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| | The Speculator
When the firing starts, duck!
It may be tempting to jump in when a troubled company starts dumping executives. Don't. Often as not, the problems behind the departure surface later, and the stock plummets.
By Victor Niederhoffer and Laurel Kenner
"The Sanitation Department will be sweeping up a lot of dead bodies this winter. These things have to happen every 10 years or so. It gets rid of the bad blood."
-- Mario Puzo, "The Godfather"
"The Godfather" contains considerable wisdom on the salubrious effects of forceful action in pursuing business interests. Mob boss Don Corleone started with reason to persuade corrupt and troublesome people to step aside, and if that didnt work, he fired them.
Even though "The Godfather" is one of our favorite business handbooks (for more recommendations, see our Web site), Mario Puzos wisdom still needs to be tested -- particularly because 2001 and 2002 have been banner years for resignations, many occurring without even the obligatory as planned for many years, or for personal reasons.
Everyone agrees that clearing out dead wood is a healthy thing. But our studies show that if this is true, it takes some time. Often, deep problems surface only after the old guy agrees to go quietly, lugging a well-stuffed severance package. The Italians have a nice way of putting this with their cynical augmentation to the proverb, New brooms sweep clean. They add, for three days.
Yet power-player firings and forced resignations seem remarkably numerous these days. Last week, President Bush gave Treasury Secretary Paul ONeill and presidential economic adviser Larry Lindsey the boot. Last month, it was Harvey Pitt who was out as SEC chairman, along with William Webster as head of the new federal accounting oversight board. Media empress Martha Stewart left the board of the New York Stock Exchange this year. Former star telecom analyst Jack Grubman resigned from Salomon Smith Barney.
High-level bloodlettings are commonplace at corporations, now, too, although its hard to tell whether more executives than usual are getting the hook. In the first three quarters of this year, 562 chief executives left their companies, down from 722 in the comparable period of 2001, according to Challenger, Gray & Christmas, an executive placement firm that periodically reports on resignations. Whats different now is that so many of the departures were at prominent companies: Dennis Kozlowski, Bernard Ebbers and Kenneth Lay were forced out of their chief executive jobs at Tyco International (TYC, news, msgs), WorldCom Group (WCOEQ, news, msgs) and Enron (ENRNQ, news, msgs), to name a few.
Certainly ousters are receiving more media attention, as the number of hits produced by a Google search shows:
| Google search results by keyword | | Keywords | 2002 | 2001 | 2000 | | resignations CEO | 7,950 | 6,480 | 5,550 | | resignations CEO NYSE | 547 | 399 | 404 | | new CEO NYSE | 7,002 | 3,420 | 3,210 |
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And boards of directors, pressed by the new centurys outrage over corporate fraud, seem to be taking management lessons from "The Godfather." Here are two Bloomberg stories, three days apart:- May 30, 2002: Tyco International Ltd. denied reports on two Web sites that Chief Executive Dennis Kozlowski resigned, quelling speculation that caused a brief rally in the shares. Kozlowski hasn't quit and has the full support of the board, Tyco spokeswoman Maryanne Kane said.
- June 3, 2002: Tyco International Ltd. said L. Dennis Kozlowski resigned as chairman and chief executive officer for ``personal reasons.''
Whether such ruthlessness helps is another story.
Before and after
Inspired by ONeills departure, we studied how stocks performed after executive resignations. Using Google and Bloomberg, we collected a sample of 38 high-profile companies that announced the resignation of a CEO, chairman or president in the past three years. We calculated their performance in the three months before and after the announcement, and compared to the S&P 500 ($INX) in the same periods.
The results should give investors pause about jumping in right away after a corporate housecleaning.
On average, the stocks fell 14% after a resignation announcement -- a full 8 percentage points worse than the S&P 500s performance in the comparable period. (They were down 23%, on average, beforehand.)
| How resignations affect stock prices | | | Resignation | Price at | 3 mos | % chg | 3 mos | % chg | | date | close | prior | | later | | | Adelphia (ADELQ, news, msgs) | 5/15/2002 | $5.70 | $19.97 | -71.50% | $0.13 | -97.70% | | WorldCom (WCOEQ, news, msgs) | 4/30/2002 | $2.48 | $9.85 | -74.80% | $0.15 | -94.00% | | Dynegy (DYN, news, msgs) | 5/28/2002 | $9.69 | $29.00 | -66.60% | $2.15 | -77.80% | | Enron (ENRNQ, news, msgs) | 8/15/2001 | $40.25 | $56.99 | -29.40% | $9.48 | -76.40% | | Peregrine Systems (PRGNQ, news, msgs) | 5/6/2002 | $0.89 | $6.26 | -85.80% | $0.33 | -62.90% | | Iomega (IOM, news, msgs) | 5/21/2001 | $17.40 | $19.00 | -8.40% | $6.90 | -60.30% | | Commerce One (CMRC, news, msgs) | 5/6/2002 | $9.50 | $17.20 | -44.80% | $3.90 | -58.90% | | CMS Energy (CMS, news, msgs) | 5/24/2002 | $18.31 | $22.76 | -19.60% | $7.70 | -57.90% | | Nortel Networks (NT, news, msgs) | 5/11/2001 | $14.63 | $16.65 | -12.10% | $7.27 | -50.30% | | Veritas Software (VRTS, news, msgs) | 11/17/2000 | $110.13 | $111.00 | -0.80% | $71.69 | -34.90% | | Arrow Electronics (ARW, news, msgs) | 6/10/2002 | $23.55 | $30.07 | -21.70% | $15.97 | -32.20% | | Kmart (KM, news, msgs) | 3/11/2002 | $1.45 | $6.05 | -76.00% | $1.01 | -30.30% | | Trizec Properties (TRZ, news, msgs) | 8/15/2002 | $12.59 | $16.83 | -25.20% | $9.72 | -22.80% | | Arlington Hospitality (HOST, news, msgs) | 8/15/2002 | $3.80 | $3.10 | 22.60% | $3.00 | -21.10% | | Kmart (KM, news, msgs) | 5/31/2000 | $8.50 | $8.69 | -2.20% | $7.02 | -17.40% | | ImClone Systems (IMCL, news, msgs) | 5/22/2002 | $10.90 | $26.06 | -58.20% | $9.51 | -12.80% | | The Gap (GPS, news, msgs) | 5/22/2002 | $13.55 | $12.41 | 9.20% | $12.01 | -11.40% | | Andrx (ADRX, news, msgs) | 10/25/2001 | $67.73 | $63.73 | 6.30% | $61.07 | -9.80% | | Qwest Communications (Q, news, msgs) | 6/17/2002 | $2.99 | $2.54 | 17.70% | $2.76 | -7.70% | | Brilliance China (CBA, news, msgs) | 6/20/2002 | $14.27 | $16.30 | -12.50% | $13.47 | -5.60% | | Tyco (TYC, news, msgs) | 6/3/2002 | $16.05 | $33.14 | -51.60% | $15.59 | -2.90% | | Prime Group Reality (PGE, news, msgs) | 4/8/2002 | $6.38 | $9.35 | -31.80% | $6.24 | -2.20% | | Cousins Properties (CUZ, news, msgs) | 2/14/2001 | $25.99 | $26.94 | -3.50% | $26.38 | 1.50% | | Applied Innovation (AINN, news, msgs) | 8/14/2002 | $3.25 | $4.15 | -21.70% | $3.40 | 4.60% | | Checkpoint Systems (CKP, news, msgs) | 6/24/2002 | $11.05 | $16.09 | -31.30% | $11.70 | 5.90% | | Bank of America (BAC, news, msgs) | 1/24/2001 | $51.06 | $44.50 | 14.70% | $54.50 | 6.70% | | Mattel (MAT, news, msgs) | 2/3/2000 | $10.88 | $13.94 | -22.00% | $11.75 | 8.00% | | IBM (IBM, news, msgs) | 1/29/2002 | $103.00 | $108.62 | -5.20% | $116.20 | 12.80% | | Toys 'R' Us (TOY, news, msgs) | 8/26/1999 | $16.00 | $23.69 | -32.50% | $18.38 | 14.90% | | JDN Realty (JDN, news, msgs) | 4/13/2000 | $9.56 | $18.00 | -46.90% | $11.00 | 15.10% | | Alcan (AL, news, msgs) | 1/11/2001 | $34.44 | $31.69 | 8.70% | $42.41 | 23.10% | | Longs Drug Stores (LDG, news, msgs) | 2/27/2002 | $24.93 | $23.42 | 6.40% | $30.91 | 24.00% | | Hercules (HPC, news, msgs) | 10/17/2000 | $14.44 | $12.50 | 15.50% | $17.94 | 24.20% | | Mylan Laboratories (MYL, news, msgs) | 6/11/2001 | $25.87 | $21.00 | 23.20% | $32.82 | 26.90% | | Charter Comm. (CHTR, news, msgs) | 9/24/2001 | $12.81 | $22.21 | -42.30% | $16.59 | 29.50% | | Polaroid (PRDCQ, news, msgs) | 5/8/2002 | $0.02 | $0.06 | -61.70% | $0.03 | 30.40% | | TRW (TRW, news, msgs) | 2/19/2002 | $41.75 | $38.61 | 8.10% | $54.66 | 30.90% | | Palm (PALM, news, msgs) | 11/8/2001 | $45.40 | $102.60 | -55.80% | $62.40 | 37.40% | | | | | | Avg. | -14.51% | | | | | | St. Dev. | 37.3% |
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The failure of stocks to rebound quickly after an executive departure may signify a realization by shareholders that the directors doing the firing were the very ones who had been overlooking the CEOs excesses rather than overseeing his performance.
An even more likely reason is that many of the old CEOs excesses come to light only after an executives departure. If a CEO is on a roll, the board will let him get away with deferrals of expenses, off-the-books transactions and other forms of camouflage designed to keep up the stock and the value of the executives options. When the game has gone so far that its necessary to remove the CEO, theres often no more room to hide the dirt.
Strangely, within this array of dismal performance, a slight regularity appears. The eight companies that rose in the three months before the resignation went up an average of some 8.5% in the next three months, versus an average decline of 24% in the next three months for the 28 companies that fell in the prior three months.
In statistical terms, the correlation coefficient between the move in the three months before the resignation and the move three months after is 0.42. This gives us some 99% confidence that this is a non-random phenomenon. In other words, there was a continuity in performance, a positive correlation between prior and subsequent performance relative to the resignation.
Trepidation after the boot
What should investors make of this information?
As our longtime readers know, we never short stocks. (Well, hardly ever.) There is too much of an upward drift in the market to embrace shorting as a strategy. The definitive study in the book "Triumph of the Optimists" showing that stocks advanced 1.5 million percent in the 20th century provides a nice benchmark of 15,000 percentage points a year that wed have to overcome for us to have much confidence in these anti-enterprise-type trades.
We will say, though, that readers may wish to exercise great care if theyre considering buying shares in any of the following companies, all of which have announced high-level resignations within the past three months:
| Companies with recent resignation announcements | | Company | Resignation | Price at close | 3 mos. prior | % chg | | Aquila (ILA, news, msgs) | 10/1/2002 | $4.13 | $8.00 | -48.4% | | Hewlett-Packard (HPQ, news, msgs) | 11/11/2002 | $14.85 | $13.31 | 11.6% | | LNR Property (LNR, news, msgs) | 9/26/2002 | $33.49 | $33.77 | -0.8% | | McDonald's (MCD, news, msgs) | 12/5/2002 | $18.78 | $21.97 | -14.5% | | Protection One (POI, news, msgs) | 12/6/2002 | $2.04 | $2.80 | -27.1% | | MCG Capital (MCGC, news, msgs) | 11/3/2002 | $9.92 | $15.40 | -35.6% |
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Bushs present to investors
As for Paul ONeill, what a relief for investors to get this tone-deaf man out of Washington.
Sometimes a small beacon casts a flood of light, and some of the former Treasury secretarys more notorious comments revealed a deep contempt for the market. Take his description of Wall Street traders as people who sit in front of flickering green screens and make decisions on a speculative basis about three-basis point movements.
He could learn their jobs in about two weeks, he told the Wall Street Journal in a Jan. 26, 2002, interview. The remark showed complete ignorance of the markets role as a forum for dispersed knowledge that sends signals to producers and customers necessary for their decisions. ONeills absurd focus on workplace safety and heavy-industry production figures were only two more signs of his remove from contemporary economic thought. (For more discussion of ONeills resignation, see our Web site.)
As relief over ONeills ouster sets in, perhaps a quiet period of harmony and bullishness in the market can develop for the end of year and beyond. Life can be so beautiful in business and the market when the whole team pulls together.
At the time of publication, Laurel Kenner and Victor Niederhoffer owned none of the stocks mentioned in this column.
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