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Berman's View

Reaping a windfall on a CEO change Add to ...

Who knows what's going to happen to BHP Billiton's Marius Kloppers, but investors have an uncanny ability to spot a chief executive officer whose days in the corner office are numbered. It's little wonder that they take an interest in these matters: A change in corporate leadership, especially a forced change, can have a profound impact on a stock.



It's going back a way, but the shift in leadership at International Business Machines Corp. in 1993 is an example that can still make people salivate. IBM was in the dumps and near bankruptcy when Lou Gerstner replaced John Akers as CEO.



The change brought new ideas to the technology behemoth, and its share price responded. Over the next nine years of Mr. Gerstner's leadership, the shares returned a total of 740 per cent by 2002, or nearly four times the pace of the S&P 500.



The IBM example might be extreme, but it isn't an isolated case where a leadership change has rewarded shareholders. David Denis and Diane Denis, finance professors at the Krannert School of Management at Purdue University, studied more than 900 top management changes, about 12 per cent of which were forced changes, at U.S. companies between 1985 and 1988 and found that they showed many similarities.



In the three years before a management change, companies tended to be struggling, with return on assets in decline. After a management change, things improved, and not just because there was a new face at board meetings.



New leadership, especially if they were not hand-groomed successors, tended to shake things up at a struggling company by initiating asset sales, layoffs and other cost-cutting measures in an effort to fix things. These shifts in direction usually sent operating profitability surging.



"This overall result masks a considerable difference between forced resignations and normal retirements," the professors said in their paper. "Forced resignations exhibit large and significant decreases in operating performance prior to management changes and significant improvements following these changes." Normal retirements, not so much.



Stock price changes tell a similar story. In the 250 days before a forced management shakeup, share prices underperformed the index by an average of 24 per cent, resulting in what the professors called "extremely large shareholder wealth losses."



In the two days following a shakeup, investors were retreated to a modest pop, with shares outperforming the index by an average of 1.5 per cent. That might not sound like much, but keep in mind that the management shakeup was probably anticipated.



As well, two days is an awfully short time period for a corporate turnaround. In the case of IBM, the shares rose a mere 4 per cent during Mr. Gerstner's entire first year at the helm of the company. Longer-term investors, who stayed focused on the improving fundamentals following the shakeup, made the big bucks.

 
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