Struck by Luck: Noisy Capability Cues and CEO Dismissal

A board’s key decision to dismiss or retain a current CEO is associated with complexity and uncertainty because CEO ability is not directly observable. Instead, boards must rely on capability cues when evaluating the ability of the CEO. However, capability cues are frequently noisy, encompassing both informative cues about CEO ability and luck factors from which nothing about the ability of the CEO can be inferred. Expanding on the behavioral theory of boards, we theorize that boards fail to perfectly distinguish between informative cues and luck factors and misattribute luck factors to CEO ability. Thus, we conjecture that boards are less likely to dismiss CEOs when capability cues appear more favorable due to luck factors. Using cognitive abilities and the decision context as contingency factors, we further argue that this effect is attenuated by director experience but accentuated by pressure from misinformed institutional investors. Exploiting a regression discontinuity design to test for causal impacts of luck factors, our results support our hypotheses.