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STANFORD GRADUATE SCHOOL OF BUSINESS—When a company does badly, no manager likes to be blamed for things that were really outside his control—like a general downturn in the economy. That goes especially for chief executives. But do boards really take external factors into account when giving CEOs the ax?

A new study finds that more CEOs are fired when their industry or the overall market is doing badly. But, say the scholars, it is not just a case of boards looking for scapegoats during harder times. The CEOs who are let go under such conditions tend to be underperformers anyway.

Looking at more than 1,600 CEO turnovers in the United States from 1993 to 2001, Dirk Jenter, associate professor of finance at the Stanford Graduate School of Business, and Fadi Kanaan of MIT first found that managers tended to be fired based on the performance of their firm regardless of the larger economic picture.

“When stock prices are up, managers are less likely to be fired; when stock prices are down, they are more likely to be fired,” said Jenter. “Our first results suggested that it does not matter whether a low stock price is driven by firm performance alone or broader market factors.”

Specifically, the researchers found that after one to two years of bad industry performance, the probability of a CEO being fired was more than 50 percent higher than after good industry performance. The pattern shows up everywhere, whether companies are large or small, whether CEOs have long tenures or short, or whether corporate boards are governed by company insiders or outsiders.

However, when the investigators looked at the data more carefully, they found that it was CEOs who were underperforming—that is, heading companies that historically had lower stock returns than their peer companies—who were most likely to be fired. “So it’s not the case that boards just willy-nilly fire CEOs when the industry or the economy is doing badly,” said Jenter.

Extrapolating from his results, Jenter conjectured that corporate boards may be using bad times as an opportunity to get rid of underperforming CEOs. “This is what I find when talking to members of boards personally,” he said. “They report that it’s really difficult to fire a CEO unless the company’s stock valuation is down.”

Boards, then, may want to consider whether they are asking enough tough questions about their CEOs in good economic times. “A rising tide may lift all boats, but the company may not be benchmarking itself well during such periods,” said Jenter. “If a firm’s stock is up 5% while several competitors are up 15%, then a board may want to think about rocking that boat.”

CEOs who underperform in good times, the study warns, should be aware that they will be scrutinized more closely when things go south. “Such CEOs need to prepare better for the next recession,” Jenter advises.

—Marguerite Rigoglioso

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  2. CEOs Donahoe and Thiry Talk Leadership Challenges
  3. Risk Taking Is Necessary Says Dimon of JP Morgan Chase

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