Changes Of Top Management And Share Prices Effects

Published Date: 02 Nov 2017

Share price reaction to announcement of changes of top management has received amount of attention and has been investigated by many researchers recently. State laws required that a corporation must be managed by a board of directors, who delegate the duty of managing to a single CEO or a team of senior managers- the top management. The selection of new CEO has been widely thought to be a critical decision that influences a firm’s future direction and effectiveness. In this section, we review several relevant studies about the event study of the announcement of changes in top management on its share price.

2.1 Review of the Literature

Event study provides a statistical method to examine the impact of an event on the value of a firm. The objective of the methodology is to assess the information of the announcement and thus, to investigate the relationship between the changes of announcement and the market stock prices of company. Moreover, there are few researchers had examined the effect of event study in different declaration such as, changes on top management announcement, merger and acquisitions announcement, announcement of resignation of board members and so forth.

In year 1988, Warner and Watts had done a research on event study which focuses on top management changes announcement for the 269 firm listed on the New York and American Stock Exchanges (NYSE and AMEX) over the fifteen years period from 1963 to 1978. According to Warner and Watts (1988), the relation between the probability of a top management change and various measure of stock performance is estimated using logit regression and it has inversely relationship. The dependent variable he used in the research is the probability of a top management change occurs during the period and the independent variables are measures of stock price performance. As Warner and Watts (1988) noted, the abnormal return at announcement of a management change is the sum if an information effect and real effect. The information effect could be negative if the changes suggest that the performance was worse than the market had realized. The real effect would be positive if the changes are in shareholders’ interest. The combination of real and information reflects would produce a wide range of results depending on the magnitude of the individual effects.

In year 1994, Furtado and Karan has analyzed the relationship between the board choices of an internal promotion or external hire of a top executive and relative corporate performance by using the 139 appointments of data during the period 1975 to 1982, who collected by Furtado and Rozeff in year 1987. The measurement of corporate performance is evaluated by accounting earnings (ROA and EBIT) which supported by other researchers, Warner (1988) and stock prices (ROE and Stock Return). Accounting performance is significant to the corporate governance, especially in terms of hiring, firing, and the compensation of the top management. It is another useful measurement to classify the variables used in evaluating firm performance. Based on Furtado and Karan (1994), they examined the variable by using the measurement of accounting earnings (EBIT and ROA) had shown the board choices of an internal promotion or external hire is significantly related to the performance. However, the market measures (ROE and Stock Return) are found to be isolated from the board’s decision.

A research regarding the measuring security performance had investigated by Saens and Sandoval (2005). In this research, they had studied the daily stock returns and the characteristic of data affect the historical performance of short run event study methodology. Moreover, the researcher concentrated on three determinations such as, portfolio size, the magnitude of an eventual abnormal performance and the event date uncertainty on detects the abnormal return. Saens and Sandoval (2005) pointed out that they are followed the Brown-Warner simulation approach and Chilean daily security return data to examine the specification and power of three parametric t-tests commonly employed in event studies which are the standardized, the cross sectional and the portfolio t-test. Their result shown that although individual security returns and security abnormal returns are evidently non-normal, the cross-sectional mean abnormal returns converge to normality as the sample size increase. However, the parametric t-tests is more appropriate in the examination of event study that engage one day event period. The simulation approach had shown the result that standardized t-test is more possible to identify the existence of an abnormal return.

Anderson (2003) examines the conflict view of empirical findings of an inverse relationship between performance and managerial turnover. The conflict is happened between Kaplan (1994) who pointed that bank monitoring substitutes for other governance mechanism and the other one researcher, Morck and Nakamura (1999) who argued that bank protect their self interests rather than interest of shareholder. The findings is shown that the management turnover is related to the ability to meet its short term obligation rather than to profitability on stock return and thus, bank monitoring is not a substitute for mechanism that serve shareholder’s interest . The findings had shown significantly related to accounting measures of firm performance but less sensitive to stock price performance measure.

Gurgul (2007) examine the relationship of stock price and announcement of resignation of board members or in other words to say, to analyze whether the announcement of resignations of board members conveys valuable information in an emerging stock market. He found the market reaction to the information is tested at different time horizons by means if event study methodology. The findings shown that the market reaction is rather positive immediately rather before the announcement release and negative over the following six-day-period starting on the event day.

In a study examining stock price reaction to announcement of change in senior management of distressed firms, Bonnier and Bruner (1988) hypothesized that the excess returns are significantly positive which is consistent with the internal corporate control hypothesis that management change following poor performance is associated with gains to shareholders. The findings presented new insight into the circumstances in which external and internal markets for manager will affect shareholder wealth.

As a result, we use the announcement of top management changes in Genting Berhad as our dependent variable whereas for the independent variable is the share price movement of Genting Berhad in our research paper.

Review of Relevant Theoretical Models

The Efficient Market Hypothesis (EMH), popularly known as the Random Walk Theory has played a significant role in the modern financial economics, especially in the field of event study. According to Fama (1970), the author has defined the term of efficient markets as one in which security prices are fully reflect all the available information and the market is considered to be efficient if the reaction of market prices to new information is instantaneous and unbiased.

However, the stocks are always trading at their fair value on stock exchanges and this make them impossible to achieve abnormal returns or outperform the overall market by given the information publicly available at the time the investment is made. In addition, efficient market hypothesis stated that all of the past information cannot be used to predict the future price movements; this is because the information is spread quickly and efficiently incorporated into asset prices at any point in time.

Therefore, there are three categories of EMH which differ in their level of available information. First and foremost, there is a weak form efficient market hypothesis which indicates that the current asset prices already reflect past price and volume information. The past information is fully reflected in the current price of the security is because of the historical data on security prices is the easiest accessible pieces of information to everyone. It also implies that no one can beat the market by using the historical information that known by everyone. Furthermore, semi strong form efficient market hypothesis is also one of the parts of EMH. It indicates that all the publicly available information is similarly already incorporated into asset prices.

In other words, all publicly available information is fully reflected in a security's current market price. This publicly available information includes not only the past prices but also data reported in a company's financial statements, company's announcement, economic factors and others. It also implies that no investor can devise a trading rule based solely on the past price patterns and publicly available information to earn abnormal returns using something that everyone knows. This further indicates that a company's financial statements are no longer useful in forecasting future price movements and securing high investment returns.

Lastly, there are strong form efficient market hypothesis in which it defines that the private information or insider information is quickly incorporated by market prices and it cannot used to gain the abnormal returns. Thus, all the private or public information is fully reflected in a security’s current prices.

According to Zhu (2008), EMH assumes that investors can find the substitute’s security to trade based on certain risk and return preferences. Based on the previous research conducted by the researchers, we know that Bursa Malaysia is in semi strong form efficiency where the security prices reflect all the historical and currently published information. As a result, we employ event study of the announcement of changes in Chief Executive Officer (CEO) of the Genting Berhad on its share price in this research paper in the effort to show markets react quickly to new information. We have chosen this event study which is considered appropriate according to the local environment where most of the local investors are concerning about it although there is more other events that can be look into.

Proposed theoretical/ Conceptual Framework

The relevant theoretical models related to the research constructs are the foundation to develop the proposed theoretical or conceptual framework. The result of the research can be different by using different theoretical models to measure it.

Based on the previous researchers, Wruck (1987), Anderson (2002) and Furtado (1994) are using logit model which described by the logistic function. This model helps the researcher to measure the correlation between management turnover and share performance. Unless performance is extreme, the model has no predictive ability (Wruck, 1987). He found that the lag between performance and a management change can be up to two years, the evidence indicates that management turnover is not highly sensitive to poor share performance. Specifically, management turnover is conditionally related to ability to meet its short-term obligations rather than to profitability or stock returns (Anderson, 2002). However, Eugene and Vijay (1994) mentioned that the logit model is important to obtain result for the board to make decision to promote an insider or to appoint an outsider as CEO of the company which is significantly related to relative corporate performance. Furthermore, in the logit model used by these authors have measured the ROA coefficient, EBIT coefficient, ROE Coefficient and STKRET Coefficient to show possible differences between five groups for both small and large firm in their response to performance. The results indicate own return which is important in explaining the profitability of a management change for both small and large firm.

There was another model used by Eugene and Vijay (1994) which is the standard event study methodology. In this model, it employed to analyze stock price behavior around the announcement related to the changes in the top management. To measure the unusual stock price performance for each firm, market model prediction error was used. On the other hand, mean standardized squared prediction model was examined to test the unusual stock price performance independent of sign.

Besides that, based on another research done by MacKinlay (1997), he use two types of model which are statistical and economic model to measure the normal return of given security. The statistical assumptions model also called Constant Mean Return Model, when using daily data the model is typically applied to nominal returns, with monthly data the model can be applied to real returns or excess returns as well as nominal return. Moreover, an economic model is using to provide more constrained normal return models. There are two common types of economic model which are Capital Assets Pricing Model (CAPM) and Arbitrage Pricing Model (APT). Thus the gains from using an APT motivated model versus the market model are small.

In additional, another research done by Takahashi (2003) using 3 models to measure the structure of compensation and CEO job turnover. The first model is basic model, which is turnover equation to calculate total compensation and option mix are endogenous variables. The second model is using to estimate two stage instrumental variables estimation to deal with endogenity. The last model is Heterogeneity model, which to estimate incorporate an unobserved explanatory variable.

In the research of Peng and Malhotra (2008), they have applied Mean Adjusted Return Models to calculate the abnormal returns (AR) and compound the AR into cumulative abnormal returns (CAR) within several days around the announcement (M&A) was making to the public. To view the market response to the announcement event, the authors tested on the abnormal returns of acquiring firm stocks in the estimation period.

Furthermore, the research which was done by the Saens and Sandavol (2005) analyzed the specification and the statistical power of three return-generating models (RGM) which are the OLS market model, market-adjusted return model and mean-adjusted return model.

Moreover, the research done by University Sebelas Maret (2008), Indonesia, the author used routine and non-routine process of succession to examine the abnormal return of the CEO changes. Besides, the research done by Theodosios and HannesF (2010), they used the random effects logit regressions model to measure the abnormal return of the effects CEO changes. Performance of the share prices are measured by industry –adjusted performance (IAROA) and dividend cuts (DIVCUT). Industry-adjusted firm performance (IAROA) has significantly negative effect on the probability of turnover and dividend cut or omission cases – which indicate poor performance-, have a significantly positive effect. (Theodosios & HannesF, 2010).

Moreover, the previous researchers Paul, Abilene, Micheal (1997) used the market model to examine the performance of share prices and announcement of CEO changes. This method is used to regress security returns against the overall return of the market and the calculation are solving by the statistical format.

Hypothesis development

A hypothesis is a proposed explanation for an observable phenomenon. Even though the words "hypothesis" and "theory" are often used synonymously in common and informal usage, a scientific hypothesis is not the same as a scientific theory. A working hypothesis is a provisionally accepted hypothesis. Testable hypothesis will be formulated once the relationship among the important variable has been established through logical reasoning in the theoretical or conceptual framework.

According to the previous research done by Wruck (1987), there are few hypotheses to investigate the relationship between top management changes and share prices. The first hypothesis applied by author is H0 (1 through 10): proportion of firms having changes is equal across the 10 portfolios, and second hypothesis is H0 (1; 10): proportion of firms having changes is equal for portfolios 1 and 10. These two hypotheses are using to investigate the probability of a top management change by deciles of annual stock return, time period from year 1963 to 1978 with sample of 269 randomly selected firms.

Besides that, different authors will use different hypothesis to investigate their researches. Based on previous researcher MacKinlay (1997), he only uses a single null hypothesis to do his research, which is the given event, has no impact on the behaviour of the returns. This approach is using to estimate the variance can be applied to the average cumulative abnormal return.

After refers to previous researches, we form a new hypothesis to investigate the relationship between announcements of top management changes and share prices. The null hypothesis is no impacts of top management changes to company share prices, the equation as below:

Ho: There is no relationship between of top management changes to share prices.

H1: There is a relationship between of top management changes to share prices

Conclusion

This section consists of the documentation of a comprehensive review of the published and unpublished information from secondary sources of data that are available on the topics of interests. Hence, the literature review is a clear and logical presentation of the relevant research work conducted thus far in the research field of interest.

In the following section we discuss our methodology in details and the section 4 presents the data analysis and the last section provides a summary of main findings, comments and some guidelines for future research.