Shares of companies without a named replacement for a departing chief executive officer (CEO) tend to outperform. This outperformance occurs despite the uncertainty about who the new leader will be.

A protracted succession occurs when a new CEO is not immediately named following the resignation of the incumbent CEO. During such periods, incumbent CEOs ran their companies for nearly six months, on average. Approximately three out of the 10 CEO turnovers occurring among S&P 1500 companies between 2005 through 2014 were protracted.

The annualized abnormal return for these 537 stocks was approximately 10% annualized. An abnormal return is the difference between the actual return and the expected return for a security. The return was calculated by adding a stock at the start of the month following a departure announcement and holding it until the end of the month in which a new CEO was announced. Notably, when a portfolio was constructed of buying (“going long”) stocks with protracted successions and short-selling stocks with prompt successions (where the new CEO was quickly announced), the abnormal returns were still 8.5%.

As to why this would be the case, the authors of the study offer two possible explanations. The first is an under-reaction to “the (expected) probability of announcing the new CEO’s identity.” The second is “tournament competition.” Executives within the company “engage in a stronger competition” for the newly opened position when there is a protracted succession.

There is a link between the under-reaction and the tournament competition. Up to 29 weeks beyond the incumbent CEO’s departure announcement, weekly stock returns increased along with the probability of a new CEO being named. This pattern was most pronounced among those firms where competition among executives is above that of the industry median level.

It’s possible another factor has a role. Protracted successions most often occur in “less profitable and worse valued firms.” These companies are less likely to pay a dividend. To the extent investors view resignation of the incumbent CEO as a positive change, the stock’s price performance could improve. The study’s authors did not discuss this possibility, though they did find that companies with proacted successions “obtain positive long-run abnormal performance.”

Source: “Lame-Duck CEOs;” Marc Gabarro, Sebastian Gryglewicz and Shuo Xia; SSRN, June 8, 2018.