Chief Executive Officer Succession and Financial Constraints: Evidence from China

• DOI: http://doi.org/10.1111/ajfs.12181
• Author: Xi Zhao,Huanyu Ma
• Published date: 01 August 2017
• Date: 01 August 2017

Chief Executive Officer Succession and

Financial Constraints: Evidence from China*

Xi Zhao*

College of Management and Economics, Tianjin University, China

Huanyu Ma**

College of Management and Economics, Tianjin University, China

Received 8 June 2016; Accepted 24 December 2016

Abstract

This study investigates the impact of Chief Executive Officer (CEO) succession on a firm’s

financial constraints. Using panel data consisting of CEO turnover and non-turnover cases of

listed companies in China, we find that new CEOs play a significant role in alleviating a

firm’s financial constraints. Specifically, the level of cash holdings, the investment to cash

flow sensitivity, and the cash to cash flow sensitivity all decline following a new CEO’s suc-

cession. These effects are stronger in cases where the turnovers are forced and the firms are

more financially constrained.

Keywords CEO succession; Financial constraints; Cash holdings; Investment to cash flow

sensitivity; Cash to cash flow sensitivity

JEL Classification: G32, G34, M12

1. Introduction

Top managers can significantly influence a firm’s strategies and performance and a

wide range of corporate activities (Hambrick and Mason, 1984; Bertrand and

Schoar, 2003). As an important event, CEO turnover has a much larger and stron-

ger organizational impact (Morgeson et al., 2015). Much research has found that

the performance and strategy of a firm change significantly before and after the

CEO turnover (see review by Kesner and Sebora, 1994; Giambatista et al., 2005;

Chang and Wong, 2009; Chung and Luo, 2013). From a holistic perspective, these

*The authors acknowledge the Editor, the Associate Editor, and two anonymous referees for

their valuable comments and suggestions. The study was supported by the National Social

Science Foundation of China (No. 16AGL007). All errors and omissions are the responsibility

of the authors.

**Corresponding author: Huanyu Ma, College of Management and Economics, Tianjin

University, No. 92, Weijin Road, Nankai District, Tianjin 300072, China. Tel: +86-185-2257-

7781, Fax: +86-022-2740-3417, email: huanyu7126@163.com.

Asia-Pacific Journal of Financial Studies (2017) 46, 583–608 doi:10.1111/ajfs.12181

©2017 Korean Securities Association 583

studies are very useful in examining the overall performance quality of a firm under

a new CEO (Hornstein, 2013). However, when a CEO turnover occurs, investment

policy, operating activities, and financing status appear to be the first to be affected.

Although there are several studies focusing on the influence of CEO succession on

investment decisions (Harrison and Fiet, 1999; Hornstein, 2013) and operating

activities (Huson et al., 2004), there is little evidence regarding the influence of

CEO succession on firm financing activities.

According to Bertrand and Schoar (2003), managers at the top level directly

influence the firm’s investment, financial, and organizational practices to boost firm

performance. The present study is an attempt to explore the role of new CEOs in

alleviating firms’ financial constraints. In particular, we investigate how the cash

holdings, the investment to cash flow sensitivity, and the cash to cash flow sensitiv-

ity of the firms change after succession. We further investigate how turnover type

and financially constrained status contribute to shaping the outcome of new CEOs.

Driven by information asymmetry and the agency problem, financial constraints

have become prevalent worldwide (Myers and Majluf, 1984; Jensen, 1986), espe-

cially in countries with less developed financial systems (Love, 2003; Love and Zic-

chino, 2006). The existence of financial constraints leads to firms deviating from

their optimal investment level (Fazzari et al., 1988; Erel et al., 2015), which hinders

efforts to maximize the firms’ value. New CEOs have strong incentives to bring

changes and funding for future-increasing investment opportunities (Amore et al. ,

2011; Hutzschenreuter et al., 2012). To achieve these goals, they would take mea-

sures to overcome the obstacles.

Based on a sample of 2964 CEO turnover cases that occurred from 2003 to

2013 in Chinese listed companies, this study finds that following the successions,

the cash holdings, the investment to cash flow sensitivity, and the cash to cash flow

sensitivity of the firms significantly decrease. In particular, we find that cash hold-

ings decline by 1.6% after CEO succession. The decline in investment to cash flow

sensitivity is also statistically significant, with the magnitude of the post-succession

sensitivity being less than a third of that before CEO succession. The magnitude in

cash to cash flow sensitivity after the succession is close to zero, which implies that

the firms are financially unconstrained following CEO succession. These results

indicate that the new CEOs alleviate the firms’ financial constraints, which can act

as a source of value to improve investment policy and further enhance firm perfor-

mance (Erel et al., 2015).

If it is the new CEO who mitigates the financial constraints, we expect that a

new CEO under greater pressure and with certain incentives may yield a greater

impact. For instance, new CEOs after forced turnovers intend to reduce financial

constraints more aggressively than those after voluntary turnovers. Consistent with

this prediction, we find that new CEOs after forced turnovers significantly decrease

cash holdings by 1.5%, investment to cash flow sensitivity by 4.9%, and cash to

cash flow sensitivity by 27.1%. Although we find that new CEOs after voluntary

turnovers also bring a decrease of cash holdings by 1.8%, which is larger than that

X. Zhao and H. Ma

584 ©2017 Korean Securities Association