When the Firing Starts, Duck!
By Victor Niederhoffer and Laurel
Kenner
"The Sanitation
Department will be sweeping up a lot of dead bodies this winter. These things
have to happen every 10 years or so. It gets rid of the bad blood."
-- Mario Puzo, "The Godfather"
"The Godfather" contains considerable
wisdom on the salubrious effects of forceful action in pursuing business
interests. Mob boss Don Corleone started with reason to persuade corrupt and
troublesome people to step aside, and if that didn’t work, he “fired” them.
Even though "The Godfather" is one of our
favorite business handbooks (for more recommendations, see Supplementary to
Column.) Mario Puzo’s wisdom still needs to be tested -- particularly because
2001 and 2002 have been banner years for resignations, many occurring without
even the obligatory “as planned for many years,” or “for personal reasons.”
Everyone agrees that clearing out dead wood is a
healthy thing. But our studies show that if this is true, it takes some time.
Often, deep problems surface only after the old guy agrees to go quietly, lugging
a well-stuffed severance package. The Italians have a nice way of putting this
with their cynical augmentation to the proverb, “New brooms sweep clean.” They
add, “for three days.”
Yet power-player firings and forced resignations seem remarkably numerous
these days. Last week, President Bush gave Treasury Secretary Paul O’Neill and
presidential economic adviser Larry Lindsey the boot. Last month, it was Harvey
Pitt who was out as SEC chairman, along with William Webster as head of the new
federal accounting oversight board. Media empress Martha Stewart left the board
of the New York Stock Exchange this year. Former star telecom analyst Jack
Grubman resigned from Salomon Smith Barney.
High-level bloodlettings are commonplace at corporations, now, too,
although it’s hard to tell whether more executives than usual are getting the
hook. In the first three quarters of this year, 562 chief executives left their
companies, down from 722 in the comparable period of 2001, according to
Challenger, Gray & Christmas, an executive placement firm that periodically
reports on resignations. What’s different now is that so many of the departures
were at prominent companies: Dennis Kozlowski, Bernard Ebbers and Kenneth Lay
were forced out of their chief executive jobs at Tyco International (TYC), WorldCom
Group (WCOEQ) and Enron (ENRNQ), to name a few.
Certainly ousters are receiving more media attention, as the number of
hits produced by a Google search shows:
|
Google search results by keyword |
||||||||||||||||
|
And boards of directors, pressed by the new century’s outrage over
corporate fraud, seem to be taking management lessons from "The
Godfather." Here are two Bloomberg stories, three days apart:
Whether such ruthlessness helps is another story.
Before and
after
Inspired by O’Neill’s departure, we studied how stocks performed after
executive resignations. Using Google and Bloomberg, we collected a sample of 38
high-profile companies that announced the resignation of a CEO, chairman or president
in the past three years. We calculated their performance in the three months
before and after the announcement, and compared to the S&P 500 in the same
periods.
The results should give investors pause about jumping in right away after
a corporate housecleaning.
On average, the stocks fell 14% after a resignation announcement -- a full
8 percentage points worse than the S&P 500’s performance in the comparable
period. (They were down 23%, on average, beforehand.)
|
How resignations affect stock
prices |
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
The failure of stocks to rebound quickly after an
executive departure may signify a realization by shareholders that the directors
doing the firing were the very ones who had been overlooking the CEO’s excesses
rather than overseeing his performance.
An even more likely reason is that many of the old CEOs’ excesses come to
light only after an executive’s departure. If a CEO is on a roll, the board
will let him get away with deferrals of expenses, off-the-books transactions
and other forms of camouflage designed to keep up the stock and the value of
the executive’s options. When the game has gone so far that it’s necessary to
remove the CEO, there’s often no more room to hide the dirt.
Strangely, within this array of dismal performance, a slight regularity
appears. The eight companies that rose in the three months before the
resignation went up an average of some 8.5% in the next three months, versus an
average decline of 24% in the next three months for the 28 companies that fell
in the prior three months.
In statistical terms, the correlation coefficient between the move in the
three months before the resignation and the move three months after is 0.42.
This gives us some 99% confidence that this is a non-random phenomenon. In
other words, there was a continuity in performance, a positive correlation
between prior and subsequent performance relative to the resignation.
Trepidation after the boot
What should investors make of this information?
As our longtime readers know, we never short stocks. (Well, hardly ever.)
There is too much of an upward drift in the market to embrace shorting as a
strategy. The definitive study in the book "Triumph of the Optimists"
showing that stocks advanced 1.5 million percent in the 20th century provides a
nice benchmark of 15,000 percentage points a year that we’d have to overcome
for us to have much confidence in these anti-enterprise-type trades.
We will say, though, that readers may wish to exercise great care if
they’re considering buying shares in any of the following companies, all of
which have announced high-level resignations within the past three months:
|
Companies with recent resignation
announcements |
|||||||||||||||||||||||||||||||||||
|
Bush’s present
to investors
As for Paul O’Neill, what a relief for investors to get this tone-deaf man
out of Washington.
Sometimes a small beacon casts a flood of light, and some of the former Treasury
secretary’s more notorious comments revealed a deep contempt for the market.
Take his description of Wall Street traders as “people who sit in front of
flickering green screens and make decisions on a speculative basis about
three-basis point movements.”
He could learn their jobs in about two weeks, he told the Wall Street
Journal in a Jan. 26, 2002, interview. The remark showed complete ignorance of
the market’s role as a forum for dispersed knowledge that sends signals to
producers and customers necessary for their decisions. O’Neill’s absurd focus
on workplace safety and heavy-industry production figures were only two more
signs of his remove from contemporary economic thought. (For more discussion of
O’Neill’s resignation, see Supplementary to Column.)
As relief over O’Neill’s ouster sets in, perhaps a quiet period of harmony
and bullishness in the market can develop for the end of year and beyond. Life
can be so beautiful in business and the market when the whole team pulls
together.