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What’s Your CEO Really Worth?

Why board members should know the value of their CEO.

On August 6 of 2010, Hewlett Packard’s board forced CEO Mark Hurd to resign after a sexual harassment investigation. On the day of the announcement of his dismissal, HP’s market value fell by $10 billion, close to a 10 percent decline. The price plummet suggests the market believed Hurd’s leadership was worth $10 billion to HP shareholders.

Some may argue that the stock price decline was an overreaction. However, it’s only since the beginning of 2011 that the stock has shown any sign of recovery, while the Nasdaq has increased by 16 percent since August 6. What’s more, Wall Street demonstrated the high value it places on Hurd once again when he became copresident of Oracle on September 7. On a day when the Nasdaq fell by 1.1 percent, Oracle’s stock price increased by 5.9 percent, creating a one-day total return of approximately 7 percent, or an $8 billion increase in Oracle’s market value.

Even if it was necessary to oust Hurd over allegedly inappropriately charged expenses and “loss of trust”—and that’s a debate for another day—it’s unlikely that HP’s board anticipated the severity with which the market would treat the decision. And therein lies the rub. Clearly, board members concerned about shareholder value maximization should carefully assess the value of the CEO before firing him or her. Having such a valuation might factor into the decision-making process, or, if a parting of the ways is inevitable, at least enable the company to prepare for and possibly take steps to mitigate the market’s reaction. Here are a few ways to tackle that challenge.

Compute the cumulative abnormal return (the company’s shareholder return compared to that of a portfolio of companies in the same industry) from the day of the appointment of the CEO until today. If the stock has underperformed, it’s likely that the market will be pleased when the CEO is fired and vice versa. During Mark Hurd’s tenure, HP’s stock price increased by 120 percent, largely outperforming market indices such as the Nasdaq, which only increased by 35 percent. This abnormal return of 85 percent corresponds to a $55 billion increase in shareholder value, so the decline in equity value of $10 billion when Hurd was dismissed should not have been a surprise. Of course, this method is not failsafe, because other factors beyond the CEO’s leadership drive stock performance.

Ask major investors their opinion about how the market would respond if the CEO were to be fired. While this can provide a sense of overall market sentiment, surveying a limited pool can be misleading. For example, at the press conference announcing Hurd’s departure, HP reported that its major investors supported the decision. Presumably these investors did not anticipate losing 10 percent of their shares’ value, so their input proved an imperfect assessment mechanism.

Examine stock market responses around events that suggest early departure. Each of Apple CEO Steve Jobs’ series of medical leaves has had a material negative effect on Apple’s stock price, consistent with the view that Jobs is a CEO with a large market value. To get a better sense of how the market would react to Hurd’s departure, HP’s board could have disclosed the accusations against him, effectively hinting at dismissal as a possible outcome, and gotten an early indication of the likely impact of forcing Hurd to resign.

While none of these methods offers a foolproof valuation, taken together they can provide a sense of a CEO’s worth and the likely impact of a change in leadership on a company’s market capitalization. Boards can then weigh that information when making a discretionary decision such as the one that led to Hurd’s departure. Of course, whether the HP board would have made a different decision if they had known that firing Hurd would have produced a loss of $10 billion of market value, we will never know.

Theo Vermaelen is professor of Finance at INSEAD, the international business school, where he teaches in MBA, PhD and executive education programs.


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