Information, Incentives, and CEO Replacement

This paper provides a new explanation for CEO turnover. In an environment in which all potential CEOs are endowed with the same ability and the firm is not looking for a strategy change, I demonstrate that CEO turnover may still occur in equilibrium. Specifically, a report-contingent CEO replacement policy changes the pay structure of the CEOs and helps reduce excessive compensation earned by a CEO who stays on the job. At the same time, hiring a new CEO to implement the project implies that the firm needs to pay a limited liability rent to the new CEO. The trade-off between the benefit and cost of CEO replacement may lead firms to optimally commit to a more aggressive CEO replacement policy than the ex-post efficient benchmark.