Impact of Internal Governance on a CEO’s Investment Cycle

This paper examines the impact of internal governance on a CEO's investment cycle. Extant literature defines internal governance as the mechanism by which senior executives help discipline the CEO to maximize shareholder value. Weisbach (1995) finds that a year or two before the CEO retires, the firm experiences a decrease in total investment. Pan, Wang and Weisbach (2016) find evidence of a CEO's investment cycle, in which investment increases over a CEO's tenure, whereas disinvestment decreases. These papers suggest that older CEOs incur agency costs as they try to extract rents as their investment horizon declines. We confirm their results, and additionally find that good internal governance helps reduce older CEOs under-investing before their exit. For younger CEOs we do not find any relationship between internal governance and investment. This suggests that older CEOs who face good internal governance under-invest less. We also find that new incoming CEOs divest these projects profitably. These results are robust to: normal CEO retirements (exclude performance-related turnover), sudden CEO deaths, and controlling for measures of board size, proportion of outsiders on the board, CEO's pay-performance sensitivity, CEO pay slice, CEO power, firm complexity and if the CEO was an outsider or not