Should Firms Look to an Insider or an Outsider When Hiring a New CEO? Evidence from China

This study examines the performance consequences of managerial turnover in firms operating in a weak institutional environment and facing pressures to restructure and downsize. A CEO promoted from within the firm has better knowledge of the organization than an outsider but may be bound by existing social ties with the workers. An outsider successor not burdened by such ties may grasp problems more quickly and allocate human resources more efficiently. In addition managers from outside the firm may have ties with government agencies and other firms that can safeguard contracts and help navigate through regulatory uncertainty. However, they may be hindered by their relative lack of knowledge of the organization. We examine the performance consequences of managerial turnover a set of firms operating in China in the 1990s after a widespread institutional change in corporate governance. We find that firms improve productivity more after turnover to an external CEO successor, and the effect is more evident in state-owned firms with large employment, those more likely to suffer from labor redundancy, and those dependent on government financial support. We control for the selection effect of CEO successors by matching firms with similar pre-turnover characteristics, and control for unobserved productivity shocks with investment and intermediate inputs. ∗ Haas School of Business, University of California, Berkeley. [email protected] .