Published in Management Science, (December, 2011) 57, no. 12): 2101-2114.

Published in Management Science,
(December, 2011) 57, no. 12): 2101-2114.
This version is prior to publication
How Do Acquirers Retain Successful Target CEOs?
The Role of Governance
Julie Wulf
Harvard Business School
Harbir Singh
The Wharton School
University of Pennsylvania
January 2011
Abstract: The resource-based view argues that acquisitions can build competitive advantage partially
through retention of valuable human capital of the target firm. However, making commitments to retain
and motivate successful top managers is a challenge when contracts are not enforceable. Investigating the
conditions under which target CEOs are retained in a sample of mergers in the 1990s, we find greater
retention of better-performing and higher-paid CEOs—both measures of valuable human capital. We also
show that the performance-retention link is stronger when the acquirer‘s governance provisions support
managers and when the acquirer‘s CEO owns more equity. While it is not common for acquirers to retain
target CEOs, we argue that they are more likely to do so when their governance environment maintains
managerial discretion. Based on a joint analysis of retention and governance, our findings are largely
consistent with a managerial human capital explanation of retention.
Acknowledgements: For helpful comments, the authors would like to thank Ramon CasadesusMasanell, Russell Coff, Jim Dana, Connie Helfat, Hongyi Li, Matt Rhodes-Kropf, Bill Simpson, Eric Van
den Steen, three anonymous referees, an anonymous associate editor, and the department editor, Bruno
Cassiman. Errors remain our own.
1. Introduction
Over the past two decades, the characteristics of mergers and acquisitions have changed dramatically.
Transactions during the 1980s were often characterized as hostile takeovers. In contrast, transactions
during the 1990s were commonly characterized as friendly mergers that involved negotiations between
two willing parties (Andrade, Mitchell and Stafford, 2001). The decade of the 1990s also has witnessed
significant changes in governance and higher rates of CEO turnover with an increasing fraction of
turnover caused by mergers and acquisitions (Booz & Co., 2006).1 While a number of perspectives on the
role of target CEOs in mergers have been discussed in the literature, we develop a managerial human
capital explanation which argues that acquisitions can build competitive advantage partially through
retention of top managers with value-creating human capital. In contrast to the literature that focuses on
the monitoring and disciplining aspects of governance, we argue that the governance of the acquiring firm
can play a role in retaining successful target CEOs when contracts are not enforceable.
The challenges that target CEOs face in evaluating promises or commitments made by acquiring
firms are illustrated by the circumstances around NationsBank‘s acquisition of BankAmerica (1998):
According to the SEC filing that described the terms of the merger agreement,
NationsBank‘s board of directors had intended for the CEO of the target firm
(David Coulter of BankAmerica) to succeed the CEO of the acquiring firm (Hugh
McColl of NationsBank) upon his retirement which was expected within 2 years.
Instead, the target CEO (Coulter) was forced to resign after the merger was
The decade of the 1990s also has witnessed significant changes in governance including: (i) an increase in
shareholder activism leading to greater monitoring and influence over firm decisions by both institutional and block
shareholders (Useem, 1993; Daily, Dalton and Rajagopalan, 2003); (ii) a trend toward more independent boards
with a higher proportion of outside directors; (iii) an increase in CEO ownership through stock options to align
incentives (an indirect measure of internal governance) (e.g., Murphy, 1999 and Holmstrom and Kaplan, 2001); and
(iv) increasing recognition that CEOs are heterogeneous in their ability to generate rents for firms (Bertrand and
Schoar, 2003 and Wang and Barney, 2006). During this same time period, there has been a more active labor market
for CEOs (Himmelberg and Hubbard, 2002) leading to higher turnover rates, lower tenure, and CEOs more
commonly being replaced or succeeded by external hires (Huson, Parrino and Starks, 2001). The trend toward
friendly, synergistic mergers combined with substantial shifts in corporate governance and fundamental changes in
CEO labor markets makes the 1990s an interesting decade in which to explore the role of target CEOs in the
governance of the merged entity.
―Mergers of NationsBank BankAmerica and Banc One, First Chicago Unveiled—Huge Deals Could Mark the
Beginning of Move to National Banking‖, S. Lipin and G. Fairclough, The Wall Street Journal, 4/14/1998.
This is an example of an employment agreement which promised succession to a target CEO, and yet it
was not honored.3 And, while succession agreements are not common, it is easy to extend the concept to a
more general case in which the acquiring firm promises the target CEO the right to ―be the boss‖, but then
fails to keep the commitment.
In this paper, we develop a managerial human capital explanation of target management retention in
M&A. Target CEOs may represent important ―assets‖ to acquiring firms to the extent that they embody
valuable human capital that can enhance firm performance. Acquirers want to retain successful CEOs
post-acquisition and, since target CEOs prefer ―being the boss,‖ acquirers make promises about
maintaining managerial discretion and providing job security. However, it is difficult for acquirers to
credibly commit to promises made to target CEOs. We argue that governance and ownership may
differentiate acquiring firms in their ability to credibly commit to managerial discretion for target CEOs
and that this in turn affects the likelihood of CEO retention.
Using a sample of mergers during the 1990s, we evaluate whether acquiring firms are more likely to
retain successful target CEOs and whether the probability of retention varies by certain ownership and
governance characteristics. First, we show that target CEOs of better-performing firms and those with
higher compensation are more likely to be retained post-merger. That is, acquiring firms retain target
CEOs with valuable human capital. Of equal interest, we find that acquiring firms with governance
provisions that support managers and acquiring firms with CEOs that are large shareholders are more
likely to retain successful target CEOs. These findings are broadly consistent with a managerial human
capital explanation of retention. Acquiring firms have the incentive to retain valuable human capital of the
target firm and they are more capable of doing so when their governance environment allows them to
credibly commit to maintaining managerial discretion.
We contribute to the existing research in several ways. First, we re-orient the governance discussion
in M&A transactions away from monitoring and dismissal of bad managers toward attraction and
Hartzell, Ofek and Yermack (2004) document the existence of explicit succession agreements for target CEOs in
only 3% of their sample (9 of 311 mergers) and find that none of these agreements were honored. In contrast, see
Wulf (2004) for examples in mergers of equals transactions in which succession agreements were honored.
retention of good managers. We extend the managerial human capital view to the context of M&A by
developing a theory for why acquirers may want to retain target management and how governance of the
acquiring firm may play a role in the target CEO‘s decision to stay. We then jointly analyze retention and
governance in a sample of friendly mergers and find results that are broadly consistent with the
predictions. To our knowledge, this is the first paper that acknowledges and documents a potential role of
the acquirer‘s governance in retaining successful target management. The implications of our analysis
suggest that a firm‘s governance choices may help to contribute to the ultimate success of M&A
2. Prior Literature and Hypothesis Development
2.1 The Acquiring Firm’s Perspective
The resource-based view considers acquisitions as a means to improve competitive advantage and
perceives target firm executives as part of the critical resources that are acquired. That is, target CEOs can
be important ―assets‖ to acquiring firms to the extent that they embody valuable human capital that can
enhance performance. 4 Their expertise may derive from general or firm-specific investments that provide
the basis by which the firm can build a long-term competitive advantage (Barney, 1991; Shleifer and
Summers, 1988, Castanias and Helfat, 1991).5 Target CEOs with valuable human capital can improve
firm performance through various mechanisms—by working harder or in a more productive manner, or
by leveraging greater ability or skill. CEO skills can include both general management skills and firmspecific skills.6 Managers can invest in developing knowledge or relationships that are specific to the
firm, for example, a deep understanding of a technology or relationships with customers, suppliers and
Target executives as valuable assets, not liabilities (Walsh and Ellwood, 1991) is a perspective that is consistent
with the notion that firms are comprised of both physical and human capital (Harris and Helfat, 1997; Rajan and
Zingales, 1998; and Bailey and Helfat, 2003).
Castanias and Helfat (1991, 1992, 2001) develop the notion of ―managerial or earned rents‖ as ―those portions of
the firm‘s rents that management creates from its superior management skills‖ that provide incentives for managers
to make investments in firm-specific human capital and to perform well.
Becker (1962) distinguishes between ―general‖ human capital (which is valued by all potential employers) and
―firm-specific‖ human capital (which involves skills and knowledge that have productive value in only one
particular company). More recently, Lazear (2003) has argued that a more informative view of firm-specific human
capital is that each job requires a slightly different combination of a multiplicity of general skills and ―firms use the
skills in different combinations with different weights attached to them.‖
critical employees. It is these firm-specific skills of managers that ultimately contribute to the superior
returns of strong-performing firms.
Several early empirical papers on M&A based on transactions during the 1980s, find evidence
consistent with the managerial human capital view.
For example, Cannella and Hambrick (1993)
document that post-acquisition performance and retention of target management is positively correlated.
Matsusaka (1993) finds positive event returns when acquirers retain the top management team of the
target firm and negative returns when acquirers replace target management.
In a very recent paper,
Bargeron, Schlingemann, Stulz, and Zutter (2009) find that target CEO retention is positively correlated
with firm performance and that target announcement abnormal returns are higher when private bidders
retain target CEOs. Broadly consistent with our theory, the authors propose that certain classes of bidders
(e.g., private vs. publicly-traded firms) are more likely to retain valuable CEOs.
The managerial human capital view recognizes heterogeneity among managers and suggests that
acquiring firms should only seek to retain target CEOs that are successful. What constitutes a successful
CEO? One direct way to characterize successful CEOs is to identify those that are effective in improving
firm performance. While CEOs cannot control many events that determine how well their firm performs,
countless studies (especially those analyzing turnover) use firm performance as a measure of a CEO‘s
effectiveness or success (e.g., Weisbach, 1988). Certainly, boards of directors must at least consider an
executive‘s track record in evaluating their effectiveness. Building on this research, we use measures of
pre-acquisition performance of the target firm to characterize successful target CEOs. We expect target
firm performance (pre-acquisition) to be positively correlated with target CEO retention.
Another way to characterize CEO success is by using compensation of the target CEO prior to the
acquisition. Wages are a reasonable proxy for the marginal productivity of labor whether the productivity
is a result of greater effort by the employee, greater skill, or a combination of the two. Harris and Helfat
(1997) argue that CEO compensation might be one indicator of the value of the human capital that the
More recently, Zollo and Singh (2004) show that the capabilities of managers in both the acquiring and target firms
are an important factor in determining post-merger performance.
CEO brings to the target firm. Firm-specific skills generate rents and firms can choose to share these rents
with managers for several reasons—first, in order to retain them, but also to provide an incentive for
managers to continue to make investments in these skills. Parsons (1972) models firm and employee
investments in firm-specific human capital and resulting implications for turnover. The model predicts
that workers who receive a wage-premium for skills (i.e., capturing returns on specific investments) will
be less likely to quit. This is broadly consistent with a positive association between pay levels and a
higher probability of retention. As a result, we expect CEO compensation (pre-acquisition) to be
positively correlated with target CEO retention.
Finally, we use tenure in position of the CEO to represent the extent of the CEO‘s firm-specific skills
or experience. Some argue that CEOs with extended tenure are more likely to be entrenched or resist
change, while others find evidence that more extensive firm-specific experience (longer tenure) has
beneficial performance effects (e.g., Kor and Mahoney, 2005). In developing our hypotheses, we adopt
the view that CEO experience and tenure contribute to firm-specific human capital and expect tenure in
the CEO position (pre-acquisition) to be positively correlated with target CEO retention.
We employ all three measures to represent target CEO success or the value of the target CEO‘s
human capital. While each measure has drawbacks, by using all three, we hope to mitigate some of the
limitations of each. The managerial human capital view suggests that target CEO retention should be
positively correlated with target firm performance, CEO compensation, and CEO tenure in the position
just prior to the acquisition.
Hypothesis 1: Conditional on a merger, the probability of acquiring firms retaining target CEOs will
be positively related to the success of the target CEO.
Hypothesis 1a: Target CEOs of better-performing firms will be more likely to be retained.
Hypothesis 1b: Target CEOs with higher compensation will be more likely to be retained.
Hypothesis 1c: Target CEOs with longer tenure in the position will be more likely to be retained.
2.2. The Target CEO’s Perspective: The Role of Governance
While acquiring firms have the incentive to retain successful target CEOs, retention is a joint decision
by both acquiring firms and the target CEOs themselves (Buchholtz, Ribbens, and Houle, 2003). From the
target CEO‘s perspective, the attractiveness of the acquiring firm as a potential employer can depend
upon a variety of factors. For example, target CEOs may be attracted to future promotion opportunities in
the acquiring firms as described in the Booz & Co. study (Lucier, Kocourek, and Habbell, 2006):
―Why do so many former chiefs stay on? There are three reasons. First, being acquired by
a larger company may be a passport to greater opportunity, even for executives who are
losing their CEO title. … Second, CEOs may stay with the acquiring company because
there is a reasonable chance that they could move on to the chief executive role of the
larger company in the future. … Third, when a deal takes an acquirer into a new business,
that company will often insist that much-needed senior talent remain with the new entity.
In this case, the CEO may agree, as part of the deal to remain with the new company,
particularly if his or her skill set and leadership are viewed as critical for success.‖ 8
In addition to considering promotion opportunities, if CEOs have made firm-specific investments, they
may be concerned about the protection of these investments because the acquirer shareholders may hold
them up (Grossman and Hart, 1986 and Hart and Moore, 1990). Whether in honoring a promise regarding
promotion or protecting firm specific-investments of the CEO, the governance of the acquirer can be an
important factor in the CEO‘s decision to stay.
We begin with the notion that target CEOs value the right to make decisions or to ―be the boss.‖9
Why might managers prefer to make decisions without the interference of shareholders? One reason is
that managers have different preferences than non-managerial shareholders. For example, CEOs might
have a preference for a no layoff policy and want to protect former employees or other assets of the
acquired firm.10 Related to this, Aghion and Tirole (1997) show that unless principal and agent
A more recent example of the importance in retaining a successful target CEO is when JP Morgan Chase acquired
Banc One with the plan to promote its CEO (Jamie Dimon) to the chief executive of the merged entity (see ―Moving
the Market: J.P. Morgan‘s Net Jumps Nearly 79%‖, R., Sidel, Wall Street Journal, October 20, 2005.)
While we assume that the most important factor to target CEOs is a commitment to decision rights, they also care
about other commitments, for example, regarding promotion opportunities and pay.
Landier, Nair and Wulf (2009) show that social factors measured by proximity to headquarters can play a role in a
CEO‘s decision to layoff divisional employees. Divisions that are located close to headquarters are less likely to
experience layoffs especially when headquarters are located in less-populated areas (and play a stronger role in the
local community).
preferences are perfectly aligned, the agent strictly prefers to have control over decisions. Another reason
is that managers may believe that they are better equipped to make decisions in comparison to
shareholders either because they have better information, more relevant expertise, or because of differing
beliefs or priors (e.g., Van den Steen, 2010). In the case of differing priors, managers may have a strong
vision for what direction the firm should take, and this is at odds with the shareholders‘ view about the
best course of action (e.g., Boot, Gopalan, and Thakor, 2006). The literature on differing priors is more
closely akin to research in strategy in which managers have skills and capabilities that lead to better
decisions (Finkelstein and Hambrick, 1989). Note that even though target CEOs may have different
preferences or beliefs from the shareholders, the shareholders may still find it valuable to retain the target
CEO because of firm-specific human capital that will be lost if s/he leaves.
Regardless of the reason for valuing discretion—whether it be because of different preferences or
differing priors between managers and shareholders—CEOs will prefer environments that maintain
managerial discretion. Since it is difficult to write a contract that unambiguously protects decision rights
in all contingencies, the acquiring firm may opportunistically renege on any promises made (Williamson,
1973). Because of this, target CEOs prefer firms that can make credible commitments. What types of
firms are able to credibly commit to maintaining managerial discretion? We consider and discuss two
types of governance environments of acquirers: firms with governance provisions that shift the balance of
power from shareholders to managers and firms with CEOs that have large equity holdings. While much
of the finance literature focuses on the role of governance in protecting investors, in this paper we focus
on the protection of managers.
To the extent that governance provisions make it difficult for shareholders to overrule management
and they are costly to change, such provisions will limit shareholder interference in the running of the
company by top management. For example, executive severance agreements provide compensation to
senior executives upon an event such as termination, demotion, or resignation. They restrict shareholder
rights since they limit the ability of a controlling shareholder to fire management without incurring an
additional cost (Gompers, Ishii, and Metrick, 2003). Golden parachutes are another example of a costly
provision to shareholders in the event of a change in control.11 Classified (or ―staggered‖) boards place
directors into different classes that serve overlapping terms, making it more difficult for large
shareholders to gain control of the board. Target CEOs should be less concerned about interference from
shareholders in acquiring firms that offer severance agreements, golden parachutes, or have classified
boards. We expect that acquiring firms with governance provisions that protect managerial rights will be
more able to credibly commit to maintaining managerial discretion.12
In addition to governance provisions, acquiring firms with CEOs that hold large equity stakes also
may be able to make credible commitments. In deciding whether to stay, the target CEO may seek
commitments from those parties in the acquiring firm who hold control rights (i.e., the shareholders).
Since the acquiring CEO is generally a key player in the negotiations between the acquirer and target,
commitments may often be made and communicated by the acquiring CEO. An acquiring CEO would
have a strong reputational incentive not to renege on any promise made personally to the target CEO, and
with large equity holdings, s/he also has the control rights needed to make the commitment credible. In
addition to being more involved in negotiations, an acquirer CEO may have preferences and beliefs that
are more congruent with those of the target CEO in comparison to other parties with control rights (nonCEO shareholders). For example, CEOs may highly value relationships with other managers and
employees, while non-CEO shareholders may place little value on such relationships. We expect, as
Aghion and Tirole (1997) and Baker, Gibbons and Murphy (1999) show, that any commitment to
delegate decision-making authority (i.e., ―real‖ authority) to the target CEO will be more credible when
More broadly, golden parachutes can be thought of as payments to target CEOs in exchange for firm-specific
human capital investments (Castanias and Helfat, 1991). As such, they align incentives of target CEOs with
shareholders thereby leading to efficient transactions and transfer of control to acquiring firms (Lambert and
Larcker, 1985; Knoeber, 1986; Singh and Harianto, 1989).
While much of the finance literature assumes that managerial supportive provisions lead to ―entrenchment‖ and
ultimately destroy shareholder value, there are clearly costs and benefits of governance provisions. Fisman,
Khurana, and Rhodes-Kropf (2005) adopt a more balanced view by analyzing trade-offs of different governance
environments and find evidence that provisions that support managers can be beneficial in certain circumstances.
the holders of ―formal‖ authority have similar preferences to the target CEO. This is more likely when
one of the major shareholders is the acquirer CEO.13
Our human capital view posits that certain governance and ownership structures enhance the ability
of the acquiring firm to credibly commit to maintaining target CEO discretion post-merger. Specifically, a
credible commitment to managerial discretion is more likely in acquiring firms with governance
provisions that limit shareholder intervention and acquiring firms with CEOs with large equity holdings
that have similar preferences to target CEOs. As such, we would expect a higher probability of retaining
successful target CEOs when the acquiring firm‘s governance is characterized by: (i) governance
provisions that are more likely to maintain managerial discretion, or (ii) a higher fraction of stock held by
the acquiring CEO.
Hypothesis 2: Acquiring firms that are more able to credibly commit to maintaining managerial
discretion are more likely to retain successful target CEOs.
Hypothesis 2a: The greater the use of governance provisions by the acquiring firm that protect
managerial discretion, the more positive the relationship between target pre-acquisition
performance and CEO retention.
Hypothesis 2b: The higher the fraction of stock held by the acquiring CEO, the greater the ability
to credibly commit to maintaining target CEO decision rights, and the more positive the
relationship between target pre-acquisition performance and CEO retention.
3. Data and Econometric Specification
3.1. Sample: The data in this paper come from a variety of sources. Data on merger transactions
come from Securities Data Company (SDC). Information on ownership and target CEO retention comes
from Securities and Exchange Commission (SEC) filings surrounding the merger announcement and
completion dates. CEO characteristics come from proxy statements and ExecuComp. Firm financials
come from Compustat. Corporate governance provisions come from Investor Responsibility Research
This line of reasoning contributes to the literature which analyzes the effect of ownership structure on managerial
discretion (e.g., Demsetz, 1983; Burkart, Gromb and Panunzi, 1997). Burkart, et. al. develop a theoretical model of
the trade-off between gains from monitoring and those from managerial discretion in which they argue ―that a firm‘s
ownership structure can act as a commitment device to delegate a certain degree of control to management.‖(pg.
694). They focus on dispersed shareholders, while we focus on ownership by existing managers.
Center (IRRC) as reported by Gompers, Ishii, and Metrick (2003). We also use the Directory of Corporate
Affiliations and Dun and Bradstreet Million Dollar Directory to verify target CEO post-merger status as
SEC filings only cover the top-five highest paid executives in the firm. Finally, we analyze merger
announcements through Lexis/Nexis to verify dates and to document announced plans for target CEO
The initial sample of mergers includes all U.S. mergers listed by SDC with announcement dates
between 1/1/1994 and 12/31/1998 that meet the following criteria: (i) the merger is not classified as a
share repurchase, a self-tender, or a sale of a minority interest; (ii) the method of financing is classified as
either a stock swap or a tender offer transaction; (iii) both acquirer and target firms are publicly traded
and listed on the CRSP database, and (iv) the market capitalization of target firms is greater than $50
million. A key feature of this study distinct from earlier empirical work is that we focus on select
characteristics of both the acquirer and the target firms. As such, we require the firms to have proxy data
on both acquirer and target for the study period and for them to be covered by ExecuComp. This results in
a sample of 220 transactions comprised of 188 completed and 32 uncompleted mergers. In this paper,
since we are focused on target CEO retention, we analyze only completed mergers. 14
To collect detailed information on both acquirer and target firms, CEO characteristics, and ownership,
we use three SEC filings: (i) the proxy statement, Form 10-K, or similar document containing ownership
data in advance of the last annual meeting before the acquisition announcement; (ii) the proxy statement,
Form S-4, Form DEF 14, or other document filed in connection with the transaction; and (iii) the first and
second proxy statement of the acquiring company filed after the merger becomes effective.
One important issue in the use of our sample selection criteria is how representative our sample is of merger
transactions during this time-frame.By using the above screens, do we systematically bias the sample in such a way
that the study results are not representative of a larger sample of transactions? To address this, we conduct some
comparisons between the study sample and a sample of more than 1000 mergers covered by SDC during a similar
timeframe. This larger sample of transactions is based on the first three screens for the study sample, but we do not
impose that the market capitalization is greater than $50 million. We then exclude the study sample transactions
from this larger sample. We compare the means and medians of transaction characteristics, and both acquirer and
target firm characteristics for both the study sample and the broader sample of transactions and find that summary
statistics are generally qualitatively similar between the two samples. Another selection issue that is not possible to
address with our data is that we don‘t observe those CEOs that are offered a position by the acquiring firm, but
choose not to stay.
3.2. Econometric Specification: To explore the determinants of target CEO retention rates, we
estimate the following probit model conditional on the firm being a target in transaction i at time t:
Pr(CEORET / t arg et ) it1  (1it1   2  it1   3Tit1 * X it1   4  it1   5 it1 )   it
where CEORET is a dummy variable equal to one if the target CEO is retained by the acquiring firm in
the year after the merger (t+1) and zero otherwise; T, X,  and Z represent target firm characteristics,
acquirer governance characteristics, target CEO characteristics, and transaction characteristics,
respectively, in the year prior to the merger (t-1). Target firm characteristics include size and return on
assets, while target CEO characteristics include compensation paid and tenure in position in the year prior
to the acquisition. Acquirer governance characteristics include the governance index, CEO ownership,
and block shareholdings. We include interaction terms between pre-acquisition performance and select
governance measures as appropriate to evaluate support for each hypothesis. Transaction characteristics
include whether the acquisition is a tender offer or merger, the relative size of the target to the acquirer,
and the number of days from announcement to merger completion. all models use mean-centered
variables (or deviations from the mean) for interaction terms and the respective main effects. We include
year indicators and report heteroskedastic-robust standard errors in all specifications.
Dependent Variables:
Data collection on CEO retention begins with both announcement and
completion dates of the merger as reported by SDC (and verified using Lexis/Nexis). The fiscal year of
the target firm prior to the year of announcement is considered to be year (–1). Year (+1) is the fiscal
year of the merged firm following completion of the merger.
For each target firm in the fiscal year prior to the announcement date (–1), the individual occupying
the position of CEO is identified using the proxy statement filed with the SEC. In the first year following
the completion of the merger (+1), the acquirer‘s proxy statement is analyzed to determine retention rates
of target CEOs. The definition of retention is whether the target CEO is reported in any capacity (i.e., as
an officer or director of the merged firm) in the acquirer‘s proxy statement in the year following merger
completion and is represented by an indicator variable.
An additional retention measure includes
retention as an officer in the second year following the merger (+2).
Independent Variables: In this paper, we use three measures to represent the value of the target CEO
to the acquirer: target firm performance, target CEO compensation, and target CEO tenure in position (all
in the year prior to the acquisition, t-1).
To represent target firm performance in the years prior to the merger, we use an industry-adjusted
accounting measure from Compustat. The measure is return on assets (ROA) and is defined as operating
income divided by assets in t-1. This measure is deviated from industry medians. For completeness and to
avoid misclassifying performance due to outliers, we also calculate three-year averages of this measure
(based on t-3, t-2 and t-1). Turning to CEO pay, we measure compensation as total compensation as
reported in ExecuComp (which includes salary, bonus and the value of stock options, restricted stock and
other forms of long-term incentives). Finally, we use tenure or the number of years in position as CEO as
a proxy for the target CEO‘s firm-specific human capital.
In this paper, we use two measures of the acquiring firm‘s governance: (i) broad governance
provisions represented by a governance index or the G-index (Gompers, Ishii, and Metrick, 2003, or
GIM) and (ii) the fraction of stock held by the acquiring CEO. The G-index characterizes the degree to
which the firm‘s governance provisions support owners versus managers or ―the balance of power
between shareholders and managers‖ (GIM, 2003). As mentioned earlier, to the extent that the G-index
proxies for provisions that make it difficult for shareholders to "punish" or overrule management, and if
they are costly to change, such provisions limit shareholder interference in top management discretion.
This index considers 24 different provisions in 5 categories—tactics for delaying hostile bidders, voting
rights, director/officer protection, other takeover defenses, and state laws (refer to Table A1 for details by
group). The index, G, is formed by adding one point if the firm has a specific defensive provision in place
and zero otherwise, leading to values between 0 and 24. Larger values of G represent more restrictions on
owners and in turn more support for managerial discretion.15 Because this index is the simple sum of
various governance measures, it is relatively common in the corporate governance literature to use
quartiles of the index (e.g., Cremers and Nair, 2005). Moreover, since our focus is on the interaction term
between the governance index and firm performance and the effect on retention, and not the level effect
of the governance index on retention, we construct an indicator variable equal to one if G is in the top
quartile of the index (i.e., greater than 12) and classify these acquirers as firms that commit to maintaining
managerial discretion. Or, said another way, firms with G greater than 12 are firms with provisions that
increase the ability of the acquiring firm to credibly commit to managerial discretion for the target CEO.
Our second measure of the acquiring firm‘s governance is CEO ownership calculated as the fraction
of the firm owned by the acquirer CEO. We use the number of shares listed in SEC proxy statements in
year (t-1) and divide that by the total number of shares outstanding as reported directly in SEC filings.
Acquiring CEOs with large stockholdings are important since they have substantial voting control and,
when they have similar preferences to target CEOs, they are more effective in maintaining managerial
We control for a number of variables that are important to merger outcomes including characteristics
specific to the transaction and the target firm. First, we include a set of control variables related to the
transaction. When the size of the target firm is large relative to the acquiring firm, the challenge of postmerger integration may be more difficult (Zollo and Singh, 2004). We might expect the likelihood of
target CEO retention to be higher, so we control for the size of the target firm relative to the size of the
acquiring firm. To measure relative size, we calculate the ratio of the target firm assets to that of the sum
of assets for the acquirer and target firm in the year prior to the merger. When acquirers operate in
different industries than the target firm, the industry-specific skills of target CEOs should be of greater
As described in GIM: ‗We divide the rules into five thematic groups and then construct a ―Governance Index‖ as
a proxy for the balance of power between shareholders and managers. Our index construction is straightforward: for
every firm we add one point for every provision that reduces shareholder rights. This reduction of rights is obvious
in most cases; the few ambiguous cases are discussed. Firms in the highest decile of the index are placed in the
―Dictatorship Portfolio‖ and are referred to as having the ―highest management power‖ or the ―weakest shareholder
rights‖; firms in the lowest decile of the index are placed in the ―Democracy Portfolio‖ and are described as having
the ―lowest management power‖ or the ―strongest shareholder rights.‖‘
value to the acquiring firm. We expect lower retention rates of target CEO when the acquiring and target
firms operate in the same industry (Walsh, 1989; Buchholtz, Ribbens, and Houle, 2003). We create an
indicator variable equal to one if the acquirer and target firms operate in the same 3-digit SIC industry and
zero otherwise. The time it takes to complete a merger can be a function of the complexity of merger
negotiations between the acquiring and target firms. This might be larger when negotiations involve
retention of valuable human capital. We include the number of days until completion (i.e., the number of
days between announcement and completion of the merger) as reported by SDC.
Also, we control for target firm characteristics.
Larger and more complex firms may require
managers with unique skills and may allow managers more opportunities to create value (Finkelstein and
Hambrick, 1989). To control for firm size, we include the logarithm of target assets in the year prior to the
merger. Finally, in the regressions that include governance measures, we control for the presence of
blockholders in the acquiring firm (i.e., the fraction of shares held by investors with greater than or equal
to 5% of the shares, excluding the CEO). Due to their significant control rights, blockholders can be very
influential in decisions around M&A including the decision to retain the target CEO.
4. Results
In Table 1, we report summary statistics for all the variables in our analysis. The average retention
rate between years (–1) and (+1) for target CEOs in any capacity (i.e., as either an officer of the merged
company or director of its board) is 50%. The comparable retention rate as an officer of the merged firm
is 22% between years (–1) to (+2). These percentages imply turnover rates that are much higher in
comparison to the approximate figure of 10% found in other studies analyzing firms without a change in
control (e.g., Martin & McConnell (1991)). However, it is not surprising that target CEOs are either
forced to leave or voluntarily choose to after their firm has been acquired. Other notable statistics are the
industry-adjusted performance measures for target firms. On average, target firms have higher ROA
relative to industry peers (positive ROA), but lower revenue growth (negative sales growth).
In Table 2, we report means for the key variables split into deals in which the acquiring firm retained
the target CEO and deals in which the target CEO was not retained. The deals are different in a
comparison of means of several key variables and these differences are generally consistent with our
predictions. The total compensation of the target CEO prior to the acquisition is larger in deals in which
the target CEO is retained (approximately $3.1 million vs. $1.8 million). The target firms in deals in
which the target CEO is retained are more profitable (higher ROA). The relative size of the target firm to
the acquiring firm is much larger in deals in which the target CEO is retained (0.38 vs. 0.21). In Table 3,
we include a correlation matrix of all of the variables used in the analysis. We can see positive and
statistically significant correlations between target CEO retention and target performance and CEO
compensation, but no relationship to tenure.
Another notable positive and statistically significant
correlation is that between CEO pay and both measures of target size: the absolute size (i.e., the
logarithm of target assets—correlation 0.44) and the relative size to the acquiring firm (i.e., the ratio of
target assets to the sum of acquirer and target assets—correlation 0.22). Since pay is highly correlated
with target firm size, we initially exclude size in the regressions that include pay, but then include all
measures in the fully-specified model.
The probit regressions analyzing the relation between target CEO retention and measures of the value
of the CEO are shown in Table 4 columns 1 through 8. All regressions include year dummies and
heteroskedastic-robust standard errors. The Wald Chi-sq. tests evaluate the joint significance of the
variables that represent the value of the CEO by comparing the restricted model (1) to the more fullyspecified models reported in each column. We designate the target CEO as being retained if s/he remains
as an officer or director in the merged firm in the year following the merger (+1). In this table, we are
evaluating the relationship between the probability of target CEO retention and measures of target firm
performance, target CEO pay, and target CEO tenure in position (i.e., Hypothesis 1). In column 2, we
evaluate the relationship between target CEO retention and the measure of pre-acquisition performance
(ROA) and find that they are positively correlated and statistically significant at the 1% level. Betterperforming target CEOs are more likely to be retained by acquiring firms.16 In columns 3 and 4, we
An alternative explanation is that good target CEOs may simply prefer to stay with acquiring firms that are betterperforming. However, the data do not support this simple explanation. In a regression of target CEO retention on
evaluate the relationship between retention and pay. In column 3, we find that the coefficient on target
CEO compensation is positive and statistically significant. (Note the number of observations decline due
to missing data in ExecuComp on target CEO pay.) However, when we include both the logarithm of
target assets and relative target size in column 4, the magnitude of the coefficient on pay declines and it is
no longer statistically significant. As mentioned earlier and as seen in the correlation matrix (Table 3),
both measures of target size are correlated with target CEO pay, especially the logarithm of target assets
(correlation is 0.44).17 Since the pay result is sensitive to controlling for target size, we conclude that our
evidence is suggestive that higher paid target CEOs are more likely to be retained. In column 5, we
evaluate the tenure of the target CEO and find no relationship between tenure in position and the
probability of retention.18 Finally, in columns 6 and 7, we include performance, pay and tenure. We find a
strong positive relationship between retention and performance, some suggestive evidence of a positive
relationship with pay, but no relationship with tenure. The p-values of the Wald tests for joint significance
are generally statistically significant in the regressions that introduce the performance and pay variables,
but insignificant in those introducing tenure.
The positive and significant coefficients on target firm performance and target CEO compensation in
the year prior to the merger support Hypothesis 1a and 1b. The evidence of a link between retention and
performance is much stronger than that with pay. However, we find no support for Hypothesis 1c
(tenure). Several other findings are worth noting. Target CEOs are more likely to be retained in deals
with relatively larger target firms and in deals that take longer to complete suggesting that CEOs are
retained in more complex transactions. It is also possible that deals in which the target CEOs are retained
acquiring and target firm performance measures (ROA) and the interactions between acquiring and target
performance, we find no evidence that better-performing acquiring firms are more likely to retain good target CEOs.
Moreover, there is no evidence that the performance of the acquiring firm is positively correlated with the
governance measures in our sample. In regressions of acquirer performance (ROA) on the governance indicator and
CEO ownership, all coefficients on the governance/ownership measures are statistically insignificant (unreported).
When we use CEO pay and target assets in place of their logarithmic transformations, the coefficient on CEO pay
is positive and statistically significant at the 5% level in all specifications (unreported). This could suggest that high
quality CEOs are at the top of the pay distribution.
We also experimented with specifications that allow for non-linear relationships between retention and tenure by
including squared-terms of tenure, but find no robust results. We did the same with target CEO age (or proximity to
retirement), but found no consistent patterns.
take longer precisely because of the challenges involved in clarifying job responsibilities and making
commitments to the target CEO.
Interestingly, target CEOs are less likely to be retained in transactions that are tender offers. Much of
the earlier finance research which supports the disciplinary motives of the market for corporate control
are based on samples of tender offer transactions. Since tender offers tend to be hostile transactions, not
retaining the CEO is more likely. To evaluate whether the inclusion of tender offers in our sample
materially affects our results, we repeat the fully-specified model in column 7 of Table 4 on a restricted
sample that excludes tender offer transactions. These results, shown in column 8, are very similar to those
found in the complete sample, despite the reduction in sample size.
Overall, we find support for a managerial human capital explanation. Target CEOs are more likely to
be retained as either an officer or director in the merged firm when the target firm is better-performing
measured by industry-adjusted ROA. While previous studies in finance of hostile takeovers have shown
that poorer-performing target CEOs are more likely to be fired (also consistent with our findings), we
show that the performance-retention link holds in a sample of friendly mergers. Another interesting
finding is that higher paid target CEOs appear more likely to be retained. We know of no other study that
has documented this relationship, but we also caution that the evidence supporting this is only suggestive.
Importantly, while the positive coefficient on performance is also consistent with the agency explanation
that poor-performing target CEOs are dismissed, the positive coefficient on pay seems to be at odds with
this explanation. If CEOs are paid more because they are ―entrenched‖, then we would expect pay and
retention to be negatively correlated—i.e., higher paid CEOs would be less likely to be retained. The fact
that we find suggestive evidence of the opposite seems to be more consistent with a managerial human
capital explanation. Finally, the weak results on tenure are generally consistent with other studies (e.g.,
Buchholtz, Ribbens, and Houle, 2003) that find no evidence of any linear relationship between target
CEO departure and tenure.
4.1. Role of Governance: Let us now analyze the relationship between the retention of the target
CEO and firm performance and how that varies with the acquiring firm‘s governance environment. In
Table 5, we again report probit regression results based on the whole sample (column 1) and the sample
that excludes tender offer transactions (column 2). In both regressions, we include our two measures of
governance for the acquiring firm: the governance indicator representing managerial discretion (i.e., if G
is in the top quartile of the index, G>12); and the fraction of shares owned by the CEO. We include the
two measures directly and also include interaction terms between each governance measure and target
ROA (all variables are mean-centered).19 Since powerful shareholders of the acquiring firm might
influence the decision to retain target management, we also include the fraction of shares held by
blockholders (excluding the CEO) as a control variable.
In both models, the coefficient on target ROA is positive and statistically significant. Of greater
interest, the coefficient on the interaction between the governance indicator and target ROA is positive
and significant. This finding is consistent with H2a. Better-performing target CEOs are more likely to be
retained when the acquiring firm has governance provisions that support managers. Moreover, the
coefficient on the interaction between the acquirer CEO ownership and target ROA is positive and
significant, a finding that is consistent with H2b. Better-performing target CEOs are more likely to be
retained when the CEO of the acquiring firm owns a higher fraction of the firm‘s stock. Note this latter
result is also consistent with the simple agency explanation in that acquirer CEOs with larger equity
stakes are more likely to dismiss poor-performing target CEOs.
However, the stronger retention-
performance link in firms with governance provisions that support managers is at odds with this
explanation. The agency explanation suggests that the retention-performance link should be stronger in
firms with governance that supports shareholders, yet we find the opposite.20
In order to address criticisms raised by Ai and Norton (2003) regarding interaction effects in non-linear models,
we created figures that show the marginal effects as calculated by the ―inteff‖ program and procedure (STATA) (not
included in paper). The interaction marginal effects are consistent with the sign of the coefficients on the interaction
terms (governance and CEO ownership interaction effects) for both samples.
To evaluate the robustness of the effect of governance on the retention of successful target CEOs, we conduct
additional analyses (unreported). First, we analyze all quartiles of the G-Index governance measure and find that
There are a couple of other notable points in Table 5 to highlight. First, the p-values of the Wald Chisq. tests show that the joint significance of the performance and governance variables is statistically
significant in both columns (1) and (2). Second, the coefficient on days until completion is positive and
significant in both specifications. The fact that mergers that retain target CEOs take longer to complete is
consistent with our theory and the idea that getting promises or commitments from influential
shareholders may extend the negotiations and lead to longer completion times. Finally, the coefficient on
the fraction of shares owned by blockholders in the acquiring firm is negative and significant suggesting
that powerful (non-CEO) shareholders are less likely to retain target CEOs.
Overall, the findings in Table 5 support a managerial human capital explanation. Better-performing
target CEOs are more likely to be retained when acquiring firms have governance provisions that support
managers and when acquiring firms have CEOs with large equity holdings. We argue that both of these
findings are consistent with the explanation that acquiring firms that are more able to credibly commit to
maintaining managerial discretion are more likely to retain successful target CEOs. That is, target CEOs
that prefer ―to be the boss‖ will be more likely to stay with an acquiring firm when governance provisions
maintain managerial discretion and acquirer CEOs (with similar preferences to target CEOs) have greater
5. Discussion and Conclusion
In contrast to physical capital or assets, human capital cannot be ―owned.‖ As such, one of the most
significant challenges facing acquiring firms is how to retain the valuable human capital of the firm that
they are buying. We develop a managerial human capital view in the context of M&A that recognizes the
importance of retaining successful target management and the role of the acquiring firm‘s governance
structure in doing so. In a joint analysis of retention and governance, we explore the conditions under
indeed, the effect only holds for the firms in the top quartile. That is, the coefficients on the interaction terms
between the lower quartile dummies and ROA are small and not statistically significant. Second, we use another
common governance index (the E- index of Bebchuk, Cohen and Ferrell, 2008) that is based on 6 governance
provisions that have been shown to limit shareholder power. They include staggered board, limitation on amending
bylaws, limitation on amending the charter, supermajority to approve a merger, golden parachute, and poison pill).
The positive effect of governance on retention of better-performing CEOs is robust to using the top quartile of this
alternative governance measure.
which target CEOs are retained by acquiring firms. We find evidence that is broadly consistent with a
managerial human capital view. First, acquiring firms retain ―successful‖ target CEOs, i.e., those that
come from better-performing firms and are higher paid. Moreover, they are more likely to do so with
governance provisions and ownership structures that allow acquiring firms to credibly commit to
maintaining managerial discretion. Specifically, the retention-performance link is stronger when the
acquiring firm‘s governance supports managers (as measured by the G-index) and the acquirer CEO has
control rights (i.e., holds a higher fraction of firm stock). Taking our findings together as a whole, they
suggest a more nuanced view of the role of governance in retaining valuable human capital in the
governing body of the post-merger entity. We conclude that acquirers appear to be making optimal
decisions to retain valuable CEOs in the presence of governance structures that are simultaneously
beneficial to both managers and owners. Managers and owners may not necessarily be at odds.
Much of the early research that supports the disciplinary view of takeovers is based primarily on
tender offer transactions occurring in hostile settings where managerial interests clearly conflict with
those of shareholders (e.g., Martin & McConnell, 1991). In contrast to this literature, we use a sample of
primarily friendly mergers during the 1990s that typically involve negotiations between the CEOs of both
the acquiring and target firms. Negotiated mergers are interesting to study because, it is exactly these
settings in which target managers may be valuable assets to acquiring firms, and the governance
environment may affect the acquirer‘s ability to retain valuable human capital.
Clearly, there are several limitations with this study. First, our measure of retention is based on
archival sources, and as a result, we cannot determine how much discretion is given to the target CEO that
stays with the merged firm. Another limitation is that our results are based on a governance index that is
comprehensive and includes a broad set of provisions (yet is robust to a narrower list). Future research
may employ finer-grained measures that identify the most effective corporate governance provisions.
Despite these limitations, we believe that our results identify the conditions under which successful target
CEOs are retained by acquiring firms. One advantage of focusing on retention around mergers, rather
than retention in general, is that we are able to isolate a specific corporate event in which decision-makers
of both the acquiring and target firms make a decision that potentially has important implications for the
success of the merger. Our tests address the marginal impact of governance provisions and ownership
structure that lead to the retention of valuable human capital in the post-merger firm.
The evidence presented in this paper provides a new and interesting insight into the relationship
between managers and owners in M&A and the role that governance may play in the retention of valuable
human capital of the target firm. The traditional view of the market for corporate control and efficiency
arguments typically consider target managers as ―liabilities‖ and emphasize the monitoring and
disciplining of managers by owners. In contrast, this paper considers managers as ―assets‖ and presents
evidence suggesting the objectives of owners and managers are not necessarily at odds. Owners of
acquiring firms can benefit from retaining human capital of target firms as they may be valuable resources
central to the firm‘s long-term competitive advantage. Acquiring firms retain these valuable resources
when the ownership structure and governance environment provide credible commitments to maintaining
managerial discretion.
Our findings suggest that a human capital explanation might be more consistent with the
characteristics of the friendly, negotiated mergers during the 1990s. Perhaps increased ownership by
CEOs has contributed to a more nuanced approach to retention of the human capital of target firms.
Acquiring firms may have developed enhanced skills in identifying valuable human capital and
recognizing the role of their governance environment in retaining successful managers. Our theoretical
and empirical contributions shed light on changes in how the market for corporate control operates while
providing some direction for future research.
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Table 1: Summary Statistics
Target CEO
Target Firm
Acquirer CEO
Acquirer Firm
Retention in any capacity (t+1)
Retention as officer (t+2)
Tenure in CEO position (years)
Total Compensation ($000's)
Log (Total Compensation)
Assets ($M)
ROA (Industry-adjusted)
Sales growth (Industry-adjusted)
Ownership (%)
Assets ($M)
Governance Index
Managerial Discretion (top quartile of G-index,
Block Shareholdings (excluding CEO)
Related Merger (Same 3-digit SIC)
Target Relative Size
# Days b/n announcement & completion/100
Tender Offer transaction
Std. Dev.
Notes: The fiscal year of the target firm prior to the year of announcement is year (–1). Year (+1) is the fiscal year of the merged firm following completion of the
merger, while year (+2) is the second fiscal year post-merger. The governance index is based on Gompers, Ishii and Metrick (2003). Target relative size is defined
as target assets/ (target + acquirer assets).
Table 2: Means of Sub-samples: Target CEO Retained vs. Not Retained
Target CEO tenure in position (years)
Target CEO Total Compensation ($000's)
Log (Target CEO Total Compensation)
Target Assets ($ M)
Target ROA (Industry-adjusted)
Target Relative Size
Target CEO Retained
Target CEO Not Retained
p-value (difference)
Table 3: Correlation Matrix
5. Target ROA
6. Acquirer CEO
Ownership (%)
7. Acquirer
8. Acquirer
Discretion (top
9. Related Merger
(same 3digit SIC)
10. Log Target
11. Target Relative
12. Days Until
13. Tender Offer
1. Target CEO
Retained as
Officer or
Director (t+1)
2. Target CEO
Retained as
Officer (t+2)
3. Target CEO
Tenure in
4. Log Target CEO
* Represents significance at the 5 % level.
Table 4 (H1): Target CEO Retention
Target Firm Performance, CEO Pay and Tenure
Target ROA
Log Target CEO Pay
Target CEO Tenure Position
Log Target Assets
Target Relative Size in Assets
Related-3 digit
Days Until Completion/100
Tender Offer
Year Dummies
Pseudo R-squared
Wald Chi-Sq.
Deg. of Freedom/p-value
Tender Offers
Probit regression models where ***, **, * represent significance at the 1%, 5%, 10% level, respectively; heteroskedastic-robust standard
errors reported in parentheses. Wald tests compare restricted model (1) (without performance, CEO pay, and tenure) to the more fullyspecified models.
Table 5 (H2): Target CEO Retention, Target Performance, and Acquirer Governance
Target ROA
Acquirer Managerial Discretion X Target ROA
Acquirer Managerial Discretion
Acquirer CEO Ownership X Target ROA
Acquirer CEO Ownership
Related-3 digit
Log Target Assets
Target Relative Size in Assets
Days Until Completion/100
Target CEO Tenure in Position
Acquirer Block Shareholdings (excl. CEO)
Tender Offer
Year Dummies
Pseudo R-squared
Whole Sample
Excludes Tender Offers
Wald Chi-Sq.
Deg. of Freedom/p-value
Probit regressions where ***, **, * represent significance at the 1%, 5%, 10% level, respectively; heteroskedastic-robust
standard errors reported in parentheses; interaction terms and respective main effects are based on mean-centered
variables. Wald tests compare restricted models (without ROA and governance variables) to the fully-specified models in
this Table.
Table A1: Governance Provisions of Gompers, Ishii, Metrick (2003)
(Table I, pg. 112)
Blank check
Classified board
Special meeting
Written consent
Compensation plans
Golden parachutes
Cumulative voting
Secret Ballot
Unequal voting
Directors‘ duties
Fair price
Pension parachutes
Poison pill
Silver parachutes
Antigreenmail law
Business combination law
Cash-out law
Directors‘ duties law
Fair price law
Control share acquisition laws