Empirical Finance Clinical - Case Study Example

Clinical study on the impact of sudden CEO expulsion over share returns and firm performance Research Aim and Objective The aim of this study is to analyze whether the sudden expulsion of a firm’s CEO significantly affects the returns of the stock and the performance of the firm. Throughout the history of management, the presence of a highest authority has always been considered necessary. The assumption of the CEO of a firm playing this crucial role in influencing the strategic direction of a firm has always been a subject of scrutiny (Randolph and Edward, 1987). Several event studies have tried to measure the effect of either a planned or unplanned succession of a CEO on the performance of the firm. This event study intends to analyze effect of an unplanned expulsion of a CEO on both the returns of security and the eventual performance of the firm. An event study is defined as an empirical investigation of the association between security returns and events of economic importance. The event considered for this study is the unpredicted resignation of the CEO of BAE Systems on 26th March 2002. The company stated on the announcement day (26th March 2002) that the CEO John Weston left with immediate effect to “pursue other interests” after serving in BAE for more than 30 years”. The news which came as a sudden shock to investors was investigated by the city analysts to find the real cause of the dismissal. BAE had been performing badly for the previous 15 months with no pressure from investors and other board members. This showed that John was a powerful CEO. Hence the sudden management change was highly disputed. Abnormal returns are considered as a measure of shareholder wealth. The real reason known to investors after the announcement day was the tension with Ministry of Defence (MoD) and profit warning in 2001. Having failed to recognize this tension, the unanticipated management change urged the investors to the prospects of the firm to a lower level (called as information effect). This would account for a significantly negative abnormal return. In the following trading days, the investors gradually adjusted the share price to a fair level thereby favouring the stockholder’s interest (called as the real effect). This would account for a significantly positive abnormal return. Hence a negative information effect and a positive real effect should produce an insignificant result that shows the underperformance of the firm in the long run. Literature Review Several articles have been found that describe the significant or insignificant impact of the performance of a firm on the change of management, especially the firm’s CEO. The significance is compared between large and small firms also. Different and contradictory results have been obtained for the same factors considered in those analyses by different analysts. Friedman and Singh (1986) found that when pre-succession performance is poor, the market’s reaction to succession tends to be positive. While Lubatkin and Colleagues (1986) found that no relationship existed between performance and market’s reaction. The effectiveness of monitoring has been emphasized by Brady and Helmich (1984), Dalton and Kesner (1985) as they declare that executive replacement is a common response to poor financial performance. Event studies on stock market reactions associated with the announcement of forced departure have produced mixed results for forced management departures in various countries and periods of time. Furtado and Rozeff (1987) and Denis and Denis (1995) document a significantly positive price reaction to the announcement of a forced executive departure in the US. Weisbach (1988) and Huson et al. (2001) find the same effect in support of value relevant monitoring in the US for the exclusive case of CEO’s. Kang and Shivdasani (1996) report positive announcement effects for the dismissals of Japanese CEO’s. However, the other studies do not support the value relevance of monitoring of top management. Warner et al. (1988) find that the announcement of dismissing a top executive in the US does not generate any significant stock price effect and Mahajan and Lummer (1993) even document a significantly negative effect. Furthermore, the three studies that we know of that pertain to European CEO’s do not report any evidence in support of the value relevance of monitoring. Dedman and Lin (2002) document negative stock price effects resulting from the announcement that a British CEO is forced to depart. Dherment-Ferere and Renneboog (2002), who study the stock price effect of French CEO turnover, find an insignificant effect during the relevant event window. Last but not least, Danisevska et al. (2004) report insignificant stock price effects for CEO’s as well as for other executive board members in the Netherlands. Lubatkin, Chung, Rogers and Owers (1989) showed that investors typically seem to revise expectations of cash flows downward during the time surrounding a succession announcement. Eugene and Michael (1987) proved that the capital market responded to management appointments and dismissals. Appointments to the four top positions of a firm were associated with small but significant increase in the stockholder wealth. Hypotheses of the study Four hypotheses have been framed to obtain a concrete conclusion about the event study on the BAE CEO ousting. Hypothesis 1: In the event window of -1 to 0, the stock market reaction to the unexpected management change will produce significantly negative abnormal returns. Hypothesis 2: In the event window of -1 to +3, the stock market reaction to the unexpected management change will not affect abnormal returns. Hypothesis 3: In the event window of +1 to +3, the stock market reaction to the unexpected management change will produce significantly positive abnormal returns. Hypothesis 4: There is no significant change in the firm’s performance due to the unexpected management change. Data collection The study will require the equity indices of the BAE Systems. The main sources of data will be the Dow Jones Factiva news source and the DataStream. The qualitative information relating to the event one day prior, on and 2 days after the announcement day is obtained from the Factiva press materials. The equity indices consisting of the FTSE All Share index, Industry Index, BAE Index and EBITDA values are obtained from DataStream. The period of study can/will be from 31st Dec 1999 to 30th March 2007 the announcement day being 26th March 2002. Just include the other sources from where you plan to collect the stock market data. Just mention what kind of data you can obtain from the DataStream. As I do not have access to the database, I cannot fill the exact information. Statistical Methodology The market model can be considered to evaluate the abnormal returns of a firm with respect to the market returns. It calculates the abnormal return as the error between the expected market return and observed market return. The daily market returns of the BAE systems can be obtained from the DataStream database. The expected market return is calculated by regressing the market index. The estimation period and test period are decided based on the available data. Average abnormal return and cumulative abnormal return can also be measured for the different event windows. Standard error of the abnormal return following t-distribution is analyzed to measure the level of significance. A p-value Read More