Two types of CEO human
capital: experience and
education, and their relation
to firm performance
MSc Business Economics-Managerial Economics and Strategy Master Thesis
Name: Yifan Liu Student number: 11708980
Supervisor: Dr. Silvia Dominguez Martinez
Statement of Originality
This document is written by Student Yifan Liu, who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document are original and that no sources other than those mentioned in the text and its references have been used in creating it.
Table of Content
1. INTRODUCTION ... 4
2. LITERATURE REVIEW... 5
2.1EVOLUTION OF CORPORATE OWNERSHIP AND CONTROL SEPARATION ... 6
2.2BOARD OF DIRECTORS ... 7
2.2THE IMPORTANCE OF CEO ... 8
2.2.1 The power of CEO ... 8
2.2.2 The human capital of CEO ... 9
2.2.1 Tenure ... 10 2.2.2 Education ... 12 3. METHODOLOGY ... 14 3.1DATA DESCRIPTION ... 15 3.2VARIABLE DESCRIPTIONS ... 16 3.2.1 Dependent variable: ... 16 3.2.2 Independent variable: ... 17 3.2.3 Control variables ... 18
3.3ORDINARY LEAST SQUARES (OLS) ... 20
4. RESULT AND DISCUSSION ... 20
4.1DESCRIPTIVE STATISTICS... 21
4.2EXPLANATION FOR REGRESSION ... 22
4.2.1 Tenure and firm performance ... 22
4.2.2 CEO education and firm performance ... 24
4.3DIFFERENCE BETWEEN FINANCIAL AND ACCOUNTING MEASURES ... 31
4.4ROBUST CHECK ... 32
5. LIMITATION ... 33
6. CONCLUSION... 33
7. APPENDIX ... 35
7.1TABLE FOR ROBUST CHECK ... 35
7.2REGRESSION RESULTS FOR YEAR 2015 ... 37
7.3REGRESSION RESULTS FOR YEAR 2016 ... 39
8. REFERENCE ... 42
1.Introduction
Human capital has received much attention both in the academic as well as the business field. Compared to the return of investment from material capital, human capital can generate much higher profits (Schultz, 1993). Therefore, making use of human capital efficiently and
enhancing its influence have become one of the most important ways to improve firm performance.
The essential decision maker within the firm, CEO and his human capital have also been the focus. Corporate shareholders are constantly searching for CEOs who have superior
managerial capability, in other words the right level of human capital, to enhance the firm performance. There is a growing number of studies focusing on the role a CEO has on corporate outcomes and if the CEO’s attributes affect corporate decisions. For instance, Mackey (2008) measured the CEO’s contribution to firm performance. The result of his study shows that around 30% of the variance in ROA of firms is related to the CEO. Similar
conclusions were also drawn by Hambrick and Quigley (2014). By applying firm-specific controls and industry controls at different time period, the authors found that 35.5% of the increase in ROA can be attributed to the CEO. These studies show that CEOs do have significant influence on firm performance.
For corporate shareholders, human capital information which can be analyzed easily could be helpful in the process of CEO selection. Several studies have considered this topic, more details will be discussed in literature review section.
In this thesis, two types of human capital namely experience at the position and education were picked to discuss. The linkage between these two and firm performance are still ambiguous. Therefore, the following research question will be investigated:
• How important is the CEO’s human capital to firm’s overall performance? To what
extent can tenure and education of the CEO help to predict firm performance?
The main distinguishing feature of this paper is that in this thesis distinguished international degree and American degree. In previous studies, only US national university rankings are used, there is no information about CEOs with international degrees. This can be problematic and influence the result. In this thesis, data from year 2014 to 2016 was used. It is found that recently there are lots of CEOs of s&p 500 list firms holding international degrees. Therefore, here we are trying to see if more detailed degree information can generate different results.
To investigate this topic, this paper will start with a comprehensive review of related literature to clarify why the CEO and his human capital is important for the firm. Then the focus will be narrowed down to two forms of human capital, experience within the company (indicated by tenure) and educational background. The education of the CEO will be discussed from three perspectives, the educational level, the educational quality and whether a MBA or Law degree obtained. Furthermore, multiple measurements for firm performance are considered to
generate answer to the research question. It is found that CEO tenure is positively related with firm performance. Furthermore, CEO education does not have a significant effect on firm performance.
2.Literature review
In this section, the relevant literature for this study will be discussed. Starting with the evolution of corporate governance, how the change in ownership and control structure in firms was be introduced, which will give readers information how CEO obtained decision making rights. Then the importance of a CEO will be discussed from two perspectives, the power of the CEO and the human capital of the CEO. These are followed by more detailed information
about two forms of human capital of the CEO and their relation to firm performance. In the end, hypotheses will be formulated.
2.1 Evolution of corporate ownership and control separation
In the 18th century, the factory system emerged in the United Kingdom as the industrial revolution started (Nelson, 1993). The previous workshop system where work was
subcontracted by agent to family workshop or crafters, was replaced by factory. This was the initial capitalist form of production and new form of organization (Kapás, 2008). At that time, the owners of the factory (firm) were responsible for all the production endowments such as raw materials, machinery, buildings and expenditure for administration and management. The workers did not hold any share of the firm, therefore had no voice or control over the firm, control over firm and ownership were actually unified(F. Miller, 2017).
As the technology developed and scale of firms expanded, the previous governance structure did not work well anymore, owners cannot only rely on their own power and ability to manage enterprises. In the early nineteenth century, a small but an increasing number of corporations started trading equity shares publicly (HILT, 2008). It was the beginning of the separation of corporate ownership and control. Outsiders had the opportunity to become shareholders of the company and enjoyed the rights for profit and influence on company. Although the ownership was still quite concentrated, the control over firms via almost complete ownership changed to be control over firms through big investors (HILT, 2008)
To attract more small investors and enhance their influence, many firms applied graduated voting rights scheme, under which the shareholder’s voting rights were configured and the firms were governed with more shareholders (HILT, 2008)However, as the size of firms further increased, this scheme also became problematic. Dispersed ownership resulted in decision making process moving from shareholders to management.
2.2 Board of directors
Most corporations have own governance institution, which exist to control and direct the firm. The elected board of directors enjoys the authority and is responsible for corporate
management. The board decides the overall strategy for the firm and managers the business, taking into account the interests of shareholders and other stakeholders.
According to Zahra and Pearce (1989), there are several perspectives on the roles of the board. The first perspective is the legalistic perspective, suggesting that board of directors operate the power mandated by law to contribute to the corporate performance. Instead of interfering in daily affairs in the company, the board functions as the control mechanism to monitor
management and corporate performance (Zahra and Pearce, 1989). On behalf of shareholders’ interests, the board also takes charge of the selection and replacement of executives and offers suggestions to the top management. The second perspective is the resource dependence perspective. This implies the capabilities of the broad to extract resources to support the corporate operations, relating to the fact that normally broad members prestige in own professional fields (Zahra and Pearce, 1989). From this perspective, actions taken by the board, such as securing scare resources for the firm, providing available information to managers in good season, can be helpful to enhance the efficiency and performance of firms (Zahra and Pearce, 1989). In addition, according to the class hegemony perspective, the board serves as the tool to maintain the power of the capitalist elite. Only the most prestigious people have the chance to be invited to join boards and they will protect reigning capitalists’ interests. The main responsibility of the board includes diminishing transaction cost for member firms and directors’ recruitment (Zahra and Pearce, 1989).
Finally, there are some operational roles played by the board. As an essential part of a firm, board appoints managers. However, managers do not always behave in the best interest of the
shareholders. This caused agency problem in the corporation. In some cases, managers may even commit fraud for their own benefits (Jensen & Meckling, 1976). Then from the perspective of the board, it is necessary to monitor the actions of the CEO and protect the interests of the owners. To do so, the board has the responsibility to, among other things, reduce agency cost, examine executives and company performance, select and reward executives (Zahra & Pearce, 1989).
2.2 The importance of CEO
Just like the power of corporate boards of directors, the relative control of CEO on firm
decision making and whether a CEO matters for firm performance has received much attention in the literature.
2.2.1 The power of CEO
There are lots of scholars arguing that CEOs have more power than the board. Too much monitoring from the board may demotivate the CEO, therefore in most of the cases, CEO enjoys some freedom in decision making and can consider own preference when making decision and can further affect the performance of the firm.
Sometimes this power of the CEO can influence the selection of the board directors. This diminishes the power of the board so that the board loses some control over the CEO.
According to Bacon and Brown (1975) , the CEO can actually influence who will get into the board. The bargaining power of CEOs with the board enables them to affect the structure of the board in their own favor. Sometimes CEOs tend to appoint outside directors who meet their satisfaction for the purpose of own influence enhancement (Wade, O’Reilly, Chandratat,
& Chandratat, 1990). And CEOs can play a central role in directors and management
recruitment process (Foster, 1982). In this case, the corporate decision process might be affected by CEO indirectly. And if a CEO is powerful enough, then he can even change the governance that evaluates their performance.
However, some studies document a positive relationship between CEOs’ power and firm performance. Adams, Almeida, and Ferreira (2005) studied publicly traded firms listed on the fortune 500 during 1992 till 1999, and found that the more powerful a CEO is, the better the company’s stock returns would be. Similar conclusion was drawn by Harjoto and Jo ( 2009), who took the life-cycle of firm into accounts, firms with more powerful CEOs exhibit better performance, especially in the early stage of firm’s life-cycle. In further research, Harjoto and Jo distinguished the type of firms and tested the effect of CEO’s power on firm performance. The study shows that compared to non-state-owned firms, state-owned firm’s performance is influenced with larger magnitude by CEO power (2009). The explanation for the positive relation between the power of the CEO and firm performance is that the dilution of the power slows the decision making process and lower the possibility of a spectacular performance (Adams et al, 2005).
2.2.2The human capital of CEO
The importance of the CEO also relates to their human capital. According to Becker (1964) , human capital should be considered equally important as physical manufactural means and capital, which can affect the performance of individuals as well as the performance at the organizational level (B. E. Becker & Huselid, 2006). For the whole firm, of course the general level of human capital is quite important, but when considering the significant influence of the CEO on corporate strategy, the human capital of the CEO should also be addressed carefully.
In general, human capital is categorized into two main forms: generic human capital and firm-specific human capital (Becker, 1964). All executives own generic human capital, although it differs in the nature as well as degree for different people (Harris & Helfat, 1997). Those general skills can be transferred between firms or between industry, common forms including education, reputation, some cognitive abilities and so on. While firm-specific human capital is restricted to the specific firm, which means those skills do not have value outside of the firm. Aivazian, Lai and Rahaman (2011) studied the effect of CEO turnover on firm performance. By investigating the interactions of multiple generic managerial and firm specific human capital, it is found that the human capital of the CEO did influence firm performance. More specific, relatively higher levels of generic managerial skills are related to lower leverage and intangible assets investment, which leads to better performance for firms. Graham and Harvey (2002) also claimed that executives who have stronger human capital tend to use more
sophisticated methods in management and operations, which yield long-term growth in firm value.
In the subsequent subsection, two forms of human capital are discussed. One belongs to generic human capital, the educational background of CEO, another one is more firm specific, namely experience.
2.2.1 Tenure
Experience can be considered as a specific form of human capital within firms. Difference in specific knowledge in the firm may lead to different firm performance. A better understanding of tasks and mechanism of firms might relate to more efficient performance. When it comes to CEO human capital, one of the commonly used indicators for experience is tenure. Tenures in most studies relates to how long a CEO has been working in the firm. In economic and strategy literature, the effect of CEO tenure on firm performance has been examined a lot. However, scholars hardly reach an agreement on the relationship.
Wu, Levitas and Priem (2005) conducted a research in bio pharmaceutical industry to test the relationship between CEO tenure and the invention activities. Innovation is an essential element for corporate success, which can be an indicator for firm performance. The authors conclude that CEOs are keener to learn about the environment and the strategy and relatively risk taking in the early stage of their tenure, therefore more inventions are generated (Wu, Levitas, and Priem, 2005). While as the time goes on, the support of the CEO on innovation shows more with the respect to quality improvement rather than the quantity. CEO are more willing to support new initiatives and develop own knowledge and skills in depth. They would be better at stimulating invention in a more stable technology environment, the quality of invention is better (Wu, Levitas, and Priem, 2005). It seems that the tenure of CEO is positively related with firm performance. Similarly, Luo, Kanuri and Andrews (2014) claim the positive effect of CEO tenure on firm performance via the interactions between firm and customers. From the learning perspective, CEOs make use of both external and internal information and are engaged in learning process in the early stage of tenure (Hambrick & Fukutomi, 1991). As tenure increases, CEOs gain better understanding of their employees, clients, corporation as well as the external context (Vera & Crossan, 2004). Therefore, the longer the tenure is, the stronger the link between firm and clients as well as employee becomes and also the overall performance of the firm is enhanced accordingly (Luo, Kanuri and Andrews, 2014).
On the other hand, different conclusions were drawn by other scholars. D. Miller and Shamsie (2001) conducted a longitudinal research in the motion picture industry, covering the period from 1939 to 1965. The relationships between CEO tenure, firm financial performance, and the product line experimentation were tested. It was found that after several years, the
performance of firm falls. In another research from D. Miller (1991), a contingency theory was used to explain this phenomenon. It is observed that organizations with short-tenured CEO on average cannot match their strategy and organizational structure to the challenges from operating environment as well as organizations with long-tenured CEO. This misalignment
leads to a decline in performance of the firm. Additional explanations were given by Hambrick and Fukutomi (1991).With longer tenure, the learning process of the CEO slows down, and the CEO becomes insensitive to the external environment and focuses too much on the previous experience and knowledge. Besides, it can also be explained via the relationship between the firm and clients. For CEO with long tenure, less interaction with external environment makes them more rely on internal information for decision making, therefore the relationship between firm and customers gets weaker, further declining the firm’s financial performance (Luo, Kanuri and Andrews, 2014).
The literature shows conflicting results on the relation between tenure and firm performance. However, in this thesis it is expected that longer tenure will give the CEO a better
understanding of the firm and operating environment. More experience would compensate for the negative effects caused by a potential decreased interaction with external environment. Therefore, a positive relationship between CEO tenure and firm performance is expected here.
The following hypotheses is formulated:
H1: The tenure of the CEO is positively related to firm performance
2.2.2 Education
Another human capital addressed here is education received by CEO. Not like experience in a specific company, the knowledge or other benefits gained via education have value across firms and even industry.
Gottesman and Morey (2006) attempts to test the relationship between the quality of CEO education and firm performance. In their study, the mean of GMAT and of SAT scores is used as an indicator for educational quality. The higher the score is, the better the quality of CEO
education is. The firm performance was indicated by buy and hold adjusted return of stock. However, no significant relationship was found in their study.
However, some scholars generate different conclusions. According to Bhagat, Bolton, & Subramanian (2010) , CEO education can potentially influence the CEO’s capabilities. Social networks built in university and graduate school can benefit the CEO’s professional career in the future. On the operational level, the decision making can base on specific standards or requirements. However, on the top of the firm, the decision-making process may be not able to follow clear gist. In this case, the social information or connection can be quite useful (Kanter, 1977). Especially when criteria for judgement are vague, those social network can lead to attractiveness and credibility for clients or partners so that the corporations can be facilitated, and firm value is potentially increased (Chaiken,1987). Those value gained via formal education usually last whole careers (D’Aveni, 1990). In this paper, it is expected that CEOs with higher degree gains more values from these social networks and knowledges. Therefore, the following hypothesis is generated:
H2a: There exists a positive relation between the CEO’s educational level and
firm performance
Also, Bhagat et al (2010) conclude that CEO education can potentially influence the CEO’s capabilities in two mutually non-exclusive ways. Higher education quality could potentially benefit the CEO’s knowledge so that they can gain better understanding of some abstract concepts in the operation. Executives who graduated from higher-ranked universities are considered to be more knowledgeable. Those CEOs have more intellectual potentials for further learning in business environment as well (Hitt, Biermant, Shimizu, & Kochhar, 2001). Therefore, in the thesis it is expected that:
H2b: The relationship between educational quality and firm performance is
Sometimes the educational background of CEO may also explain differences in corporate operations. For example, Thomas, Litschert and Ramaswamy (1991) that well-educated CEOs with marketing background tend to apply more market innovations. During the process of data collection, it is found that a number of CEOs hold MBA degree or have a law degree.
According to Bertrand and Schoar (2003), managers with MBA degree are more likely to take aggressive strategy, such as more diverse acquisions, higher capital expenditure and so on, than those without MBA degree, this is supported by empirical evidence. This might imply that MBA degree holders may be better at recognizing business opportunities and can react quickly for strategy decision-making (Geletkanycz & Black, 2001). Therefore, the following hypothesis is formulated:
H2c: Firms with CEO having MBA degrees perform better than firms with CEO holding other types degree.
In this paper, it is predicted that CEO education has an effect on firm performance. Education is an important channel through which people learn professional knowledge. The measurement for education would be from different dimensions to give a more comprehensive explanations. More details about methodology will be followed in later sections.
3. Methodology
In this section, the methodology applied in this thesis will be explained. First the data
description, the sources and gathering of the data will be discussed. Then the variables used in this study will be given. To give readers a better understanding, the definition and
measurement for each variable are also included. Finally, the detailed method for research will be discussed as well.
3.1 Data description
The sample consists of data on companies and CEOs from S&P 500 list. The time period is set from 2014 to 2016. Several databases were used in this thesis. The first one is WRDS, which included data about most CEO characteristics and firm characteristics required in this research. Data on some CEO characteristics such as name, age, company, gender, total compensation, date became/left as CEO was collected from WRDS ExecuComp dataset “annual
compensation”. In this database, it is also possible to distinguish S&P 500 company and non-S&P 500 company with the S&P index “SP” in data set. The accounting data of firms such as capital expenditure, net income, total assets and so on can be collected from WRDS: CRSP/Compustat Merged – Fundamentals Annual. In addition, Thomoson ONE and
bloomberg database which include the education information of executives are used. Taking for example the firm Netflix. For the CEO Mr. Reed Hasting the following information is available: age 56, MS in computer science (Stanford University, 88), BA in Mathematics (Bowdoin college,83). Meanwhile, some annual reports and other publicly accessible information is used to supplement the missing part in the database about CEO education.
The database of WRDS: CRSP is combined with the database of WRDS: ExecComp by using R programming. Only firms with completed financial information and CEO information would be kept in the combined database. In total, there are 484 firms with 590 CEO involved (some firms might have CEO succession during the selected period) in the three years data. Then the education information is manually collected via Thomoson ONE, Bloomberg database and annual report of firms and combined with the other datafiles.
3.2 Variable descriptions
3.2.1 Dependent variable:
The dependent variable in this thesis is firm performance, which is measured from both financial perspective and accounting perspective.
In the financial literature, one of the most common ways to measure firm performance is Tobin’s Q. It uses an asset’s market value to compare the cost of its replacement (Damodaran, 2002) . Mathematically, Tobin Q of a firm can be expressed as the following formula:
Tobin’s Q = Market value of Assets / Replacement cost of assets
= (Market capital + total liability) / (Common stock + Total liability)
The meaning of value of Tobin’s Q is straight forward. If the Tobin’s Q is between 0 and 1, then the money for corporate assets replacement is more than the stock value of firm, which means that the value of stock is undervalued. While if the Tobin’s Q is over 1, then it implies that the company’s stock is overvalued. According to Damodaran (2002), Tobin Q is affected by the relative efficiency of firm management compared to second-best bidder. When the value of Q is smaller than 1, then it implies that firms gain less than the required return of an investment, because if the asset market value is equal to the cost of replacement then an investment has no net present value (Damodaran, 2002). It has been shown that shareholders from firm with higher Tobin’s Q normally gain higher tender offers than those from firms with low Tobin’s Q (Lang, Stulz, & Walkling, 1989). Moreover, the lower Tobin Q a firm has, the more likely that the firm would be buyout for asset restructured and value enhancement.
From accounting perspective, firm performance can also be measure by Return on Asset. It is defined as the ratio of firm net income to its total assets, implying the efficiency of earning generated with corporate assets.
These two measurements have been applied widely in the financial and economic literature, therefore it is believed that it is valid for the research purpose of this thesis as well. Moreover, in the robustness check another measurement of firm performanceROE, is also applied. It is calculated as the ratio of net income to shareholders’ equity, this is also from accounting perspective.
3.2.2 Independent variable:
There are two independent variables used in the study. The first one is CEO tenure. There is no direct information about CEO tenure. However, it can be calculated based on data from WRDS: ExcuComp. Here the CEO tenure is defined as the difference between fiscal year and the date became CEO. In this thesis, we did not distinguish CEOs between internal candidate and external candidate. The tenure in this study is measured as the time in the position. It is believed that on the different position the mission and tasks would be different, the tenure in job probably is a better measure for experience than the time in firm. The information about CEO previous work are not completed in the database, therefore it is not possible to compare the difference caused in the study. In order to check if linearity of the relationship between CEO tenure and firm performance, a new variable Tenure squared (T2) is generated.
Another independent variable is CEO education. It is measured from two level. The first one is concerned with the educational level achieved by CEO. Graduate degree is considered to be superior to undergraduate school. In other words, graduate degree is treated as better
educational level than undergraduate degree. The educational level measurement is referred to the method used by Vincent & George (2002) which is based on scale. Higher scale stands for
higher education level (no degree = 0, undergraduate = 1, graduate =2, phd =3). The second measurement is about the educational quality of CEOs’ institutions. It is assumed that the more prestigious the institution is, the better the educational quality is. During the data
collection process, it is found that many CEOs are not graduated from US university, therefore here the ranking from U.S News & World Report’s Best Global universities in 2018 is used for the measurement. This is contrasting to Bhagat et al, who used the US national ranking for the measurement. There is no CEOs in the sample graduating in 2018. Furthermore, there could be some changes in ranking as the time goes by. However, this paper assumes that during past decades top universities still stay at the top (in practice this applies to the majority of university) and the ranking does not change. According to the ranking, universities were classified into Top100 and Top500 (top 500 does not include top 100 university). Considering the data distribution in the sample, this can be a proper scale to distinguish the educational quality of institution. For each ranking category a dummy was assigned, if the university lies in the category, for example Top 100, then the dummy variable TOP100 marked as 1, otherwise the value is 0. Furthermore, three dummy variables are included corresponding to the type of degrees gained, namely MBA, Law, Both MBA and Law degree. Via these additional dummy, we can test if holding a MBA or Law degree matters.
3.2.3 Control variables
Firm performance can be affected by many other factors, in order to give more accurate result, based on previous literature and research, several control variables are introduced in the analysis:
• CEO compensation: directly available from WRDS: ExcuComp. According to Gao and
Li (2015), the CEO compensation is positively related with firm performance. High compensations motivate CEOs and therefore it results in better firm performance.
• Capital expenditures: directly available from WRDS: CRSP/Compustat Merged –
Fundamentals Annual. Considering the different size of firm, here the ratio of capital expenditures to firm’s total assets is used. The reason of including this variable is based on the finding of Jiang, Chen and Huang (2006), who argued that companies investing relatively higher capital compared to their total assets and scales would normally show higher stock returns. Firms should only conduct investment projects which can lead to positive NPV, and the study result of Jiang et al (2006) confirmed this prediction.
• Leverage: Based on WRDS: CRSP/Compustat Merged database, it is calculated by the
following formula: Leverage = (Total long-term debt +Debit in current liability) / Total stock equity. According to the study from Ibhagui & Olokoyo (2018), the leverage does have an negative effect on firm performance and magnitude of this effect depends on the size of firm. For small firms, the influence from leverage can be more
significant and obvious. Long term debts can be costly considering interests and other cost. It can be a heavier burden for small firms compared to large firms which have better financial conditions.
• Firm Size: is defined as the logarithm of total assets. It is claimed that firm size
negatively influences on firm’s profitability by Olawale, Ilo and Lawal (2017), which used a set of panel data of 12 firms in Nigeria covering period 2005 to 2013 to test this relationship. Larger firms can be more decentralized, and largely controlled by the managers rather than the shareholders. Linking with agency theory, managers might pursue own benefits enhancement rather than behavior in the interests of the
shareholders and firms, therefore lead to low firm performance.
Also, in some year, there might be some changes in CEO succession, it might affect the prediction which is based on CEO human capital. Therefore, a dummy for succession is
created here to control, the value 1 implies that there is a change of CEO in that year,
otherwise the value equals to 0.
3.3 Ordinary Least Squares (OLS)
In order to estimate if and how the independent variables can explain dependent variable, the main tool applied in this thesis is Ordinary Least Squares (OLS). Based on the research question, the dependent variable is firm performance, measured by Tobin’s Q and ROA, and the independent variables is the CEO’s education and tenure. Tests would be conducted for each year separately. The following model will be used:
Firm performancei = β0 + β1 * CEO_educationi + β2 * CEO_tenurei + η1*CEO_agei +
η2*CEO_compensationi+ η3*CapitalExpenditurei+ η4*Leveragei + η5*FirmSizei +
η6*SuccessionDummyi + Ɛ
Stata is used to find the coefficients in the formula. Some companies stay in the list for all three years and their CEOs were not changed during this period, but some companies might be just listed in one or two years. If conducting regression with three years data together, the results can be biased. Companies staying in the list for longer time are counted for several times, but their CEOs’ education and tenure do not differ a lot. No panel data will be used in this case. The more detailed test for each hypothesis will be followed later in “Results and Discussion” section.
4. Result and discussion
The results of this study will be reviewed in this section. It starts with the descriptive statistics and a correlation matrix. The main variables will be discussed in section 4.1. Then the results of the different regressions will be described and explained in section 4.2. The tables and
results shown below are based on data in 2014. Results from data in year 2015 and 2016 show similar conclusion, therefore they are included in appendix.
4.1 Descriptive statistics
Table 1 presents an overview of variables included in the regression. As is shown in the table, for year 2014, there are 486 observations for each variable. On average, firms in the list have a mean value of 2.24 for Tobin’s Q. The value of Tobin’s Q ranges from 0.98 to 6.16. This means that the money required for replacement of assets is less than stock values for most of the listed firms. Hence, firms’ stock is overvalued. Also, CEOs’ average age is 57 years old, the time on their position (Tenure) shows a large variance. Tenure lies between 0.26 and 27.14 years and has a standard deviation of 6.22. The total compensation of CEO also displays a big difference. The lowest value is 1,507 thousand US dollars while the highest one is 36,614 thousand US dollars. Other variables such as ROA, Capital expenditure (compared to total assets) exhibit a lower standard deviation.
Table 1 – Descriptive statistics
Table 2 is the correlation matrix of main variables in the regressions, and whether the correlation is significant or not is indicated by the mark “*” in the table. Not surprisingly to see from that table, Age is correlated with Tenure significantly. It makes sense because
long- tenured CEO might also be older in most of the case. Besides, it is also found a positive correlation between total compensation and firm size. Firm with larger size, might have better financial condition so that they can afford higher compensation for CEO. Another significant correlation in the table is between CEO educational level and capital expenditure. It seems that CEO who achieved higher education tends to have lower capital expenditure of firm. This correlation matrix is based on data in 2014.
Table 2 – Correlation Matrix
4.2 Explanation for regression
4.2.1 Tenure and firm performance
The first group of regressions done in this study is to investigate the relationship between CEO tenure and firm performance. Table 3 shows all results. Column (1) to (4) use Tobin’s Q as the measurement of firm performance and column (5) to (7) issued ROA to be the dependent variable.
Column (1) shows a significantly positive relationship between Tenure and Tobin’s Q. As the tenure of the CEO increase, the performance of the firm improves as well. And this
added control variables share some effect on Tobin’s Q. Besides, based on Column (4), when the dummy variable of succession is added, the coefficient slightly drops from 0.0201 to 0.0186, but still remains significant. Considering conflicting conclusions from other scholars, the variable Tenure squared (T2) is included to check if the relationship is non-linear. As can be seen in column (2), after adding T2, the coefficient between Tenure and Tobin’s Q, and the coefficient between Tenure squared (T2) both are positive. However, neither of them is significant. Hence, it is concluded that the relationship between Tenure and Tobin’s Q is linear in this study.
However, when taking ROA as the measurement of firm performance, the relationship between Tenure and ROA is positive but not significant (Column (5), (6) and (7)).
Based on the regression results, it can be concluded that CEO’s tenure is positively associated with firm’s Tobin’s Q, which indicates that a longer-tenured CEO can lead to an increased financial performance of the firm. And the succession of the CEO does not influence the relationship between tenure and firm performance significantly. The results partially support the hypothesis. The tenure of CEO is positively related to firm’s performance (measured by Tobin’s Q), but no significant relationship was shown between Tenure and ROA. In the later section the potential reasons for this difference would be explained.
4.2.2 CEO education and firm performance
There are three groups of regressions done in this study to explore the relationship between CEO education and firm performance. These are from different perspectives of educational background, which will be discussed separately in the following subsections.
4.2.2.1 The education level and firm performance
The first group of regressions is to investigate if the educational level would affect firm performance. Four regressions were conducted, and Table 4 depicts these results. Three dummy variables including undergraduate, graduate and Phd were generated as independent variables, which are derived from CEO educational level. The CEOs with no degree are excluded and as the basis for regressions comparison here. As can be seen in column (1) when regressing educational level variables with Tobin’s Q, only the coefficient between graduate and Tobin’s Q is significant, is -0.548. And all the coefficient in column is negative.
However, after adding control variables, the significance disappears and the sign of coefficient between undergraduate and Tobin’s Q, between graduate and Tobin’s Q changed from
negative to positive. The magnitude changes a lot as well (Column (2)). To figure out which control variables drive these changes, additional regressions were done. Total compensation (TC), Capital expenditure (CE) and Size were excluded from control variables respectively.
The reason for excluding these three variables is because only coefficients between them and Tobin’s Q show significant. It is found that the coefficient remains significant and the magnitude does not change much when excluding Size, but this is not the case when Total compensation or Capital expenditure was excluded. And it is the joint effect of Total
compensation, size and capital expenditure lead to the change of coefficient sign from negative trend to positive trend. Therefore, these changes actually were driven by these endogenous control variables, which picked up some effects. Firms with better performance are able to have higher compensation and higher capital expenditure, might be also better able to higher better CEOs.
When using ROA as the dependent variable, it is also observed that the trend of coefficient changes, which changes from negative coefficient to positive coefficient for undergraduate and graduate. This is also affected by the control variables. According to column (3) and column (4), there is no significant coefficient here.
Therefore, it can be concluded that the education level of the CEO does not have a significant effect on firm performance. CEOs with higher degrees do not necessarily generate better firm performance than CEOs with no degrees.
4.2.2.2 The quality of education and firm performance
The second group regression is considering the relationship between the quality of education and firm performance. As mentioned before, the measurement of educational quality is based on the ranking of university, where CEOs achieved their highest degree, in U.S News & World Report’s Best Global universities 2018 list. Not many CEOs hold PhD degree, therefore here only the graduate and undergraduate degree will be considered. Universities outside top 500 in the rankings were excluded, therefore Out500 is the basis for comparison in regressions. The results are displayed in Table 5.
Column (1) to (4) are regressions considering CEOs who only obtained undergraduate degree. As can be seen in the table, in column (1) the coefficient between TOP500 and Tobin’s Q is – 0.123, and the coefficient between TOP100 and Tobin’s Q is 0.248, both are not significant.
After including control variables, the coefficients drop down slightly, however there is still no significance found in the table (column (2)). When using ROA as the dependent variable, it shows no significant coefficient in the table, this is both shown in the case including and excluding control variables (column (3) and (4)).
Column (5) to (8) are only considering the case that CEOs obtaining graduate degree as the highest educational level. When using Tobin’s Q as the dependent variable, there is no significant relationship found between educational quality variables and Tobin’s Q (column (5) and (6)). When using ROA as the dependent variable, the coefficient between TOP100 and ROA is -0.0163, which is significant at 10% significant level. The coefficient between
TOP500 and ROA is -0.0208, which is significant at 5% significant level. After including control variables, the coefficient between TOP100 and ROA changes to -0.0105 and it is not significant. And the coefficient between TOP500 and ROA changes to -0.0159, remaining significant. These changes are driven by control variables, which pick some effects on ROA. With the attempt to exclude endogenous control variables total compensation (TC), CE (capital expenditure) and Size, it is found that the two coefficient remains significant. However, the values of R-squared increases after including those control variables, showing that control variables prove the model a lot.
According to the results above, it is concluded that for CEOs who obtain undergraduate degree, CEOs graduating from TOP100 or TOP500 university do not necessarily perform better than those CEOs who graduated from a university which lies out 500 in the ranking list. That is to say, educational quality does not relate to firm performance for CEOs who hold undergraduate degree only. For CEOs who obtain graduate degrees as the highest degree, educational quality of CEOs’ universities does not relate to firm performance measured by Tobin’s Q. But considering ROA, the result is a bit puzzled. It partially shows that the educational quality is negatively related to the ROA of the firm. CEOs who graduated from Top 500 universities have negative effects on the ROA compared to CEOs holding degree
from universities which lie outsider top 500 in the ranking. But the similar result was not observed in the case that CEOs graduates from top 100 universities.
Table5 Education quality and firm performance2014
4.2.2.3 Does MBA or Law degree matter?
The third group of regression is to test if obtaining a MBA or Law degree matters for firm performance. Table 6 uses Tobin’s Q as the dependent variable while Table 7 shows results for regression ROA issued as the independent variable.
In Table 6, Column (1) and (2) tested if an MBA degree can affect Tobin’s Q. MBA is a type of graduate degree, only CEOs who obtained a degree above undergraduate level will be considered. The result shows no significance. Column (3) and (4) present results for CEOs who have a law degree, here both CEOs who obtained a degree at undergraduate level and a higher level are included. There is no significant relationship found in the table. Column (5) and (6) are testing if CEO with both MBA and Law degree would have effect on Tobin’s Q. After including control variables, no significant conclusion can be generated.
Comparing the coefficient between MBA a Tobin’s Q, it seems the magnitude changes a lot after including control variables. In column (2), it changes from -0.239 to -0.0702. In column (6), it changes from -0.221 to -0.0747, and the significance disappeared. This is driven by endogenous control variables. CEOs with MBA degree may require higher salary. Firms which perform better can offer higher compensation and can afford hire CEOs asking for higher salary. These endogenous variables pick up some effects of MBA degree on firm performance.
In Table 7, ROA is issued as dependent variable. The results show similar conclusion as that in table 6. There is no significant coefficient found in the table. The control variables do not affect the magnitude (the coefficient) as much as they did on the regressions in table 6.
Hence, a CEO with MBA or Law degree does not necessarily performs better than a CEO without MBA or Law degree. A MBA or law degrees of the CEO does not matter for firm performance.
To conclude, although the CEOs’ education was measured in three different ways, and
regressions were conducted from different perspectives. No significant link between CEO education and firm performance can be drawn based on the results in this study. This is contrary to the original expectation. The hypothesis about education was not supported.
4.3 Difference between financial and accounting measures
In the previous parts, Tobin’s Q and ROA are used as the indicator of firm performance. However, results differ for the measures. This might be related to the nature of two measurements.
Tobin’s Q considers market value of firms, which is a type of operational measurement for firm performance, while ROA is a type of global performance measures. According to Crook, Todd, Combs, Woehr and Ketchen (2011), global organizational performance measures show weaker correlation with human capital than operational performance measures. In this study, when there is no significant coefficient found in regression with Tobin’s Q, there is also no significance found in those with ROA, but not in the other way around, which is
corresponding with conclusions from Crook et al. Only considering global organizational performance measure might lead to the negligence on firm’s competitive advantages or disadvantages (Ray, Barney, & Muhanna, 2004).
Also, Tobin’s Q is a measurement for long-term firm performance, while ROA is a
measurement from accounting perspective, which is more proper reflection of the short run firm performance. The short run performance of a firm does not necessarily follow the same trend of the long run firm performance. Take the result in Table 1 as an example, in the short run, the experience of the CEO maybe not benefit the firm performance in the short period but in the long run. It takes time to implement strategy and adjust the operational environment.
These might explain the different result in the regressions.
4.4 Robust check
To further confirm the results of study, robust checks were conducted. ROE was used as an alternative measurement for firm performance. As another accounting indicator, regressions with ROE as dependent variable show a similar result with those using ROA. No significant relationship between tenure and firm performance is found. Also, the relation between education and firm performance.is not significant.
Also, data from year 2015 and year 2016 was used for robust checks as well. The regressions with data from year 2015 show similar results with the conclusion from year 2014. However, the results based on data from year 2016 shows some different conclusion. In the table C1, there is no significant relationship found between Tobin’s Q and CEO’s tenure. In the table C4, negatively relationship between holding an MBA degree and Tobin’s Q was found, and it is significant. Regressions in which ROA was issued as the dependent variable show similar results with regressions with data from year 2014 and year 2015. Although the data were originally collected from academic database, there is a possibility that some data is
problematic. The different results can also be caused by the fluctuation of firm performance. Further check can be done with other methods. In this thesis, the results from year 2014 corresponds to the results from year 2015, and all the results from regression with ROA issued to be the dependent variable reveal similar conclusion. Hence, the original conclusions will be insisted.
5. Limitation
There are several limitations in this study. The first limitation is that only the human capital of the CEO is considered. Other managers were not considered in the study. The CEO plays an essential role in decision making and can largely influence firm performance, but without the work and cooperation of other managers and employees it is not possible to operate the firm well.
Second, due to limited access to data, it was not possible to be distinguished between inside successor and outside successor for CEOs. It is not a problem to use tenure to measure CEOs’ experience when he or she comes from another firm or institution, because as outsider, he does not have firm specific knowledge. However, if the CEO was an internal candidate, he does not have knowledge in the CEO position and tasks but might have some knowledge about other issues in the firm. This difference might have some impact on the results.
Third, firm performance can be affected by a number of factors. It is not possible to control for
all variables for the study. This might explain why R2 in the regressions were not high. The
independent variable cannot explain the dependent variables in a large extent.
Besides, there might exist endogenous problems in the tests. On one hand, the human capital of CEO can cause effects on firm performance, on the other hand, a good performing firm might be able to afford CEOs with higher educational level or qualities. Although attempting to exclude this problem, we did not find a good way to avoid the effect from this.
6. Conclusion
To conclude, this study investigated the effects of two types of CEO’s human capital, namely experience and education on firm performance. With the aim to answer the research question: “How important is the CEO human capital to firm’s overall performance? To what extent can
the tenure and education background of CEO help to predict the firm performance?” Firm’s data and CEO’s information of S & P500 companies were collected. The time period covers the period from 2014 to 2016. After reviewing relevant literature and inducing methodology. Several groups of regression were conducted and discussed. First the relationship between CEO experience in job and firm performance was tested. The experience was measured by variable tenure. The results show a non-linear but positive effect of tenure on firm
performance measured by Tobin’s Q. Then the impact of education on firm performance were investigated from three perspectives including education level, education quality and whether obtaining MBA/Law degree. There is no significant relationship found. Therefore, this study did prove that CEO human capital can influence firm’s overall performance. With two types of CEO human capital discussed in this paper, only the experience in job can help to predict the firm performance but not the education background of CEO.
The results might provide several implications for CEO selection process. According to the result of this study, education background of CEO might not be considered as a distinguishing factor when hiring a CEO, because it shows no significant effect on firm’s performance in this study. Also, neither frequent CEO replacement nor extremely long-tenured CEO would be wise for firm, which can harm firm performance.
There are more can be investigated in future study. As already mentioned, the relationship between CEO tenure and firm financial performance is not linear. In this study, we did not explore deeper in this topic, but this leave a space for others to study if exist an optimal tenure of CEO when it comes to firm performance. In addition, in previous section, several
limitations of this study are mentioned, further study can try to address those limitations to see if different conclusion can be drawn.
7.Appendix
7.1 Table for robust check
ROE and Tenure (Table A1)
ROE & educational quality (Table A3)
7.2 Regression results for Year 2015
Tenure and firm performance (Table B1)
Educational quality and firm performance(Table B3)
MBA/Law degree and ROA(Table B5)
7.3 Regression results for Year 2016
Educational level and firm performance(Table C2)
MBA/Law degree and Tobin’s Q(Table C4)
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