Change gears before speeding up: The roles of Chief Executive Officer human capital and venture capitalist monitoring in Chief Executive Officer change before initial public offering

• Author: Yan (Anthea) Zhang,Salim Chahine
• DOI: http://doi.org/10.1002/smj.3197
• Published date: 01 September 2020
• Date: 01 September 2020

RESEARCH ARTICLE

Change gears before speeding up: The roles of

Chief Executive Officer human capital and

venture capitalist monitoring in Chief

Executive Officer change before initial public

offering

Salim Chahine

1

| Yan (Anthea) Zhang

2

1

The Suliman S. Olayan School of

Business, American University of Beirut,

Beirut, Lebanon

2

Jones Graduate School of Business, Rice

University, Jones Graduate School of

Business, Rice University, Houston, Texas

Correspondence

Yan (Anthea) Zhang, Jones Graduate

School of Business, Rice University, Jones

Graduate School of Business, Rice

University, Houston, TX 77005-1892.

Email: yanzh@rice.edu

Abstract

Research Summary: With data on 1,156 venture capi-

talist (VC)-backed U.S. initial public offerings (IPOs),

we find that the initial level of Chief Executive Officer

(CEO) human capital (HC) when a firm receives its

first VC investment is negatively related to the likeli-

hood of changing CEO before IPO. The distance

between a firm and its lead VC has a positive effect on

the likelihood and this effect is stronger when the initial

CEO HC is lower. These results suggest that as a larger

distance amounts to greater cost of VC direct monitor-

ing, VC is more compelled to change CEO, especially

when initial CEO HC is lower. Controlling for the endo-

geneity of CEO change, we find that CEO change before

IPO has a positive relationship with the firm's IPO valu-

ation and changes in operating performance.

Managerial Summary: Changing CEO prior to IPO is

common in startups, especially in those backed by VCs.

We argue that VC can monitor a portfolio firm in two

ways (which are not mutually exclusive): directly moni-

toring onsite the firm and indirectly monitoring relying

upon the firm's top management especially CEO. We

propose and find empirical evidence to support that as

Salim Chahine and Yan (Anthea) Zhang contributed equally to this study.

Authorships are alphabetically listed.

Received: 30 September 2019 Revised: 12 November 2019 Accepted: 16 November 2019 Published on: 22 June 2020

DOI: 10.1002/smj.3197

Strat Mgmt J. 2020;41:1653–1681. wileyonlinelibrary.com/journal/smj © 2020 John Wiley & Sons, Ltd. 1653

a larger distance between a firm and its lead VC

amounts to greater cost of direct monitoring and thus

making direct monitoring less feasible, the VC is more

compelled to change CEO, especially when the CEO is

deemed less capable (i.e., having a lower level of

human capital). We also find that CEO change before

IPO increases a firm's IPO valuation and changes in

operating performance.

KEYWORDS

CEO change, CEO human capital, initial public offering, IPO

performance, venture capital

1|INTRODUCTION

On June 20, 2017, Uber, a unicorn startup, ousted its co-founder Chief Executive Officer (CEO)

Travis Kalanick. After a high profile search that included candidates such as Meg Whitman, CEO

and board chair of Hewlett-Packard, and Jeff Immelt, then CEO and board chair of General Elec-

tric, Uber hired Dara Khosrowshahi as CEO on August 30,2017. This change in the CEO position

represented an important step moving toward Uber's planned initial public offering (IPO) in

2019. While what happened in Uberwas controversial and unusual, consistingof scandals includ-

ing accused sexual harassments, changing CEO prior to IPO is quite common in startups, espe-

cially in those backed by venture capitalists (VCs). As documented by Wasserman (2012, p. 299),

among the 1,542 startups in the technology and life science sectors that he surveyed, 61% of these

firms replaced CEO, sometimes multiple times, after receiving VC funding.

Changing CEO prior to IPO is necessary to many startups because the environment of a pub-

lic-listed company is different from and more complex than that of a startup. Firms preparing for

IPO need to assemble a broad range of managerial capabilities to deal with the more complex envi-

ronment after IPO. As professional investors, VCs typically understand such needs and pay special

attention to the leadership and governance of their portfolio firms (Pollock, Fund, & Baker, 2009;

Sahlman, 1990). If necessary, they can use their power in the boardroom and/or through their

investment contracts to replace the incumbent CEO (Levin, 2002). However, changing CEO is not

cost- or risk-free, even if VCs have the power to do it in their portfolio firms. The literature on

CEO succession has demonstrated that changing CEO can be disruptive, even in large and mature

corporations (for a review, see Finkelstein, Hambrick, & Cannella, 2009). Compared to large and

mature corporations, startups typically do not have well-established organizational structures, p ro-

cedures or policies, and rely heavily upon the specific individuals at key positions. Thus, replacing

CEO can present a great challenge to startups and the VCs that back the startups.

Therefore, it is important to examine how VCs make decisions on CEO change in their port-

folio firms. Recent studies on this topic have found that firm size, firm growth, founder owner-

ship (Boeker & Karichalil, 2002), and industry uncertainty (Pollock et al., 2009) may affect such

decisions. These studies suggest that task environments of startups, as indicated by their size,

growth and industry uncertainty can affect such decisions and power, as indicated by founder

ownership, matters too.

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