TURNOVER IN THE Top MANAGEMENT COHORT AND FINANCIAL PERFORMANCE Roy A. Cook Fort Lewis College Durango, Colorado Daniel S. Cochran Gareth Stephen Taylor Mississippi State University Starksville, Mississippi Introduction The subject of turnover in organizations has always captured the attention of both practitioners and academicians. Stories of management upheaval and change abound as organizations downsize and restructure to meet the challenges of a globally com- petitive environment. Corporate giants such as Sears, Tenneco, Chrysler, General Motors, and Wang have made dramatic management changes. Research on this sub- ject has ranged from the frequlmtly suggested approach of comparing an organization's turnover with some type of industry standard ([14], [23]) to analyses of specifically targeted positions and occupational groupings ([8], [32]). Published investigations of the relationship between turnover and organizational per- formance have typically focused on the movement of individuals into and out of the top positions within an organization or on the outcomes of movement by more than one individual into or out of an organization. However, with few exceptions, the relationship between top management turnover and organizational performance has received scant attention. Specifically, literature on managerial succession has proven to be inconclusive in regard to subsequent organizational performance [3]. Consequently, the nature of the managerial turnover-organizational performance re- lationship has not been fully specified. For example, is there a relationship between managerial turnover and organizational performance? If so, are there relevant points at which varying. levels of turnover either enhance or retard the overall financial per- formance of an organization? If there is a significant relationship between varying levels of turnover in the top management cohort and long-term organizational finan- cial performance, then it would seem reasonable to use organizational resources in an attempt to influence the level of turnover within this group. Theoretical Background The need for a team or cohort of individuals rather than one person to accom- plish top management tasks of an organization was well-documented almost twenty years ago [9]. Speculation as to the relationship between managerial succession and subsequent organizational performance can be traced to Barnard [1] who hypothesized that a change in the top management team would result in organizational chaos. Staw 18 Journal ofBusiness Strategies Vol. 10, No.1 [31] also observed that the loss of large numbers of key employees may be detrimen- tal to the organization because of the general disruption that may occur. However, the significance of this disruption will depend on the specialized knowledge of the position holder and/or the interdependence of established work roles between key group members. Researchers, noting that strategic decision makers ultimately determine organiza- tional success or failure, have begun the task of focusing attention on the significance of top management turnover and chief executive officer succession ([2], [22], [20], [35]). However, the empirical investigations into this subject have been limited and inconclusive. The primary focus appears to have been on single top management positions rather than multiple positions in the top management cohort. "Some evi- dence suggests that succession creates an organizational crisis and thus negatively af- fects organizational performance. Other evidence suggests that succession enhances performance. And finally, a third body of evidence suggests that succession and per- formance are unrelated" ([3], p. 93). The scarcity of research into the specific ques- tion of turnover in the top management cohort can be seen by reviewing the findings of the key studies on this subject presented in Table 1. Some of the contradictory findings of the early studies may be traced to small sample sizes. Later studies, how- ever, began to point to the possibility of a relationship between top management turn- over and organizational performance. As researchers examined the potential impacts of employee turnover on organiza- tions, it was observed that some level of exchange of human resources between the organization and the environment is required for the organization to remain viable [21]. This would preclude the possibility of maintaining a long-term rate of zero turnover. However, it should also be noted that turnover in top management positions could result in disruption of reporting relationships due to changes in cohort membership. Hope- fully, the results of the present research will provide insights for strategic decision makers as they face key human resource issues. Based on the fmdings of previous research and professional opinions from mem- bers of the banking community ([11], [13], [29], [30]), the following independent variables were included in our analyses: Percentage of Agricultural and Commercial Loans in Loan Portfolio; Percentage of Real Estate Loans in Loan Portfolio; Percent- age of Individual Loans in Loan Portfolio; Income Production; Net Loan Charge Offs to Average Loans; Loan to Deposit Ratio; Total Overhead Expense to Average Earn- ing Assets; Effective Tax Rate; and Equity Multiplier (see the Appendix for a defmi- tion of each variable.). By examining the joint effects of turnover and previously identified variables related to the overall financial performance of banks, a more com- plete picture of the significance of turnover in the top management cohort can be iden- tified. Therefore, we tested the following hypothesis: Turnover in the top management cohort is related to organizational financial performance in the presence of other theoretically specified independent variables. Spring 1993 Cook, Cochran & Taylor: Turnover in the Top Management 19 Table 1: Turnover and Top Management Organizational Performance Investi- Time Statistical Succession Performance Major gator Organizations Frame Technique Variable(s) Variable(s) Findings Trow 108 small Varies Cross tabu- Annual rate Changes in Organizations (1961) manufacturing by com- lations; of succes- profitabil- that plan for companies pany tests of sion of man- ity succession significance agers show profit- ability Grusky Business cor- 1949- Chi square Changes in Size; amt. Frequency of (1961) porations 1959 top manage- of bureau- succession ment cracy positively re- lated to size Brown 26 NFL Teams 1970- Regression Changes of Percentage No relation- (1982) 1978 head coach, of games ship between chief oper- won in succession ational man- regular and perfor- ager, assis- season of mance tant coaches, a given players year Wagner, 31 Fortune 1976- Multiple Proportion of Return on Proportion of Pfeffer, & 500 companies 1980 regression turnover in investment turnover in O'Reilly the top mgt. top mgt. group (1984) group inversely rela- ed to financial performance & positively re- lated to co- efficient of va- riation of dis- tance between managers Reinganum 353 New York 1978- Event study Change in Abnormal Succession (1985) & American 1979 chairman stock mkt effects depen- Stock Ex- and/or pres- perform- dent on size of changes traded ident ance firm, origin of companies successor, and disposition of predecessor Goodstein 327 Califor- 1980- Pooled time CEO & Board Number of Changes in & Boeker nia hospitals 1986 series; cross- composition product hospital ow- (1991) sectional changes and/or ser- nership & mgt. structure vice addi- significant using lagged tions or catalysts to ser- indep. variable deletions vice changes structure Adapted from Glenn R. Carroll, (1984), "Dynamics of Publisher Succession in Newspaper Organiza- tions," Administrative Science Quarterly, 39:96. 20 Journal ofBusiness Strategies Research Design Vol. 10, No.1 In order to gain a better understanding of the potential relationship between vary- ing levels of top management turnover and fmancial performance, we analyzed data from all regulated banks in the state of Nebraska over a seven-year time span. This period provided an interesting strategic window for analysis since the banking indus- try was experiencing a great deal of turbulence and change due to the impact of regu- latory changes initiated by the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA). DIDMCA brought comparability to the banking in- dustry as Federal Reserve requirements were extended to institutions which had previ- ously avoided this control. In addition to providing a large relatively homogeneous group of organizations for our research, the possibility of industry effects was con- trolled by using a single industry. Since researchers have failed to reach a consensus on a universal measure of or- ganizational financial performance, we identified two measures of performance com- monly monitored in the banking industry: Return on Average Assets and Return on Average Equity ([10], [13], [28], [30]). Return on Average Assets captures the re- sponse of an organization's fmancial performance relative to managerial policies, while Return on Average Equity captures the concept of investor wealth maximization. Sample and Data In order to control for differences in the external environment, the banks selected for this study were all domiciled in the state of Nebraska. The banking industry in Nebraska provided a large number of observations (391) as well as a relatively homo- geneous group due to state-mandated legislative restrictions on interstate and branch banking. Information about managerial turnover was taken from a listing of bank officers reported in the Nebraska Edition of the American Bank Directory. Financial performance data are based on Uniform Bank Performance Reports submitted to the Federal Deposit Insurance Corporation and published annually in Sheshunoff Banks of Nebraska ([24], [25], [26], [27], [28], [29]). The time frame selected for analysis begins after the passage and phase-in of the Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA). As previously noted, DIDMCA brought comparability in financial re- porting standards to the banking industry. Top management turnover in this envi- ronment was measured over a two-year time frame which is in keeping with previous turnover research in top management conducted by Helmich and Brown [17] and Wagner, et al. [33]. No attempt has been made to separate voluntary and involuntary turnover for purposes of analysis because it is virtually impossible to obtain accurate information as to the voluntary/involuntary status of separations in the top management hierarchi- cal level ([18], [19]). In fact, individuals leaving the upper echelons of organizations are often described as "pursuing other opportunities" which makes it difficult to de- termine the actual nature of departures. Spring 1993 Cook, Cochran & Taylor: Turnover in the Top Management 21 Since the present research required identifying turnover among persons who are in positions that can have an impact on long-run organization [mandaI performance, it was necessary to limit the number of positions to those who participate in top management decisions. An earlier survey of banks operating in the State of Nebraska identified the following positions as part of the top management cohort: Chairman of the Board, President, Chairman of the Executive Committee, Executive Vice President, Senior Vice President, Vice President, Cashier, and Treasurer [7]. Total turnover in this group was defined by the percentage of individuals who were no longer in the top management cohort over a two-year period between the spring of 1980 following the passage of DIDMCA and the spring of 1982. Statistical Analyses The recorded data were analyzed using the stepwise procedure for multiple linear regression in order to identify representative models applicable for each dependent variable and year being studied. The relationship between turnover in the top man- agement cohort and organizational financial performance was analyzed by lagging fi- nancial performance for one-, two-, three-, four-, and five-year periods. TIlls procedure is in keeping with the previously reported research where lagged time periods were used for analyzing organizational performance ([22], [34], [35]). In addition to using the stepwise multiple regression procedure for analysis, the correlations among the independent variables in each of the samples were screened for the presence of multicollinearity. Although the potential problem of multicollinearity was recognized, it was not considered to be a significant problem since previously tested performance models were being utilized. However, reported unadjusted R2 and ad- justed R2 statistics were compared to check for any unusually large differences be- tween these statistics which might indicate a potential problem with multicollinearity. Additionally, analyses were performed using a Chow test [5] to determine whether the specified models could be universally applied to those banks experiencing some turn- over as well as those experiencing no turnover in the top management cohort. Results An abridged presentation of the results highlighting the turnover variable and ad- justed R2 of each separate regression equation for the Return on Average Assets and Return on Average Equity Models is shown in Table 2. Our analyses of the data indicated that there were no statistically significant rela- tionships evident between turnover in the top management cohort and the organiza- tional financial performance measures of return on average assets or equity in the presence of the other theoretically specified variables for any of the years investigated. In addition, an examination of the correlation matrices for all variables by year in both models indicated that turnover was significantly correlated with return on average as- sets only in 1983 (-.002, p<.05) and 1987 (-.106, p<.05). However, there appears to 22 Journal ofBusiness Strategies Table 2: Partial Summary of Regression Statistics Return on Assets Model Vol. 10, No.1 Year Turnover Variable B p value Adjusted R2 1983 1984 1985 1986 1987 -.037 -.032 .037 .031 .017 -1.053 -1.234 1.353 1.155 .506 .293 .218 .177 .249 .613 .544* .744* .728* .716* .602* Return on Equity Model Turnover Variable Year B p value Adjusted R2 1983 0.000 -.218 .828 .550*** 1984 0.000 -.120 .904 .728* 1985 .045 1.664 .097 .725* 1986 -.027 .992 .322 .724* 1987 .023 .616 .539 .511* *p<.05 **p<.OI ***p<.OOI be little practical significance to observed correlations of this magnitude. More im- portantly, turnover was not correlated with return on average equity in any of the years studied. Therefore, the a priori null hypothesis that turnover in the top management co- hort is not related to return on average assets in the presence of other theoretically specified independent variables cannot be rejected. However, there were variables significantly related to the financial performance measures selected for this study. The variables found to be significantly related to return on average assets and equity were net loan charge offs, income production, loans-to-deposits, overhead, real estate loan mix, loans to individuals, and the equity multiplier. Although the relationships be- tween the independent variables identified as being statistically significant in the speci- fied models were not of specific interest to this research, they are similar to previous research findings investigating variables within managerial control that contribute to bank performance ([13], [4]). Comparison of those banks experiencing some turnover in the top management cohort (146) and no turnover in the top management cohort (245) were conducted using the Chow test [5]. The results from these tests for the return on average assets and equity models are presented in Tables 3 and 4 respectively. Spring 1993 Cook, Cochran & Taylor: Turnover in the Top Management 23 Table 3: Chow Test Comparisons of Banks Exhibiting Some Turnover with Those Exhibiting No Turnover in the Top Management Cohort Return on Assets Model Year N Nl N2 SSEN SSENI SSEN2 F F(k, N-2k) 1983 389 243 143 121.89912 86.44974 28.96013 4.2621* 2.21 1984 388 242 146 167.11605 116.90118 46.70638 1.6212 2.21 1985 387 242 145 169.70026 116.25415 50.34694 1.4026 2.21 1986 391 245 146 239.67803 168.16200 68.56420 .9502 2.21 1987 375 234 141 94.65772 60.46571 32.40972 1.4009 2.21 N = All Banks Nl = Turnover = 0 NZ = Turnover> 0 p<.05 Table 4: Chow Test Comparisons of Banks Exhibiting Some Turnover with Those Exhibiting No Turnover in the Top Management Cohort Return on Equity Model Year N Nl N2 SSEN SSENI SSEN2 F F(k, N-2k) 1983 384 239 145 9956.59524 5782.24242 3515.16104 4.39584* 2.10 1984 377 236 141 11822.88687 7266.05243 3965.80560 3.20115* 2.10 1985 377 236 141 12630.04959 8928.26000 3086.42309 3.11578* 2.10 1986 378 235 143 19434.64098 11648.98351 7169.25776 1.99808 2.10 1987 370 230 140 12620.95809 6340.90090 5346.76392 4.76456* 2.10 N = All Banks Nl = Turnover = 0 NZ = Turnover;> 0 p<.05 24 Journal ofBusiness Strategies Vol. 10, No.1 In order to perform these tests, a standard model was specified based on the variables that consistently entered the stepwise regression procedure with significant coefficients, and then an hierarchical regression procedure [6] was utilized to analyze each sub- group by year to insure comparability. This procedure is designed to test statistically whether the relationships between the coefficients of the dependent performance vari- ables and the coefficients of the independent variables differ significantly between the subgroups. Discussion The absence of empirical evidence confirming the significance of the relationship between top management turnover and subsequent organizational financial performance should concern academicians and practitioners alike. Although the Chow tests indi- cated turnover was not significant in either of the specified models, the mixed results obtained from these comparisons may have been influenced by the possibility of ritual scapegoating ([12], [15]) or pruning of management deadwood [34] as a result of unacceptable organizational performance. Moreover, banking regulations requiring bank officers to have significant experience may lead to homogeneity within the top man- agement ranks [16]. These findings may prove to be important for several reasons. First, this research adds to the developing body of knowledge about the relationship between turnover and organizational performance which has proven to be inconclusive or contradictory. Second, there is no evidence in this research to indicate that banks experiencing some turnover in the top management cohort will have significantly different financial per- formance than those banks which experience no turnover in the top management co- hort. Third, our findings point out potential flaws in singularly focusing attention and resources on attempting to control the turnover process within the top management group. Fourth, it points to the need for a better understanding of the environmental influences beyond the control of strategic decision makers that may constrain orga- nizational performance and the possible need to focus attention on specific performance criteria within their control. Fifth, since it has been assumed that it takes time for changes to occur in organi- zational performance after strategic decisions have been made, the use of a longitudi- nal design with time lags has important implications. The absence of a significant relationship between turnover and financial performance during the research time frame proved to be revealing since it appeared that financial performance was not materially effected by turnover in the top management cohort. However, the absence of any relationship is significant since it may call into question focusing time and attention on identifying responsible levels of turnover or a specific "equilibrium" point of ac- ceptable turnover for the top management cohort. Although these ideas may be found to be true in other industries or within groups at lower hierarchical levels of an orga- nization, they were not present in the current findings. The future holds the promise of increasing our understanding of the potential impact of turnover within identified organizational hierarchies or groups. However, Spring 1993 Cook, Cochran & Taylor: Turnover in the Top Management 25 in order to make generalizable statements, additional research is needed. By expand- ing the present research within industries to include large groupings of comparably sized organizations operating within similar economic constraints as well as undertaking more complex, across industry studies, it should be possible to make more generalizable statements as to potential relationships. It would also seem reasonable to investigate similar relationships in succeedingly lower hierarchical levels within the organization since individuals at these lower lev- els engage in strategy implementation [36]. Individuals at these lower levels engage in multiple decisions which, cumulatively, may have a significant affect on organiza- tional performance and, therefore, could be fertile ground for further research and managerial attention. Insights into the cohort turnover/performance relationship could prove to be helpful for strategic decision makers in today's highly competitive envi- ronment as they face difficult decisions relating to downsizing, restructuring, consen- sus building, and work team composition and stability. References 1. Barnard, Chester J. The Functions of the Executive. Cambridge, MA: Harvard Univer- sity Press (1948). 2. Brown, M. Craig. "Administrative Succession and Organizational Performance: The Succession Effect." Administrative Science Quarterly, Vol. 27 (1982), pp. 1-16. 3. Carroll, Glenn R. "Dynamics of Publisher Succession in Newspaper Organizations." Administrative Science Quarterly, Vol. 29 (1984), pp. 93-113. 4. Cates, David C. 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Strategic Management Journal, Vol. 11 (1990); pp. 231-241. 28 Journal ofBusiness Strategies Appendix: Definitions of Independent Variables Vol. 10, No. 1 Percentage of Agricultural and Commercial Loans in Loan Portfolio: The percentage of agricultural and commercial loans to total domestic loans Percentage of Real Estate Loans in Loan Portfolio: The percentage of real estate loans to total domestic loans Percentage of Individual Loans in Loan Portfolio: The percentage of individual loans to total domestic loans Income Production: Combination of interest income (tax adjusted) and total non-interest income as a percentage of average assets Net Loan Charge Offs to Average Loans: Net loans actually written off as losses, recognizing recoveries from previously written off loans, as a percentage of the average loan portfolio Loan to Deposit Ratio: The percentage of total loans to total deposits after reduction for all governmen- tal deposits Total Overhead Expense to Average Earning Assets: The aggregate of salaries and benefits, occupancy expense, and other operating expenses to average earning assets Effective Tax Rate: Calculation of taxes paid as a percentage of income before extraordinary items for each year Equity Multiplier: Leverage component-<:alculated by dividing average annual assets by average an- nual equity Turnover In the Top Management Cohort and Financial Performance