Author: Yiu, Wing Him
Title: What’s in a forced CEO turnover announcement? The cut loss hypothesis on option implied volatility
Degree: D.B.A.
Year: 2022
Subject: Chief executive officers
Options ,Finance)
Stock options
Hong Kong Polytechnic University -- Dissertations
Department: Faculty of Business
Pages: 150 pages
Language: English
Abstract: When one talks about a forced CEO turnover, it is usually about an incompetent manager delivering a mediocre business result, leading to the capital punishment of firing. In my thesis, I use the ability, strategy, scapegoat and cut loss hypothesis to investigate what is in fact the rationale behind a forced CEO turnover event. Using option data available from all the U.S. listed exchanges during 2001-2017, I find out that the ability and the strategy hypotheses are not supported while the scapegoat hypotheses is rejected. I also find out that the effect of Option Implied Volatility due to a forced CEO turnover can be explained by whether the announcement is in accordance or in violation of the cut loss hypothesis. Announcing a forced CEO event during a trading break or replacing a fired CEO with a CEO with long serviceable years triggers the cut loss mechanism, thus sending the Option Implied Volatility higher. Results found in my multivariate model about the cut loss hypothesis are robust after controlling stock return, size and financial leverage ratios, and also when I use alternative independent variables to control for the size effect of firms or weekends instead of trading breaks.
I call the hypothesis I develop the cut loss hypothesis, because concerning an ultra-short time frame of one day less (T-1) to one day plus (T+1) around the forced CEO turnover announcement, an investor uses an almost knee-jerk mechanism to avoid short term risk when he or she sees major uncertainty in his or her equity interest, hence the Option Implied Volatility is driven up. Cases that result in major uncertainty include long serviceable years for the successor CEOs (3 years or more) and announcing the forced CEO turnover during trading breaks. In the former case, a company shows genuine interest to fundamentally change the outlook of the company by choosing someone with ample time to do so. In the latter case, a company disallows any chance of the investors to get out of their equity interests. The strong t-statistic of the interaction term between long serviceable years and whether the forced CEO announcement is made during trading breaks confirms the cut loss hypothesis, when an investor's knee-jerk reaction to sell drives up the Option Implied Volatility.
My findings in this thesis are substantially different from the likes of Clayton, Hartzell and Rosenberg (2005) and Huson, Malatesta, Parrino (2004) because the previous studies focus on realized equity volatility while I focus on short term Option Implied Volatility. While their observation periods are as long as 60 months, my observation period is only one day before and one day after the forced CEO turnover is announced. While the scapegoat hypothesis is rejected outright in my thesis and in theirs, my findings based on the strategy hypothesis and the ability hypothesis are different from the prior research. With strategy hypothesis and ability hypothesis more prominent in the long term because a strategic change led by a new CEO takes time to effectuate, the signalling effect is more dominating in the short run, resulting in the statistical significance of the newly developed cut loss hypothesis. I hope this thesis can bring insight to the financial world the anomalous yet still rather untouched signalling effect of forced CEO turnovers.
Rights: All rights reserved
Access: restricted access

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