dahya et al - 2009 - one man two hats- what's all the commotion

A first mover: The Cadbury Committee Report Arguably, the global movement toward the separation of the combined CEO andCOB position can be traced back to the Cadbury Committee’s report o

One Man Two Hats: What’s All

the Commotion!

Jay Dahya∗

Baruch College, CUNY

Laura Galguera Garcia

University of Oviedo

Jos van Bommel

University of Oxford

Abstract

We examine performance in publicly listed U.K companies over a period that

encom-passes the issuance of the Cadbury Committee’s Code of Best Practice, which calls for the

abolition of the combined CEO/COB position We find that companies splitting the combinedCEO/COB position to conform to the Code’s requirement did not exhibit any absolute or rel-ative improvement in performance when compared to various peer-group benchmarks We donot necessarily scoff at mandated board structures, but the evidence suggests that this particularlegislature coerced the abandonment of the combined CEO/COB position and appears to be

wide of the mark.

Keywords: Cadbury, CEO, directors, governance, UK

JEL Classifications: G28, G30, G34

∗Corresponding author: Baruch College, City University of New York, One Bernard Baruch Way,

Box B10-225, New York, NY 10010-5585; Phone: (646) 312-3511; Fax: (646) 312-3451; E-mail: jay.dahya@baruch.cuny.edu

We appreciate assistance in compiling the data from Companies House U.K., Lloyds Share Registration Services, Hemmington Scott, and the Subotnick Financial Services Center This paper has benefited from the helpful comments of Linda Allen, David Denis, Diane Denis, Jack Francis, Joanne Li, Colin Mayer, John McConnell, and seminar participants at Baruch College, Queen’s University, Belfast, and FMA European Meetings 2005 Jay Dahya acknowledges financial support from the Baruch College Fund, INQUIRE-UK, and the Eugene M Lang Junior Faculty Fellowship.

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Traditionally, the top executive position on the boards of directors of publiclytraded corporations around the world has been held by a single individual holdingthe title of joint chief executive officer (CEO) and chairman of the board (COB).For example, in 1990, the positions of CEO and COB were combined for 372 of theFortune 500 firms (i.e., 74.4% of the firms) Similarly, in 1990, of the largest 25% offirms (ranked by market capitalization) listed on the stock exchanges of the UnitedKingdom, France, Australia, Belgium, Canada, Japan, Italy, India, and Brazil, thetitles of CEO and COB were combined in more than 60% of the listed firms in eachcountry.

During the 1990s and beyond, publicly traded corporations worldwide haveexperienced increased pressure to separate the combined position of CEO and COB

so two different individuals would maintain the titles of CEO and COB Between 1992and 2004, at least 16 countries have witnessed the publication of reports sponsored

by their governments, or sometimes by their major stock exchanges, advocating thattwo different individuals hold the positions of CEO and COB.1 The new standardtypically requires a major overhaul in the leadership structure on corporate boards

As far as the United States is concerned, the recommendation has shown up in theSarbanes-Oxley Act and has garnered much publicity For all the aforementionedcountries, the proposal has been implemented with a sense of urgency, with littleevidence to indicate that its adoption would actually prove beneficial

Arguably, the global movement toward the separation of the combined chairmanand CEO position can be traced back to the Committee on the Financial Aspects ofCorporate Governance, commonly referred to as the Cadbury Report, in the UnitedKingdom in 1992 The Cadbury Committee Report recommended that the positions

of CEO and COB in U.K.-listed companies be held by two different individuals.Compliance of this key recommendation required U.K companies to make notewor-thy changes In 1988, for example, 63.6% of the Financial Times (FT) 500 and 57.6%

of all London Stock Exchange (LSE) companies had the positions of CEO and COBheld by the same individual By 2000, 9.8% of the FT 500 and 22.8% of all LSE-listedcompanies had the posts of CEO and COB held by a single person An underlyingpresumption of this movement is that boards with different individuals holding thepositions of CEO and COB will significantly improve the quality of board monitoringand as a result lead to better corporate performance However, in large measure, thispresumption lacks empirical support

Various studies show that combining the positions neither improves nor destroyscorporate performance (Berg and Smith, 1978; Chaganti, Mahajan and Sharma, 1985;Baliga, Moyer and Rao, 1996; Brickley, Coles and Jarrell, 1997; Daly and Dalton,1997; Palmon and Wald, 2002) There are several explanations as to why prior stud-ies might fail to find a convincing relationship, if one exists First, firms tend to

1 The countries include Australia, Belgium, Brazil, Canada, Cyprus, Czech Republic, France, Greece, India, Japan, Kenya, Kyrgyz Republic, Malaysia, Singapore, South Africa, and the United Kingdom.

combine the positions of CEO and COB during top executive succession events.Disentangling the effects of executive succession from the effects of combining thepositions of CEO and COB has proved to be a significant challenge (Brickley, Colesand Jarrell, 1997) Second, the variables themselves may be endogenous That is, ifcombining the positions of CEO and COB does affect corporate performance, thenwhen every top executive position is at its optimum configuration, there will be norelation to observe in the cross-section between the combined position of CEO/COBand performance.2 Finally, prior studies have focused primarily on U.S companies,and most U.S companies continue to combine the positions Thus, it is difficult tofind corporate boards that do not combine the positions to serve as a control group.

In this study, we investigate further the relation between combining the tions of CEO and COB and corporate performance over the years surrounding theissuance of the Cadbury Report (in December 1992) in the United Kingdom By usingU.K firms in our analysis, we hope to alleviate some of the shortcomings attributed

posi-to studies conducted with U.S data First, because corporate boards were pressured(through a government-sponsored mandate) to separate the combined positions ofCEO and COB, the effects of CEO succession can be disentangled from the effects

of combining the positions Second, it can be argued that the Cadbury tion represented an exogenous event that radically altered top executive leadershipstructures in the United Kingdom And, third, the aforementioned changes, as shown

recommenda-in Figure 1, were concentrated over a relatively short time and the large sample of topexecutive positions with altered structures provides a clean before- and after-eventanalysis.3 Additionally, exploring the adoption of this one key Cadbury recommen-dation is interesting in its own right because many other countries appeared to havemodeled their corporate governance codes on the Cadbury Report Because the Cad-bury Report was one of the first of such national mandates, it has now been in effectlong enough that the impact on corporate performance, if any, can be observed Thus,this study can be thought of as a precursor of what might occur in other countries thathave adopted (or are contemplating adopting) similar guidelines

The key question that we ask in this study is whether U.K companies thatcomplied with the Cadbury recommendation, by separating the combined posi-tion of CEO and COB, experienced an improvement in corporate performance

We find that compliance is not associated with any (statistically or economically

2 The rationale for this explanation is drawn from studies by Bhagat and Black (2002) and Hermalin and Weisbach (1991), among others, who report evidence consistent with endogeneity between board composition and corporate performance.

3 Figure 1 presents the proportion of all publicly traded industrial companies that combined the positions

of CEO and COB on the LSE against those on the New York Stock Exchange (NYSE) from 1986 through

2000 As observed in Figure 1, the aftermath of the Cadbury Report witnessed widespread reduction in the number of firms combing the positions of CEO and COB (from 72% to 20%) In comparison, the proportion of firms combining the titles of CEO and COB for firms listed on the NYSE is essentially unchanged (around 78% throughout).

significant) improvement in operating or stock price performance relative to mark companies.

bench-Nonetheless, we recognize that our measure of operating performance may bebiased since all sample firms experience a drop in earnings over 1989–1992 and what

we observe is merely a natural mean reversion in earnings for a given benchmarkover this period To address this concern, we recompute our performance measureusing a performance-matching method (Barber and Lyon, 1996) Against this morerobust benchmark, companies that adopted the recommendation experienced eitherdeterioration or no change in operating performance relative to benchmark companiesover the period of our analysis As a further check on our performance measure,

we conduct our analysis using stock price in place of operating performance Theresults on stock returns show that separating the combined CEO and COB post is notassociated with any significant improvement in stock price performance relative tobenchmark companies In sum, our analysis on the adoption of this one key item of theCadbury Report dashes hope that this feel-good factor will lead to global corporategovernance rapture

As with any study of this nature, numerous caveats are in order First, we donot necessarily scoff at mandated top executive structures, but the evidence in thisstudy shows that such a mandate was not associated with any improvement in theperformance of U.K companies We also acknowledge the experience may be unique

to the United Kingdom or to the time period studied Studies of other countries intime will provide insight regarding the extent to which the findings from the U.K.setting can be generalized

1 Background

1.1 A first mover: The Cadbury Committee Report

Arguably, the global movement toward the separation of the combined CEO andCOB position can be traced back to the Cadbury Committee’s report on the financialaspects of corporate governance issued in December 1992 The Cadbury Committeewas appointed by the Conservative Party government in the United Kingdom with

a broad directive to examine the financial aspects of corporate governance The key

proposals of the Committee were contained in the Code of Best Practice, which

presents the committee’s recommendations on the structure and responsibilities ofcorporate boards of directors in U.K listed companies Among other things, the

Code of Best Practice recommended the separation of the combined CEO and COB

position so two different individuals hold the positions of CEO and COB

As of 2007, the Code has not been enacted into securities law, and compliancewith the Code is entirely voluntary Nonetheless, the Code was heavily backed by theLSE, which as of June 1993 has required a statement from each listed company onwhether the company is in compliance with the recommendations contained in theCode To gauge the significance of the Cadbury Report, it is imperative to appreciatethe circumstances surrounding its publication The Cadbury Committee was appointed

following several corporate collapses of prominent FTSE companies over the late1980s and early 1990s, including Maxwell Communications PLC and Colorol PLC,among others At its publication, those on both sides of the debate received theCadbury Code with a great degree of cynicism On the one hand, there were thosewho felt that legislation would be inevitable to enforce the recommendations contained

in the Code On the other hand, there were those who felt that the balance betweenstockholders and senior management is best left to capital market forces

1.2 Global movement toward separating the combined CEO

and COB position

The Cadbury Committee Report sparked global corporate governance frenzy.Between the publication of the Cadbury Report in December 1992 and December

2002, at least 16 other countries witnessed publication of similar guidelines calling

for the separation of the combined CEO and COB position In the spirit of the Cadbury

Report, in 1994, the Dey Report established guidelines for boards of publicly traded

Canadian corporations and the King Report purported similar rules for South African corporations In 1995, the Bosch Committee’s Report on Corporate Practices and

Conduct in Australia prescribed that two different individuals should hold the titles of

CEO and COB in publicly traded firms, and the Conseil National du Patronat Francais

in the Vienot Report, published in France, put forth similar recommendations.

From 1996 to 1999, five additional countries issued guidelines coercing

corpora-tions in Japan (Report of the Corporate Governance Forum of Japan, 1997), Belgium (Cardon Report, 1998), Brazil (Report of the Instituto Braziliero de Governanca Cor-

porativa, 1999), Greece (Principles of Corporate Governance issued by the Greek

Capital Markets Commission, 1999), and India (Kumar Mangalam Report issued by

Securities and Exchange Board of India, 1999) to separate the combined position.Since 2000, at least six more countries have promulgated guidelines in line with theCadbury recommendation These include Cyprus (Cyprus Stock Exchange, 2003),Czech Republic (Czech Securities Commission, 2001), Kenya (Private Sector Cor-porate Governance Initiative sponsored by the Stock Exchange Committee, 2003),Kyrzyg Republic (Securities Commission, 2002), Malaysia (Securities CommissionMalaysia, 2000), and Singapore (Council on Corporate Disclosure and Governanceestablished by the Securities Commission, 2001)

The general presumption underlying the global movement toward the eradication

of the combined CEO and COB position is that boards with two separate als holding the post would facilitate an independent check on the behavior of theCEO and more importantly improve the overall quality of corporate monitoring andperformance

individu-1.3 Prior studies

Financial economists have devoted considerable effort on analyzing the linkbetween board composition and corporate performance Studies on the topic fall

into one of two categories: (1) those that examine the link between the fraction ofoutside directors on the corporate board and corporate performance, and (2) thosethat examine combining the CEO and COB positions and corporate performance.The first category can be further subdivided into those that affect the way in whichboards accomplish discrete tasks and those that examine cross-sectional relationsbetween board composition and corporate performance.4 Our review on the morepertinent second category will be brief since Brickley, Coles, and Jarrell (1997),Dahya and Travlos (2002), and Palmon and Wald (2002) provide a comprehensivereview of prior literature on the connection between combining the CEO and COBpositions and corporate performance.

Studies on the relation between combined titles and corporate performance, erally correlate various measures of corporate performance on whether the CEO andCOB positions are combined or not For example, Brickley, Coles and Jarrell (1997)

gen-study a sample of 661 large U.S firms contained in the Forbes survey of executive

compensation in 1988 They perform a battery of tests including cross-sectional gressions of performance, as measured by return on capital and stock returns, against

re-an indicator variable for a combined CEO re-and COB re-and various control variables.With various regression specifications, they fail to report any statistically significantrelation between combined titles and corporate performance The apparent conclu-sion is that combining the CEO and COB positions in large U.S corporations is anefficient set-up that preserves shareholder value

Of course, Brickley, Coles and Jarrell (1997) is not the only study to analyze therelation between combining the CEO and COB and corporate performance Baliga,Moyer and Rao (1996) compare operating performance among 181 industrial U.S.firms that have changed the structure of the combined CEO and COB position Thisstudy fails to locate any operating performance changes surrounding changes in thestatus of the combined CEO and COB position Similarly, Berg and Smith (1978) andDaly and Dalton (1997) analyze differences in the financial performance of thosecompanies combining the titles of CEO and COB versus those that do not Bothstudies fail to show any differences in performance for the two sets of firms andconclude that combining the CEO and COB positions is indeed not a suboptimalboard configuration

These findings appear to contrast with observations advanced by Jensen (1993)and Hermalin and Weisbach (1991) who suggest that the combined position of CEO

4 Studies that explore how board composition affects the way in which boards accomplish discrete tasks, such as responding to hostile takeovers, hiring and firing the CEO, and setting CEO compensation, include Brickley, Coles and Terry (1994), Brickley and James (1987), Byrd and Hickman (1992), Core, Holthausen and Larcker (1999), Cotter, Shivdasani and Zenner (1997), Franks and Mayer (1996), Shivdasani (1993), among others Whereas, Agrawal and Knoeber (1996), Bhagat and Black (2002), Dahya and McConnell (2007), Dahya, Dimitrov and McConnell (2008), Coles, Daniel and Naveen (2008), Boone, Field, Karpoff and Raheja (2007), Denis and Sarin (1999), Hermalin and Weisbach (1991), Kaplan and Reishus (1990), Mehran (1995), and Yermack (1996) explore the cross-sectional relation between board composition and corporate performance.

and COB, among other things, lessens the monitoring ability of the corporate board.Consistent with these observations, Palmon and Wald (2002) argue that the widelyreported absence of a relation between leadership structure and firm performance may

be due to the neglect of firm size as an important explanatory variable Specifically,they hypothesize that small firms benefit more from the clarity and decisiveness of

decision making under a single sure-footed executive, while large firms benefit more

from the checks and balances associated with a separation of the two functions In theirempirical analysis, Palmon and Wald (2002) report a negative announcement periodstock return when small firms announce the switch from a combined CEO/COB toseparate functions on the Dow Jones Interactive Newswire and a positive announce-ment effect when large firms undertake the same maneuver Consistent with theresults reported by Palmon and Wald (2002) on large U.S companies, Dahya, Lonieand Power (1996), Dedman (2000), and Carapeto, Lasfer and Machera (2005) reportpositive announcement returns to the separation of the unitary leadership structure for

various samples of large U.K publicly traded companies from 1989 through 2003.

One obvious shortcoming with the studies on leadership structure and corporateperformance is that the two variables may be endogenously determined (Hermalin andWeisbach, 1998) If so, it could be that firms that are inclined to combine the CEO andCOB positions may also be more likely to display inferior (superior) performance

If that is the case, the results observed in prior U.S studies (a combined CEO/COBposition neither improves nor destroys corporate performance) and in contemporane-ous U.K studies (a positive stock price effect to leadership structure changes in largefirms) might indeed be spurious

Because the Cadbury Report spurred dramatic changes in the board configuration

of U.K companies, we are presented with a large sample of changes in the CEO/COBposition over a relatively short time, which provides an opportunity to alleviate en-dogeneity, if any, and also limits the effects of top executive succession on corporateperformance Against this backdrop and as the first mover in the global movementtoward the eradication of the combined CEO and COB position, this study exploresthe separation of the combined CEO and COB position on corporate performance inU.K companies, in relation to the issuance of the Cadbury Report

2 Sample and data sources

Our sample includes industrial companies listed on the LSE from 1989 through

1996 In the aggregate, 1,124 firms enter the analysis with at least one year of data

on top executive structure and certain financial information To begin, we record thename(s) of the CEO and COB from the board roster in the Stock Exchange Yearbook ineach year for each firm from 1988 through 1996 This enables us to record CEO/COBsuccession in each year from 1989 through 1996 for our sample firms Since we areonly concerned with changes in the combined position of CEO and COB that are notassociated with CEO/COB succession, we screen all CEO/COB successions unrelated

Table 1

Descriptive statistics for U.K industrial firms listed on the LSE, 1989–1996

Descriptive statistics on publicly traded U.K industrial firms (with data on board composition and financial information) from 1989 through 1996 In the aggregate, the sample includes 1,124 firms that enter the

analysis with at least one year of data Accounting information and share prices are taken from stream Board and equity ownership characteristics are taken from annual filings at Companies House and

Data-supplemented with data from the Corporate Register and Stock Exchange Yearbooks from 1988 through 1996.

to Cadbury compliance and remove them from further analysis.5 In this way, we limitour analysis to all changes in the combined CEO and COB position that do not stemfrom CEO/COB succession

For each firm in the sample, for each year 1989–1996, we also used the StockExchange Yearbook, the Corporate Register, and annual filings maintained at Com-panies House to determine the size of the corporate board, the number of outsidedirectors, the total number of shares held by the CEO, the total number of shares held

by board members, the total number of shares held by institutions, and the number

of block shareholders; a block shareholder is defined as any institutional shareholderowning greater than three percent of the company’s common stock

Summary statistics on the combined position of CEO and COB, outside directors,book value of total assets, market value of equity and CEO, board and institutionalshare ownership, along with the number of firms in the sample from 1989 through

1996 are presented in Table 1 The primary statistic of interest to us is the fraction

of firms that combined the positions of CEO and COB (Joint CEO/COB) Table 1shows a marked decrease in the fraction of firms that combined the positions of CEOand COB (Joint CEO/COB) from 56% in 1989 to 33% in 1996 The decrease in thenumber of firms combining the titles of CEO and COB are concentrated in the years

5 We also require that a statement containing details of the (nonsuccession related) change in the top executive leadership structure be filed with Companies House In an effort to corroborate the Companies House filings, we examine news articles in the Financial Times, Extel Weekly News Summaries and Macarthy’s New Information Service If data on the announcement of a separation in the combined CEO and COB position is not available for a given firm, we directly liaise with the company to ascertain that information, whenever possible.

following the issuance of the Cadbury Report.6 A similar marked increase in thepercentage of outside directors (from 30% to 48%) and board size (from 6.9 to 8.2)

is observed over the same time period Table 1 also shows that the fraction of sharesowned by the CEO increased, on average, by 125% and the median market value ofequity and median book value of assets grew, on average, by 50% over the eight-yearinterval

For our analysis, we split the sample firms into four mutually exclusive groups:(1) the set of firms for which two individuals maintain the titles of CEO and COBevery year in which they were listed on the LSE over the period 1989–1996 (we call

this the Always separated CEO and COB set, 318 firms); (2) the set of firms that always combined the positions of CEO and COB (we call this the Always joined

CEO and COB set, 247 firms); (3) the set of firms that recently created the combined

position of CEO and COB (we call this the Created joint CEO and COB set, 169

firms); and (4) the remaining set of firms that comprises those that split the combinedposition of CEO and COB, such that two individuals would hold the titles of CEO

and COB any year during the interval 1989–1996 (we call this the Adopted Cadbury

& separated joint CEO and COB set, 390 firms).

The summary statistics contained in Table 1 are expanded on in Table 2 for each

of the four sets of firms Panel A is the Adopted Cadbury & separated joint CEO and

COB set, Panel B is the Always separated CEO and COB set, Panel C is the Joined CEO and COB set, and Panel D is the Created joint CEO and COB set The average

firm in the “Adopted Cadbury & separated joint CEO and COB” set shows a markedincrease in board size from 6.6 members in 1989 to 8.3 members in 1996 A similarincrease in board membership is observed in Panels B and C for firms that alwaysseparated the CEO/COB position (from 7.6 to 8.5 members) and for firms that alwaysjoined the CEO/COB positions (from 5.5 to 6.8 members) The “Created joint CEOand COB,” set in Panel D, exhibits a mild decrease from 6.4 to 5.7 members.All four panels in Table 2 show an average increase of 5–15% in the fraction

of outside directors on the corporate board Consistent with Dahya and McConnell(2007), this increase can be ascribed to the widespread adoption of the other keyrecommendation of the Cadbury Report that established a minimum representation

of outsiders on the board This implies that in our multivariate analysis we shouldcontrol for the fraction of outside directors on the corporate board

By definition, of course, the “Adopted Cadbury & separated joint CEO and COB”set will begin with a large proportion of companies combining the posts of CEO andCOB and will end up with zero by 1996 As might be expected, this statistic shows its

6 We acknowledge that the Cadbury recommendation cannot be held entirely accountable for the whole decline However, we have been meticulous to exclude all succession-related changes in the CEO/COB position To alleviate this concern further, we have plotted a line-of-best-fit using data on the number of firms combining the positions of CEO and COB over 1989–1991 to estimate the proportion of firms with

a unitary leadership structure in the absence of a Cadbury-type recommendation by 1996 Our estimate suggests that 50% of the firms, at most would combine the two posts The actual number of firms combining the CEO and COB positions by 1996 was 33%—a staggering 17% lower than the linear estimate.

Table 2

Board and financial statistics for U.K industrial firms listed on the LSE, 1989–1996

Descriptive statistics on publicly traded U.K industrial firms (with data on board composition and financial information) from 1989–1996 In the aggregate, the sample includes 1,124 firms that enter the analysis with

at least one year of data We split the sample into four mutually exclusive groups: (1) the set of firms that separated the titles of CEO and COB in order to comply with the Cadbury Committee recommendation listed on the LSE any year over the period 1989–1996 (the split CEO/COB titles set); (2) the set of firms that maintained separate titles in all years in which they were listed over the period 1989–1996 (the always- separate CEO/COB titles set), (3) the set of firms that never split the titles of CEO and COB any year in which they were listed over the period 1989–1996 (the joint CEO/COB titles set); and (4) the remaining set of firms which comprise those that joined separate CEO and COB titles to form a single post any year in which they were listed over 1989–1996 (the create joint CEO/COB titles set) To determine how to classify a firm,

we identified the CEO and COB each year for each firm from the Stock Exchange Yearbook Accounting

information and share prices are taken from Datastream Return on assets (ROA) is calculated as earnings

before interest, taxes and depreciation divided by beginning-of-year total book value of assets.

Panel B: Firms that always separated the titles of CEO and COB

Percentage of outside directors 0.37 0.38 0.39 0.41 0.44 0.45 0.45 0.47 CEO equity ownership (%) 2.44 2.19 2.23 3.07 4.02 4.67 4.35 4.99 Book value of assets (£m) 467.20 444.70 461.80 493.50 523.30 591.40 617.40 646.30 Market value of equity (£m) 553.90 466.60 475.50 481.10 561.00 619.50 688.00 774.00

Panel C: Firms that always joined the titles of CEO and COB

Percentage of outside directors 0.29 0.29 0.29 0.31 0.35 0.39 0.40 0.37 CEO equity ownership (%) 9.28 9.17 8.55 7.86 8.40 7.84 8.33 8.39 Book value of assets (£m) 207.20 215.60 210.80 210.00 197.50 203.40 199.50 206.80 Market value of equity (£m) 165.60 148.90 180.80 169.90 159.00 182.90 166.80 155.80

Panel D: Firms that created the joint title of CEO and COB

sharpest decline between year-end 1992 and 1993 This statistic continues to exhibit

a relatively sharp annual reduction throughout 1996 Yet again by construction, the

“Created joint CEO and COB” set will begin with a small proportion of companiescombining the posts of CEO and COB and will end up with all firms combining thetwo titles by year-end 1996

Table 2 also provides an overview of the fraction of shares owned by the CEOfor each of the four sets of firms On average, the fraction of the company’s sharesowned by the CEO ranges between 1.8% and 9.9% for firms who have either alwaysjoined the CEO and COB positions or have created the combined CEO and COBposition (Panels C and D, respectively) The same statistic ranges from 1.6% to 5.0%for firms who have either adopted Cadbury and separated the combined CEO andCOB position or have always separated the titles of CEO and COB (Panels A and B,respectively) Therefore, we also control for the fraction of shares owned by the CEO(combined CEO and COB) in our multivariate analysis.7

Finally, in terms of market value of equity and book value of assets, firms inthe “Adopted Cadbury & separated CEO and COB” set are similar in size to firmsthat always joined the CEO and COB In turn, these two sets of firms are smallerthan those in the “Always separated CEO and COB” set and larger than those in the

“Joined CEO and COB” set Thus, we also control for firm size

In our multivariate analysis, we employ accounting earnings to measure porate performance We use return on assets (ROA) as the measure of accountingearnings For each sample firm for each year for which such data are available, wecalculate ROA as earnings before depreciation, interest, and taxes—all scaled by thebeginning-of-the year total book value of assets Accounting data are taken from

cor-Datastream each year for each firm from 1986 through 1999, where data are

avail-able Because firms enter and exit the sample naturally, the number of firms differsfrom year to year Therefore, for any year where a firm has the requisite data, thefirm is included in the sample We also identified each firm according to its FinancialTimes Industry Classification (FTIC) to enable industry-matching of sample firms

3 Analysis and results

3.1 ROA performance: An overview

As a first-pass analysis, Figure 2 presents an overview of the operating mance of the four sets of firms from 1989 through 1996.8 This figure shows the

perfor-7 The results in Table 2 on CEO equity ownership are consistent with those reported by Schmid and Zimmermann (2007) in their analysis on leadership structure for a sample of Swiss firms Specifically, CEO ownership is smaller in firms separating the combined posts of CEO and COB (than in firms that combined the two positions) It would appear that managerial equity ownership serves as a supplementary check on potential entrenchment of the CEO/COB position and mitigates agency costs associated with a combined role.

8 The statistic that we use for presenting our results is the trimmed mean of the distribution of ROAs where the distribution is trimmed at the 1% and 99% level Henceforth, we refer to this statistic as the mean of the distribution.

mean ROA from 1989 through 1996 for the always joined and always separated CEOand COB sets remains essentially the same Firms combining the positions of CEOand COB do not seem to perform any better or worse than firms that do not Forexample, the average ROA of the “Always joined CEO and COB” set (the dotted line)starts out at the same point as the “Always separated CEO and COB” set (the dashedline) and progressively moves above the line by 1996, while the average ROA of the

“Adopted Cadbury & separated joint CEO and COB” set (the solid line) ends belowthe average ROA of the two aforementioned sets of firms (i.e., always joined andalways separated) by 1996

Baliga, Moyer and Rao (1996) report that a combination of the CEO and COBpositions creates a clear-cut leadership role and potentially more rapid implementation

of decisions, which translates into higher corporate performance Presumably, such aleadership structure is particularly important during times in which firms experiencefinancial hardship and are forced to restructure operations Hence, the observationthat firms combining the separate posts of CEO and COB in Figure 2 experience

a substantial reduction in ROA (when compared to before the structure change) isconsistent with this conjecture Moreover, the subsequent increase in ROA followingthe switch to a unitary leadership structure suggests that under certain circumstances,

firms might profit from clear-cut leadership and sure-footed action that is associated

with a combined CEO/COB position

At face value, Figure 2 indicates that adoption of the Cadbury recommendation isnot associated with any improvement in operating profitability relative to other firms.Rather, the firms that adopted the Cadbury recommendation start on par in terms ofprofitability in 1992 but end marginally below the “Always joined CEO and COB” set

of firms by 1996 In the remainder of this section, we explore the issue from variousperspectives with a battery of tests Each of the tests supports the interpretation inFigure 2: adoption of the Cadbury recommendation to split the combined titles ofCEO and COB does not improve corporate performance.9

3.2 Changes in ROA with industry- and performance-matched benchmarks (in event time)

Having examined the time series level of ROA performance, we now examinechanges in ROA from before to after the adoption for the “Adopted Cadbury &separated CEO and COB” set of firms in comparison to various benchmarks In theanalysis, the year in which a firm adopted the Cadbury recommendation and separated

the position is event year y Year y + 1 is the year following event year y, and so forth.

We match firms from the three remaining subsets to year y as follows: for the subset

9 One important observation from Figure 2 warrants further explanation All four sets of firms show a sharp decline in ROA from 1989 through 1992 and a rebound from 1993 to 1996 This timeframe coincides with the period of our analysis In the next section, we check on whether the coincidental occurrence of these events might explain the relation, if any, between combining the posts and corporate performance.

that created the combined CEO/COB position, year y is when the change in leadership

was first announced; and for the two subsets that did not undergo any change inthe CEO/COB position, we match each firm in these subsets by the calendar year

represented by y for each firm in the subset adopting the Cadbury recommendation,

which results in some duplication of matches In Figure 3, we present an overview ofthe operating performance of the four sets of firms in event time over a seven-yearinterval surrounding the adoption of the Cadbury recommendation Univariate tests

of statistical significance are reported in Tables 3–6

Figure 3 illustrates the mean ROA of the four sets of firms over a seven-yearinterval centered on the year in which firms adopted the Cadbury recommendation.10

In Figure 3, the mean ROA of the “Adopted Cadbury & separated CEO and COB”

firms increases slightly in the year after adoption and more dramatically in years y+ 2

and y+ 3 Table 3 (Panel B) shows that the increase is not statistically significant

(< 0.05 level or less) over all three intervals (i.e., y − 1 to y + 1, y − 1 to y + 2, and

y − 1 to y + 3) This confirms the trend in Figure 2 that adoption of the Cadbury

recommendation has little, if any, impact on operating performance It is still plausiblethat the modest increase in ROA is somehow biased due to macroeconomic factorsthat have little to do with reconfiguring the combined CEO and COB position For

example, the modest increase in ROA from y − 1 through y + 2 may be due to the

economy-wide uptick in corporate profitability over 1992–1996 If this is indeed thecase, then the actual effect of splitting the combined CEO and COB position mightactually result in a decrease in ROA

To control for macroeconomic factors for each of the “Adopted Cadbury &separated CEO and COB” firms, we identify all firms in the “Always separated CEOand COB,” “Always joined CEO and COB, ” and the “Created Joint CEO and COB”sets with the same FTIC in which the firm had an available ROA during any calendar

year over the adopting firm’s y − 1 through y + 3 interval We then compute the

adopted-Cadbury firm’s industry-matched mean ROA for the three remaining sets of

firms for each year over the interval y − 1 through y + 3 The mean ROAs from

before to after y for the “Adopted Cadbury & separated CEO and COB” set and their

industry-matched always separated, always joined, and combined sets are presented

in Panel A of Table 3 The mean ROA from y − 1 to y + 3 for the “Adopted Cadbury

& separated CEO/COB” set is essentially unchanged (One notable exception is in

year y+ 2 when ROA is 9.61% We investigate this further when we discuss the

results in Panel B of Table 3.) From y − 1 to y + 3, the industry-matched always

separated set (column D) and the industry-matched always joined set (column H)

exhibit an increase in absolute ROA of 0.58% and 0.83% from y − 1 through y + 3.

In comparison, the industry-matched combined set undergoes a drop in absolute ROA

of 0.10% (column L)

10This set contains 820 firms in year y The number of firms in year y − 1, y − 2, and y − 3 is 786, 751, and 682, respectively; the number of firms in year y + 1, y + 2, and y + 3 is 885, 859, and 834.