Corporate Finance - Review Paper

Anish Shankar Menon

January 2, 2015

Brief information about the paper

The title of the paper is The Young and the Restless: An International
Study of CEO Age and Acquisition Propensity. The authors are
Teng Zhang, Stephen P. Ferris, Narayanan Jayaraman and Sanjiv
Sabherwal.

Introduction

The paper studies the effect of Chief Executive Officer (CEO) age on the
propensity of a firm to engage in merger and acquisition activity in the United
Kingdom (UK). The main finding of this paper is that younger CEOs are
more likely to acquire other firms, acquire firms outside their main business
line and also pay cash for the acquisition. The authors examine different
competing explanations for this behaviour and suggest that such behaviour
is a signalling mechanism adopted by the younger CEOs to demonstrate their
worth to the market. These results, they claim, are robust to the overconfidence effect.

Critique

3.1

Critique of the idea

The first part of the title is borrowed from a long standing American soap
opera. The second part however seems to be misleading. The authors state
in the title that it is an international study but they only study CEO age
and acquisition in the UK.

According to the authors, literature shows that there are two opposing
theories that link CEO age and propensity for merger and acquisition. The
first is the CEO conservatism effect which says that younger CEOs would
not want to risk their career and would therefore not take risky decisions.
The other is the CEO signalling-incentive effect. This states that younger
CEOs want to signal their competence to the market and hence would take
riskier decisions than their older counterparts. They would be more sensitive
to compensation related factors and would be willing to take additional risk.
The second theory is actually two seperate theories. The authors find that
only the signalling effect holds good and the compensation effect is absent.
The authors argue that since there is no effect of compensation or overconfidence (which they seperately test for) then the likely cause of this negative
relation between age and acquisition activity is the signalling explanation.

First, the authors need not club the signalling and compensation explanations together. This would bring more clarity in their arguments. Second,
the authors are trying to align their findings with an existing explanation.
They do this by eliminating the two out of three explanations and then saying that the remaining explanation is most likely the valid explanation of the

phenomenon. They could have explored new explanations as well.

A reason given by the authors for choosing to study the CEO behaviour
in the UK is because according to them, the UK is the second largest capital
market in the world. They do not define what they mean by capital market in
this context nor do they cite the source from where they got this information.

The authors state that when the company does not have a CEO, they
use the chairman of the board as a proxy. They have not stated how many
firms are there for which they have used the above proxy. The assumption
is that the chairman would function as the CEO in these firms. The authors
do not provide any evidence to support their assumption.

The implicit assumption throughout the paper is that the CEO is responsible for the major acquisition decisions of the company. The authors
however do not provide evidence for this assumption. There might be various
other stakeholders who could exert significant influence over the acquisition
decisions of the company. The authors could refine their study even better
if they controlled for the influence of other stakeholders such as the board of
directors, promoters and others.

The authors then define their datasets and variables.

3.2

Critique of methodology

The study has been heavilly influenced by Li et al. (2011) and Yim (2013).
Both the conceptual ideas and the methodology of this paper relies on the
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two cited earlier.

Yim (2013) accounts for various CEO fixed effects that can confound the
results. These include tangible measures such as qualification and intangible
measures such as charisma. These have not been addressed in this paper.

The authors use logistic regression and report odds ratios (similar to Li
et al. (2011) and Yim (2013)). The formula (1 Odds ratio) 100 gives the
percentage change of the impact of the variable. Though the coefficients are
statistically significant, the percentage change is less than 1% in the coefficient of interest.

Yim (2013) has divided the CEOs into 6 different age groups. Thus the
effect of each age group is known. This paper does not follow this methodology. Hence it is difficult to see how the change between age groups occurs
which is seen in Yim (2013).

The authors assume a value of 5% of the firms market capitalization as

the threshold beyond which the CEO is presonally interested in the acquisition. The authors have not explicitly made it clear whether this 5% is the
market capitalization of the acquirer or the target firm (though it does seem
to be the market capitalization of the acquirer firm) and neither have they
provided a rationale as to why they chose this figure as the cutoff point (5%
is used as the cutoff in Yim (2013)). Irrespective of whether the figure represents the market capitalization of the target or the acquirer company, the
relative size of both matter.

The authors use CEO tenure as a proxy for the power of the CEO to
influence the Board. It could be argued that the CEO could be enjoying
a longer tenure due to his/her being compliant to the wishes of the Board.
Geddes and Vinod (1997) find that tenure is positively correlated with the
number of outside directors on the board.

Geddes and Vinod (1997) show that older CEOs are more likely to leave
the firm than their younger counterparts. However older CEOs could have
more power over the board by virtue of their longer association with it. This
could lead to a confounding effect that could be considered.

In the case of the relationship between age and compensation, the authors note that the UK has different rules and regulations with regard to
CEO compensation as compared to the US resulting in the UK CEOs being paid higher compared to their US counterparts. They however use the
methodology in Yim (2013) without controlling for those effects. The authors say that the UK CEOs have lower equity based pay as compared to the
US CEOs and Yim (2013) says that the compensation concerns are primarily
driven by equity based remuneration. It would therefore not be surprising to
see that using the same model as in Yim (2013), the authors have not seen
any compensation effects in acquisition propensity. In a UK based study
McKnight et al. (2000) find that CEO age and remuneration are positively
related. They further observe that there is a positive relation between firm
size and level of salary and this relationship weakens with age. This leads to
the conclusion that the UK CEOs might have compensation incentives to go
for acquisitions which is counter to the observation in this paper.

Suggestions and conclusion

The authors could check if there are any endogeneity issues in the study.
There might be many other factors not accounted for that if taken into account could give different results. CEO age, firm age and CEO tenure could
be related. The authors claim that yound CEOs are not driven by compensation when it comes to their acquisition decisions. It might be that they
are not interested in monetary compensation only and there are other nonmonetary benefits that they seek to enjoy.

Many factors could affect the acquisition decision. The assumption that
the CEO is the sole decision maker is very strong. Board composition could
be an important determinant of decision making. Board age could matter.
The authors could look into these matters to obtain a more robust result.

Serfling (2014) observes that CEO age can significantly affect their risk
appetites. Faccio et al. (2012) observe that CEO gender has a strong correlation with their risk appetites. McKnight and Tomkins (2004) note that
there are contradictory observations in the case of correlation between age
and risk taking behavior.s The authors could control for these effect.

Two other determinants of acquisitions could be the management style

of the previous CEO. If the previous CEO was inclined towards acquisitions
as a vehicle of inorganic growth of the firm, the new CEO might follow in
his/her footsteps. The authors could control for whether the CEO is a promoter CEO or not or if his/her family has a significant ownership in the firm.

Though this area has been relatively less researched the idea of the paper
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is not novel as similar studies have been conducted in the United States. The
authors use words like international and global to signal that their paper
has a wider significance. Using these phrases can be quite misleading. The
paper is primarily a study of the CEOs in the UK. The authors could build
upon this and conduct a truly international study.

References
Faccio, M., Marchica, M. T., and Mura, R. (2012). CEO gender, corporate
risk-taking, and the efficiency of capital allocation. Working Paper.
Geddes, R. R. and Vinod, H. D. (1997). Ceo age and outside directors: A
hazard analysis. Review of Industrial Organization, 12:767780.
Li, X., Low, A., and Makhija, A. K. (2011). Career concerns and the busy
life of young ceos. Working Paper.
McKnight, P. J. and Tomkins, C. (2004). The implications of firm and
individual characteristics on ceo pay. European Management Journal, 1:27
40.
McKnight, P. J., Tomkins, C., Weir, C., and Hobson, D. (2000). Ceo age
and top executive pay: A uk empirical study. Journal of Management and
Governance, 4:173187.
Serfling, M. A. (2014). Ceo age and the riskiness of corporate policies. Journal
of Corporate Finance, 25:251273.
Yim, S. (2013). The acquisitiveness of youth:ceo age and acquisition behavior.
Journal of Financial Economics.