CEO age and managerial discretion: evidence from CEO succession.

Author:Wang, Hongxia

    CEO succession is a critical organizational event (Grusky, 1960) and has been of great interest to scholars in finance, management, and organizational behavior. In the past decade, research on succession has greatly improved our understanding of the antecedents and consequence of CEO succession. Many theories, such as agency, similarity, job match, human capital, and organizational learning, have been employed to explain the antecedents and outcomes of CEO succession (Giambatista, Rowe, and Riaz, 2005). However, there is a lack of research on the explanatory power of the managerial discretion theory on CEO succession.

    Managerial discretion refers to the "latitude of managerial action" (Hambrick and Finkelstein, 1987). The level of managerial discretion of a firm can constrain or provide choices for the CEO. The strategic choices of management are determined by how much leeway a manager has. Since managerial discretion defines the working environment of a manager, the level of managerial discretion could potentially affect a board's choice of a successor CEO. CEO succession research cannot be isolated from a firm's specific operating environment. A firm's environmental and strategic contexts can affect the board's decisions on CEO appointments. The board of directors should be able to fit different types of managers into different firm-specific circumstances. As Giambatista et al. (2005) point out, contextual approaches are crucial for understanding CEO succession. What we propose is to examine CEO succession in the context of managerial discretion.

    Even though the existing work on CEO succession has not focused on "managerial discretion," abundant empirical results support the idea that it impacts CEO succession. For example, the effects of board-related antecedents on the selection of a CEO have been documented in the literature on succession (e.g. Ocasio, 1994; Zajac and Westphal, 1996; Cannella and Shen, 2001). Leadership characteristics and actions, such as managerial ability and CEO tenure, also influence CEO succession (e.g. Ocasio, 1994; Allgood and Farrell, 2003). Firm-specific factors, such as firm size, age, growth, riskiness, regulatory constraints, and portfolio options, are significantly related to a board's CEO appointment decisions (Joos, Leone, and Zimmerman, 2003). Berry, Bizjak, Lemmon, and Naveen (2006) find that firm complexity and scope affect CEO succession. Some scholars examine the impact of the factors beyond the firm level, such as product differentiation and industry growth rate (Datta and Rajagpalan, 1998), as well as industry-level regulatory change (Haveman, Russo, and Meyer, 2001). These industry-level factors and other firm-specific variables determine the level of managerial discretion (Hambrick and Finkelstein, 1987; Crossland and Hambrick, 2007). This study is designed to pool discretion-related factors together and reexamine CEO succession through the theoretical lens of managerial discretion.

    Focusing on CEO age might provide important insights into CEO turnover/succession and incentives of organizations (Brickley, 2003). CEO age is an important criterion for a board's CEO succession decisions (Davidson, Nemec, and Worrell, 2006). Hambrick and Finkelstein (1987) propose that firms with a high level of discretion generally have younger and risk-prone managers, and firms with a low level of discretion generally have older and risk-averse managers. We empirically test the relation between CEO age and managerial discretion. We identify CEO age at succession as our test variable.

    Managerial discretion could provide some explanation for the specific CEO choices made by boards. The requirements of each CEO position are different, and boards may consider age in their hiring decisions. Are younger CEOs employed in firms with higher management leeway? What happens if the average age of the board is similar to the CEO candidate's age? Does the similarity attraction theory moderate the effect of managerial discretion on the preferred CEO age? Does the origin and designated status of the successor affect the relation between managerial discretion and the new CEO's age? These are the major issues to be addressed in this study. We discuss relative theories and extant literature and propose our testable hypotheses in Section 2. We describe our sample and data in Section 3. We present our empirical results in Section 4, and conclude in Section 5.


    2.1 Managerial Discretion

    Environmental, organizational, and individual managerial characteristics affect the degree of discretion of a CEO (Hambrick and Finkelstein, 1987). Environmental and organizational factors define how the industry level or firm-specific contexts exert constraints or provide opportunities for the CEO of a firm. The individual managerial factors emphasize the difference among CEOs and their ability to identify and take advantage of the leeway that environmental and organizational factors provide (Hambrick and Finkelstein, 1987). Recent studies have enriched the original discretion theory. Crossland and Hambrick (2007) propose that executive leeway also comes from the macro-environment or national system. Finskelstein and Peteraf (2007) identify managerial activities as another source of managerial discretion. The greater the degree of the complexity, uncertainty, and unobservability of a manager's activities are, the higher a manager's discretion will be. They further propose that managerial discretion can change over time because all sources of discretion can change in strength and direction. Scholars suggest three levels of discretion: national (Crossland and Hambrick, 2007), industrial (e.g. Cordeiro and Rajagoplan, 2003), and firm-level (e.g. Finkelstein and Body, 1998; Wright and Kroll, 2002).

    Upper-echelon theory can be related to discretion (Hambrick and Mason, 1984). It proposes that top executives could greatly influence the outcome of their organizations. The strategic choices and performance level of a firm reflect its managerial characteristics (Hambrick and Mason, 1984). Hambrick and Finkelstein (1987) and Hambrick (2007) argue that upper-echelon theory is conditional on how much managerial discretion exists. The CEO of a firm does not affect shareholder wealth unless he or she has the discretion to exert influence on the firm. Managerial discretion develops in contexts of a high level of ambiguity and of the absence of constraints (Hambrick and Finkelstein, 1987; Hambrick, 2007) and determines the magnitude of influence of the CEO on a firm through his or her actions. High discretion increases the CEO's potential marginal product, and hence, the CEO's potential impact on a firm's value (Hambrick and Finkelstein, 1987; Finkelstein and Boyd, 1998).

    Given the potential influence of managerial discretion on a CEO's actions and the consequential effects on firm value, managerial discretion likely affects the board's selection of a successor CEO. Peteraf and Reed (2007) argue that internal fit within a firm enhances firm performance. Finding the right person to fill the CEO position is an important task for the board. With the fiduciary duty to protect shareholders and directors' incentives of maintaining good reputations, the board of directors acts in the best interests of shareholders and pursues a reasonable fit in CEO selection and may match a CEO candidate with the managerial discretion level to ensure successful succession and improved firm performance.

    2.2 CEO Age and Succession

    Upper-echelon theory suggests that managerial background characteristics determine strategic choices, and consequently, affect firm performance (Hambrick and Mason, 1984). The origin and the functional background of a CEO have been extensively examined in succession literature (e.g. Agrawal, Knoeber, Tsoulouhas, 2006; Davidson, Nemec, Worrell, 2002; Zajac, 1990). However, only a few studies focus on CEO age. Brickley (2003) calls for research on CEO age to better understand CEO succession. Davidson et al. (2006) provide empirical evidence that the board uses age as a criterion for its CEO hiring decisions. Joos et al. (2003) find a match between CEO age and some specific firm factors. We examine how boards of directors match CEO candidates' age with managerial discretion levels.

    By nature, the young are different from the old, both physically and psychologically. The young are more energetic, less risk-averse, and faster to learn and make decisions. A person's incentives and behaviors may change with age (Gibbons and Murphy, 1992). Empirical research has documented how age affects CEO behaviors. CEO age shapes the attitude towards change more strongly in a CEO's early years after taking office (Musteen, Barker III, and Baeten, 2006). Older CEOs are more likely to engage in earnings management (Davidson, Xie, Xu, and Ning, 2007). Firms with older CEOs tend to reduce capital expenditure (Conyon and Florou, 2003). Older CEOs are more conservative (Hambrick and Mason, 1984); more risk-averse (MacCrimmon and Wehrung, 1990; Joos et al., 2003); have more human capital; and are usually hired in large, complex companies (Joos et al., 2003). In contrast, managerial youth is associated with a firm's growth (e.g. Hambrick and Mason, 1984), risky strategies (Hambrick and Mason, 1984), greater R&D spending (Barker and Mueller, 2002), and product or market innovation (Thomas, Litschert, and Ramaswamy, 1991). They are less effort and risk-averse and have a longer expected tenure. These results indicate the importance of CEO age to a firm, and a potential link between CEO age and managerial discretion. These results also imply that the changing business environment could favor younger CEOs.

    CEO age conveys important information of a CEO's personal traits, and possibly the potential scope of actions and expected changes that he or she might bring to a firm. Market...

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