Journal of Accounting and Economics 7 (1985) 175-178.

North-Holland

A DISCUSSION OF CEO DEATHS AND THE REACTION OF

STOCK PRICES*

G. William SCHWERT
University of Rochester, Rochester, N Y 14627, USA

Received June 1984, final version received July 1984

When I agreed to discuss this paper ('An Analysis of the Stock Price Reaction
to Sudden Executive Deaths: Implications for the Managerial Labor Market',
by Bruce Johnson, Robert P. Magee, Nandu J. Nagarajan and Harry A.
Newman) several weeks ago I did not anticipate that I was going to catch the
flu that has been going around the country lately. Since I did catch it, and have
been suffering for the last couple of weeks, I thought there was a good chance
that I would simulate an executive death for you. Just in the last few days I
have managed to recover enough so that I think that won't happen, but you
never know. And that is a key element in this study, because this paper
analyzes what happens to the stock price when the chief executive officer
(CEO) or another important corporate official dies. The paper argues that there
are generally rents associated with the contract between the firm and the
manager, so that the death of the CEO or other important official will either
increase or decrease the value of the stockholder's claims. However, a CEO
death causes an immediate stock price reaction only if the death is unexpected;
otherwise, the stock price will react when the information of CEO's terminal
illness first becomes public knowledge.
Table I contains a description of the sample. There are 53 CEO or corporate
executive deaths. As one would expect, they are randomly distributed across
time. Table 2 describes the mean age, years employed by the firm, position and
so forth of the people in this sample. This table contains some interesting facts:
19% of these people were more than 70 years old at the time they entered the
sample; 7.5% of them were less than 50 when they entered the sample. The
executive had been with the firm for 23 years on average at the time of his
death. About 30% of the people in the sample had been with their firm for
more than 30 years. Most interesting, the proportion of the firm's outstanding
common shares controlled by the executive is 9.5% on average. The fact that

* I have received helpful comments from Michael Jensen and Jerold Zimmerman on a previous
draft of this paper. Because Johnson, Magee, Newman and Nagarajan revised their empirical work
in response to my comments at the Conference, the text of this paper departs from the comments I
presented at the Conference.
0165-4101/85/$3.301985, Elsevier Science Publishers B.V. (North-Holland)
176 G. W. Schwert, Discussion

the CEO controls almost 10% of the stock in the firm - and these are New
York Stock Exchange-listed firms - means that this is not a random sample of
executives. There is a problem of sample selection bias. At the time of death,
CEOs who own a lot of stock are less likely to have already retired. They are
still in the job when they die, which is what it takes to be in this sample.
Another interpretation is that they are more likely to die on the job if they own
a lot of stock, perhaps because they work harder if they own a large equity
position. Table 2 also contains information on the cause of death. Half of the
sample died of heart attacks. Many of these events were probably unexpected.
In fact, the sample was selected to avoid cases of dying after a long illness.
Table 3 contains the 15 daily stock returns, adjusted for general market
movements, centered on the day the Wall Street Journal published the
obituary. The mean excess returns on the few days before the announcement
are small negative numbers and the first few days afterwards are small positive
numbers. The cumulative average return goes from 0.89% on day - 1 up to 3%
a week later. There is some hint that stock prices go up. But it is not a very
significant event overall.
Table 5 segregates subsamples of firms where the authors think the events
are different. They find that when the founder of the company dies, there is an
average stock price increase of 3.5% during the period between the death and
the publication of the obituary in the Wall Street Journal (between 1 and 3
days). The death of the person who built the corporation in its early days, but
may have outlived his usefulness, is apparently a favorable event for stock-
holders. This result raises the question: Does this mean that every time the
founder of the company dies the stock price goes up? The answer is clearly
negative. Consider a case like Eagle Computer, which is a small Silicon Valley
computer manufacturer. In the week before they were due to go public in 1983
the CEO ran into a bridge abutment in his automobile. The initial public
offering was postponed because the CEO was an important asset to his
company. They went public a week later at a slightly lower price, and like most
of the other companies that went public in 1983 their price is lower now than
when it was issued. But it is clear in a case like Eagle Computer, where the
company is in its formative stages, that a CEO death is bad news.
On the other hand I can think of many stories, and Bob Kaplan provided
me with another at the break, about situations where somebody hung on too
long in his job, and couldn't be forced out because of his controlling stock
interest. The death of such individuals is good news for the other stockholders.
That is the straightforward interpretation of the evidence in table 5 based on
15 observations.
After table 5, the paper becomes more complicated. The authors model the
variables that explain the stock price reaction around the day of the CEO
death. They specify a cross-sectional regression of the stock price adjustment
against several variables. FNDR is an indicator variable equal to 1.0 if the
deceased was the founder of the company, and equal to 0 otherwise. This
 G. W. Schwert, Discussion 177

variable captures the difference in stock price reaction that was observed in
table 5.
The variable P O S I T I O N is the direct compensation of the deceased execu-
tive relative to the next highest paid executive in a company. P O S I T I O N
would be greater than 1.0 if this is the person with the highest salary plus
bonus. Otherwise, P O S I T I O N would be less than 1.0. The idea is that direct
compensation measures the importance of the position.
Another variable the authors consider is called ABILITY. This is approxi-
mately a three-year average of (a) the standardized growth rate of sales, (b)
return on equity (ROE), and (c) stock price performance. It is a generalized
measure of how the firm performed for the last three years. It is defined to
average to zero across this sample of firms. If the firm has been doing well,
presumably because the managers were making good decisions, having a
manager die ought to be bad news.
The authors consider two variables that interact with A B I L I T Y . Both
variables weight A B I L I T Y by the fraction of the firm's outstanding common
shares controlled by the executive (SHARES). SCOST equals S H A R E S times
A B I L I T Y when A B I L I T Y is negative, and zero otherwise. S B E N E F I T equals
S H A R E S times A B I L I T Y when A B I L I T Y is positive. The authors argue that
a CEO who owns many shares could be making very good decisions (so that
A B I L I T Y is positive), in which case the stock price reaction to that CEO death
would be negative. If the CEO with large stockholdings was making bad
decisions (so that A B I L I T Y was low), the stock price reaction would be
positive. Thus, the sign of the regression coefficients for both S C O S T and
S B E N E F I T should be negative.
Table 7 contains a correlation matrix of the variables that are used in the
regression model. FNDR is correlated 0.25 with ABILITY. This means that if
the executive who died was the founder, the company was performing better
than the average of the firms in this sample. On the other hand, the correlation
of FNDR with P O S I T I O N is -0.04. This means that the direct compensation
of founders who died was not higher than for the other deceased executives in
this sample. Given the control position of these founders, and their length of
time in the job, it is surprising that the founders did not have higher direct
compensation. On the other hand, it is possible that these individuals chose not
to take their compensation in the form of salary plus bonus, perhaps for tax
reasons. It is also possible that many of the founders hired managers as CEOs
to run the operations of the company.
Thus, there are some intriguing facts in this sample of data. There are several
possible interpretations of the correlations in table 7 that provide different
perspectives on the regression results in table 6.
Table 6 contains estimates of regression models that explain the three-day
standardized abnormal stock return as a function of these variables. The
FNDR variable has a reliably positive coefficient, which means that the stock
price goes up more when the person who died was the founder of the company.
178 G. W. Schwert, Discussion

This is analogous to the 'founder effect' in table 5. Thus, the regression results
in table 6 provide a more precise analysis of the subsample of firms where the
founder died.
The P O S I T I O N variable has a substantial negative coefficient. This means
that the higher the POSITION of the person who died, holding everything else
constant, the worse the stock price effect.
The A B I L I T Y variable, which is predicted to have a negative effect, has a
small positive coefficient, but it is not reliably different from zero.
The interaction variables S C O S T and SBENEFIT are predicted to have
negative coefficients. The estimates are negative, but they are not reliably
different from zero. The coefficient of S C O S T is about 1.8 standard errors
from zero, which is weak evidence that indicates that shareholders benefit if an
executive who owns a lot of stock in a poorly performing company dies.
Probably the most impressive statistic in table 6 is that this regression
explains about 25% of the cross-sectional variance of the standardized daily
stock price reactions simply by measuring characteristics of the person who
died. Considering that there is probably news about the potential imminent
death of some of these people, the obituary should not necessarily have a
dominant effect on the stock price. Other factors also affect stock prices. I am
surprised that the regression models explain as much as they do, and I
compliment the authors on their success.
Most researchers would have stopped at table 3, where they examine the
sample of CEO deaths and find not much stock price effect on average. If
managers are paid their marginal revenue product, or if the death is not a
surprise, I wouldrr't expect any stock price reaction. But the authors probe
further and examine the unusual characteristics of the people in their sample to
discover several interesting phenomena. While this study is not the definitive
analysis of rents in managerial labor markets, it certainly provides a valuable
starting point on which future papers can build.
There is one final point that could lead to future research. Jerry Warner has
pointed out that the 'founder effect' may simply reflect the fact that a large
'control block' of stock is being broken up due to the executive death. If this
event increases the likelihood of a future corporate control fight (tender offer,
merger, or proxy fight), and if the stock market anticipates the future takeover,
the stock price will rise. This has no necessary implications for the managerial
abilities of the executive prior to his death, it simply reflects the fact that a
corporate control transaction is unlikely when a large block of stock is closely
held, and that control fights generally benefit target firm shareholders. One
possible way to discriminate between these hypotheses would be to collect a
sample of deaths of individuals who held large blocks of stock, but who were
not executives of the corporation. The results from such a sample would clarify
the reasons for the positive stock price reaction when an executive with
substantial shareholdings dies. This is just one of many future research
problems that are suggested by the Johnson, Magee, Newman and Nagarajan
paper.