Golden Handcuffs : CEO Employment Contracts when the Firm May Benefit from Anticipated Retention

The relative performance evaluation hypothesis postulates that market-wide and industry-wide performance should not affect the likelihood of CEO involuntary turnover. However, recent academic literature has documented that following poor industry and market performance the likelihood of CEO involuntary turnover increases. This paper presents a model that explains how the lack of relative performance evaluation in CEO turnover can emerge as an efficient result. I analyze a learning model of managerial ability; the model assumes that the firm benefits from stakeholders' anticipation of the retention of its CEO. The model is consistent with several other features of the labor market for CEOs such as observations that CEO compensation correlates with both idiosyncratic firm performance and market performance; that CEOs rarely change employers; and that the value of a firm may increase following a CEO turnover announcement in which the departing CEO accepts employment at another firm. To support this last assertion, I document that in almost half of the cases in a sample of CEO moves to a larger firm the value of the old firm increases following the turnover announcement