How Do Founder CEOs Create Value?

• Author: William C. Johnson,Sangho Yi
• Date: 01 October 2013
• DOI: http://doi.org/10.1111/ajfs.12031
• Published date: 01 October 2013

How Do Founder CEOs Create Value?*

William C. Johnson

Sawyer Business School, Suffolk University

Sangho Yi**

Sogang Business School, Sogang University

Received 27 November 2012; Accepted 22 June 2013

Abstract

We examine the value impact of founder CEOs and explore possible mechanisms whereby

founder CEOs’ unique characteristics affect their firms’ value and long-term market perfor-

mance. We find that founder CEOs’ status is positively related to market valuation and long-

term stock performance of firms. Furthermore, a lower likelihood of involuntary turnover for

founder CEOs is positively associated with market valuation. We also find that CEOs are

most likely to generate positive abnormal returns when protected from takeover markets.

Our paper suggests that founder CEOs create value by strengthening a firm’s stakeholder

relationships and alleviating information asymmetry in financial markets, when other certify-

ing entities do not participate in initial public offerings.

Keywords Founder CEO; Corporate governance; IPO stock relative valuation; Stakeholder

relationships; Involuntary turnover

JEL Classification: G30,G34,G39

1. Introduction

Previous studies suggest that founder CEOs may differ from professional CEOs in

terms of their incentives, the types of private benefits they enjoy from having con-

trol of a firm, the potential magnitude of moral hazard problems they may face,

their risk preferences, and their investment horizon (Adams et al., 2009; Fahlenb-

rach, 2009; Gao and Jain, 2011). Examining how market valuation and performance

are affected by control and ownership by this particular class of managers, i.e., foun-

der CEOs, is an extremely important issue in the corporate governance literature.

Empirical evidence concerning the impact of founder CEOs on a firm’s market

valuation and stock market performance in the extant literature is characterized by

*Acknowledgments: We would like to thank the editor and several anonymous referees for

their helpful comments. All errors remain our own.

**Corresponding author: Sangho Yi, Sogang Business School, Sogang University, Seoul 121-

742, South Korea. Tel: +82 2 705 8864, Fax: +82 2 705 8180, email: yisangho@sogang.ac.kr.

Asia-Pacific Journal of Financial Studies (2013) 42, 777–812 doi:10.1111/ajfs.12031

©2013 Korean Securities Association 777

inconsistent findings. For example, Johnson et al. (1985) demonstrate that firms

experience significantly positive cumulative abnormal returns in the event of the

unexpected death of their founder CEOs. However, several other studies report con-

tradictory findings. For example, Adams et al. (2009) mak e use of Tobin’s Q and

return on assets to demonstrate that founder CEOs who retain control of a firm

have a positive impact on its performance. Fahlenbrach (2009) demonstrates that

investing in firms run by founder CEOs results in benchmark-adjusted returns of

8.3% per year.

This paper revisits the issue of whether the retention of a founder CEO is asso-

ciated with higher market valuation and better long-term stock performance by

analyzing a set of firms at the initial public offering (IPO) stage. We use a novel

empirical approach that examines the relationship between founder CEO status, an

IPO firm’s antitakeover provisions (ATPs), certifying financial institutions, and cus-

tomer-supplier relationships, to assess the value impact of founder CEO status.

More specifically, we examine how founder CEO status affects IPO stock valuation,

Tobin’s Q, and long-term stock performance. In a similar vein, we examine whether

founder CEOs are more or less likely to experience involuntary turnover and

whether this lower likelihood of involuntary turnover is positively associated with

market valuation and long-term stock performance. More importantly, we examine

whether and under what circumstances firm value increases when a firm employs

stronger antitakeover measures to remove takeover threats to founder CEOs. This

enables us to gain a deeper understanding of the potential mechanisms whereby a

founder CEO may impact firm value and long-term stock performance. Unlike pre-

vious studies, which focus on the effects of founder CEO status on various corpo-

rate investment decisions (Fahlenbrach, 2009), we pay attention to two potential

sources of value creation or destruction. The first source of value creation for foun-

der CEOs is reducing hold-up problems and inter-firm contracting frictions since

these frictions may be alleviated by CEOs who are also firm founders (Macaulay,

1963; Shleifer and Summers, 1988). The second source of value creation for founder

CEOs is from reducing information asymmetry between a firm and the financial

markets, which may lead to adverse selection and moral hazard discounts. The

superior firm-specific and industry-level knowledge that a founder CEO has may

alleviate this information asymmetry when external certifying financial institutions

are not involved in a firm’s IPO (Fahlenbrach, 2004). For this purpose, we examine

the value implications of founder CEO status for firms with large customers and

the association between founder CEO status and firm value for firms without ven-

ture capitalists or high reputation underwriters.

We believe that IPO firms provide an important avenue of inquiry to study the

value impact of founder CEOs for the following reasons. First, Gao and Jain (2011)

suggest that the survival and prosperity of an IPO firm critically depends on the

ability and motivation of its CEOs. Second, many previous studies have focused on

large seasoned firms (Adams et al., 2009); however, there may be significant differ-

ences between small IPO firms and large seasoned firms (Morck et al., 1988). Third,

W. C. Johnson and S. Yi

778 ©2013 Korean Securities Association

it is particularly important for IPO firms to efficiently institute and maintain solid

stakeholder relationships (Coombs and Harrison, 2010). Thus, an IPO provides a

useful setting to examine whether founder CEOs create value by facilitating a firm’s

relationships with its stakeholders (Shleifer and Summers, 1988). Last, the early-

stage development of a firm and the involvement of a founder CEO can have long-

run performance implications.

The empirical approach that we take to examine the value impact of founder

CEO status is different from that of previous studies in the following significant

ways. First, we utilize an IPO firm’s stock valuation at the IPO offer price divided

by the valuation of a comparable firm, called the relative stock valuation, to assess

the effect of founder CEO status on firm value, a measure that is widely used in the

IPO literature, but has limited use in the corporate governance literature. Previous

studies suggest that an IPO firm’s relative stock valuation is a reliable measure of

firm value because sophisticated underwriters utilize information from their institu-

tional clients and gained from the road shows in setting the IPO firm’s offer price

(Kim and Ritter, 1999; Purnanandam and Swaminathan, 2004; Chemmanur and

Loutskina, 2006; Johnson et al., 2010). The IPO relative valuation avoids several sta-

tistical problems associated with Tobin’s Q as pointed out by Erickson and Whited

(2012).

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Second, compared with previous studies, we approach the issue of the

value impact of founder CEOs with a wider perspective. We focus on the interac-

tions between governance, firm founders, important relationships with external

stakeholders such as large customers, and various certifying financial institutions as

important determinants of the value impact of founder CEOs. Third, we explore

the potential mechanisms whereby a founder CEO may have an impact on a firm’s

value and long-term stock performance. For instance, we suggest that alleviating

contractual frictions arising from customer-supplier relationships and alleviating

costly information asymmetry inherent in financial markets may be important

sources of value contributions for founder CEOs.

We find that in our sample of IPO firms, a substantial percentage of the firms

(37%) go public with the firm founder as CEO. Such a finding suggests that the

CEOs are more likely to play a larger role in firm value creation compared to large

public firms where only 11% of founders are also the CEO (Fahlenbrach, 2009).

These results support the previous findings of Adams et al. (2009), Fahlenbrach

(2009) and Gao and Jain (2011).

As for the valuation effects of founder CEOs, we find that founder CEO firms

are valued more highly based on relative valuation and Tobin’s Q. There are several

findings related to the valuation effects of founder CEOs. First, if founder CEOs are

entrenched and with more takeover defenses, the value of the firm further increases.

Second, our results support the argument that founder CEOs may create value by

facilitating a firm’s business relationships with large customers and by alleviating

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Our results remain qualitatively similar if we utilize a market value measure of firm value

such as Tobin’s Q.

Founder CEOs and value

©2013 Korean Securities Association 779