The effect of CEO's general ability on company performance: Evidence from the takeover market and earnings management

Abstract

I show that Chief Executive Officers (CEOs) that have accumulated general managerial skills through lifetime work experience demonstrate enhanced performance in the takeover market, as measured by market reactions to the deal. These reactions are more pronounced when the CEO acquires small, but complex firms, suggesting target selection as an underlying mechanism. I find no evidence that the effect stems from the structure of the deal or the CEO’s past M&A activity. I also find that the documented increase in innovative activity for firms with high general ability is heightened when the CEO makes acquisitions. In sum, the evidence suggests that the increased pay for generalist CEOs is partially justified by their performance in the takeover market. I also provide evidence that CEOs with broad experience in their background are more likely to utilize discretionary accruals than CEOs with focused experience. This appears to be a result of transitions to CEOs with high general ability and not simply a selection of these CEOs by firms that utilize discretionary accruals extensively. Two mechanisms appear to underlie this result. First, CEOs with general ability tend to manage earnings when more options are exercised. Second, CEOs with high general ability appear more willing to bear the risk inherent in the use of discretionary accruals given their enhanced tolerance for failure stemming from outside career options.