Changes in Bank Profitability Post-CEO Succession: Does Prior CEO Experience Improve Bank Performance?

Over the past decade, there has been an important new trend in CEO succession, with companies increasingly hiring executives with former experience as CEOs. The banking industry has witnessed a similar trend. Considering that CEO experience may have been gained in different contexts, it is natural to wonder whether and how previous CEO experience impacts bank performance.

Our study, ‘Changes in Bank Profitability Post-CEO Succession: Does Prior CEO Experience Improve Bank Performance?’, published in the British Accounting Review, addresses these issues.

Theoretical arguments seem to be in favour of a CEO who has previously served in this capacity.  Specifically, human capital theory emphasizes that an individual’s ability is directly related to his/her past experience and career path.  Social capital theory, on the other hand, believes social networks and resources play an important role in an individual’s career success. As such, both theories suggest that previous CEO experience brings a wealth of skills and contacts that can be beneficial to the organization. This may be especially true for financial institutions since banks are more complex and require managers who have specialized skills and knowledge sets compared to non-financial institutions.  

 Based on a uniquely hand-collected dataset that captures the information of 142 CEO succession events in bank holding companies (BHCs), we found that prior CEO experience is positively associated with bank profitability changes in the post-succession period. Furthermore, our results suggest that the longer the previous CEO’s experience, the greater the level of profitability improvement post-turnover. We find that our empirical evidence contrasts with that presented in existing studies relating to non-financial firms.

 Having established a positive relationship between CEO experience and bank profitability, we investigate further whether the location of where CEO experience was obtained makes a difference. We further categorize the prior experience as it gained inside the bank group (inside CEO experience) and experience gained outside the bank group (outside CEO experience). Our analysis shows that there is a significant positive relation between outside CEO experience and the change in bank profitability after succession. No effect is found on the experience gained inside the bank. The results from our study show that the positive performance effect post succession is primarily driven by outside experience, and that successors with prior CEO experience obtained outside the bank group bring better skill sets.  Additionally, our results indicate that a new CEO’s prior experience is beneficial to both the short-term and long-term performance of the bank.

 Nevertheless, the outcome of CEO succession can be driven by the succession context. For example, banks with a poor financial status may be more inclined to hire a CEO with more experience in order to improve their profitability. This may lead to the results in the analysis being influenced by the performance of the bank prior to its turnover. To address this concern, we control for the succession context in the empirical analysis. The results suggest that there is a higher level of profitability improvement in poorly performing banks. Meanwhile, the positive effect of outside CEO experience on bank profitability change still holds.

The final part of our study aims to identify the mechanism by which prior CEO experience contributes to bank profitability. We find that outside CEO experience is not related to the change in any income items. In contrast, it is negatively related to the change in bank costs. Especially, we find that the new CEOs with prior CEO experience obtained from outside the bank tend to improve bank profitability through managing the adjustable parts of the expenses—the non-interest expenses such as employment salaries, property and equipment expenses, as well as understating the discretional part of LLP, in order to boost profitability. Generally, our results support the conclusion that CEOs who are recruited from outside the bank are more likely to manipulate earnings, perhaps because they are under greater pressure to demonstrate superior performance.

 Our study has provided two important takeaways:

 Firstly, our study examines the impact of CEO characteristics on bank performance during CEO succession events and shows that the location of CEO experience matters to the bank performance.

 Second, to the best of our knowledge, our study is the first to examine banks’ earnings management by newly appointed CEOs and whether it is influenced by specific CEO characteristics. We find that earnings manipulation in the form of understating bank discretional LLP can partly explain the bank profitability improvement in the post-succession period. Furthermore, we find that this is more likely to occur for new CEOs with prior CEO experience obtained outside of the bank.  This is an important ethical issue that has not been fully examined.

A link to the authors’ paper on the British Accounting Review (Open Access) is available here.  

Douglas Cumming is the DeSantis Distinguished Professor of Finance and Entrepreneurship at Florida Atlantic University.

Peigong Li is a Professor at Shanghai Lixin University of Accounting and Finance, China. 

Feng Zhan is an Associate Professor at the Dan Department of Management, Western University.

Julia Wanwan Zhu is a Lecturer in Accounting and Finance at Leeds University Business School.