Clint Harritt, Managing Partner
J.C. Penney (JCP) may have "cockroaches in the kitchen," such as problems in the business model, competition, and a dim future, but the negative investor perception surrounding CEO firings is often unfounded. The company appointed an interim CEO, Myron Ullman, and in time is expected to hire a new CEO. The company is a turnaround - and as Warren Buffett reminds us, "Turnarounds rarely turn." However, recent and historical evidence points to the hiring of new CEOs being a positive catalyst to share prices, in general, for distressed companies.
Normal CEO Retirements
In a 1995 study, Performance Changes Following Top Management Dismissals, researchers David J. Denis and Diane K. Denis showed that following normal retirements, operating performance at companies actually increased in the ensuing three years. The same study showed that normal retirements also tend to be followed by significant increases in assets (book value) at a company over the three years following a CEO retirement.
Forced CEO Resignations
Most surprising is that even forced resignations are also favorable news for shareholders. The Denis and Denis study showed that after a CEO forced resignation, most companies experienced a significant increase in operating performance within the first year. The companies that performed best of all in that following year had been headed previously by CEOs who were forced to resign because their companies were performing poorly.
In a 1989 study, An Analysis of Stock Price Relation to Management Change in Distressed Firms, Karl Adam Bonnier and Robert F. Bruner showed that shareholders of distressed firms gained from a change in senior managers, within 1-50 days.
Investors clearly perceive management turnover to be bad news for a company. For example, hosts on CNBC's "Mad Money" show usually exhort viewers that when a CEO leaves: stay away. This general misperception may be an opportunity. Since we know that either operating performance or share prices can improve dramatically with a new manager in place, we can consider buying with a wider margin of safety during the weeks when the share price is depressed, and prior to the new hire announcement.
Many positive investments have stemmed from a management overhaul:
- Shares in Groupon (GRPN) are up 38% since the departure of Andrew Mason in March, and hiring of co-CEOs.
- Shares in Best Buy (BBY) are up 36% since the hiring of Herbert Joly as CEO in August 2012.
- Shares in Yahoo (YHOO) are up 49% since the hiring of Marissa Mayer as CEO in July 2012.
- Shares in Green Mountain Coffee Roasters (GMCR) are up 101% since the hiring of Brian Kelley in November 2012.
- In the case of Francesca's (FRAN), the women's retail clothing company, the stock price dropped 17% the day after CEO John De Merritt announced his retirement on September 4, 2012. Earnings, revenue, and profit are still growing at the company with a new CEO, but share price is unchanged.
This article is not a recommendation to buy J.C. Penney, as there is additional due diligence required beyond the CEO hire. However, an increase in share prices may very well result from the hope a new CEO brings to the fortunes of J.C. Penney.