bewkes, who replaced Richard Parsons in 2007 as CEO of Time Warner Inc., reportedly has a clause in his contract that allows him to resign if the former CEO (Parsons) remains on the board for more than one year10. However, determining whether the Retention Light situation is good or bad for stockholders remains an empirical question.
To investigate this issue, we examined whether Retention Light outcomes are related to the firm’s stock returns during the two-year period after CEO turnover. We find that the performance effects of Retention Light can be positive or negative depending on the attributes of the former CEO in the Retention Light position. In particular, we find a negative association with post-turnover stock returns when Retention Light involves a CEO who was not a founder of the firm, whose retention is more associated with the CEO’s power. In contrast, there is no significant association between Retention Light and post-turnover stock returns when the retained CEO was a founder of the firm. This evidence suggests that the negative results for non-founders as indicative of a powerful former CEO holding the influential board chairman position but lacking the pecuniary and non-pecuniary attachment to the firm that founder CEOs typically possess.
Hence, there appears to be a difference between retaining, for example, Bill Gates (he served as chairman of Microsoft for nearly eight years after departing the CEO role) or Howard Schultz (he departed as Starbuck’s CEO in 2000 and served as chairman for eight years before re-assuming the CEO role in 2008) compared with a CEO who was not the firm’s founder. However, even in these cases, directors’ routinely found themselves confronting serious and widely-publicized management conflicts. Steve Ballmer and Bill Gates clashed on numerous occasions when Mr. Gates, as chairman, frequently attended meetings presided over by Mr. Ballmer.11 In February 2007, Howard Schultz, in his capacity as Starbucks’ chairman, bypassed then-CEO Jim Donald by sending an ominous memo directly to senior Starbuck executives, warning that the firm needed to eliminate automatic espresso machines, change store designs, and eliminate in-store grinding, because these are eroding the brand’s virtues and commoditizing the brand. Starbuck’s stock price slid over 20 percent in the months following the leaked memo. Even though the empirical evidence does not indicate that retaining former CEOs who were also the firm’s founder is associated with statistically lower post-turnover stock returns, directors still faced an on-going need to monitor and manage the relationship between a former CEO and his or her successor.
Directors are naturally concerned about the CEO succession process, because it is a high-profile event that is difficult to accomplish, and the consequences of selecting the wrong successor are numerous. The empirical evidence highlights how one important precursor to the succession process is determining what to do with the departing CEO. Overall, the consequences broadly echo the results of a 2006 Korn/Ferry survey, which reported that 63 percent of directors recommended that exiting CEOs not be retained on the board.12 Several questions for directors to consider when making the Retention Light decision include: (1) Are we offering the departing CEO continued board service because of solid pre-turnover performance, or is it due to his or her power and influence over the board? (2) Will the departing CEO adversely influence our process of selecting a successor, or alter the quality and characteristics of prospective successor CEOs? (3) If we retain the departing CEO as board chairman, are we prepared to take action should conflict arise between the former CEO and his or her successor? Collectively, the evidence suggests that prior to offering continued board service, directors may want to consider the old adage “An ounce of prevention is worth a pound of cure.”
1 Business Week “EMC: Turmoil at the Top? Tensions may flare between a former CEO and his successor” March 11, 2002.
3 Evans, H., N. Nagarajan, and J. Schloetzer. 2010. CEO Turnover and Retention Light: Retaining Former CEOs on the Board. Journal of Accounting Research, forthcoming. Retention Light is different from temporary “pass-the-baton” CEO successions in which the former CEO remains on the board for a brief period, typically less than one year, prior to exiting the firm and transferring the position to a new insider CEO.
4 Retention Light may also help the firm retain important contacts with creditors, customers, etc. Although the firm could potentially obtain such benefits via a consulting contract with the former CEO, the board’s monitoring and advising function is likely best achieved through a board position. After Mr. Ruettgers departed the board chairman position, he was named a special advisor to EMC.
5 Dechow, P., and Sloan, R. 1991. Executive incentives and the horizon problem. Journal of Accounting and Economics 14, 51-89.
6 Berenbeim, R. 1995. Corporate boards: CEO selection, evaluation and succession. Conference Board report 1103-95-RR, New York, NY.
7 Business Week “EMC: Turmoil at the Top? Tensions may flare between a former CEO and his successor” March 11, 2002.
8Sherman, H.D. 1991. Catch 22: The Retired CEO as Company Director, Institutional Shareholder Services
9 Carey, C., Ogden, D. 2000. CEO Succession. Oxford University Press, Oxford.
10 The Wall Street Journal, May 19, 2008 B6
11 The Wall Street Journal, June 5, 2008
12 Monks, R., Minow, N., 2008. Corporate Governance. Blackwell Publishing, Malden, MA.