Stock investors can be jumpy sorts. When a chief executive officer (CEO) leaves a company, they want to know why. When a new CEO comes in, they worry whether that's going to be good or bad for the bottom line. Good or bad, it's news, and news generally makes a stock more volatile in the short term.

Key Takeaways

  • A CEO transition will usually make a stock's price more volatile in the short term.
  • This is why many companies signal a transition well in advance.
  • An abrupt departure by a CEO is rarely good news.

That's why some public companies prepare succession plans worthy of a Tudor monarch. If a long-serving CEO is nearing retirement age, a new leader will emerge, gradually taking on a more public role before the boss makes the inevitable announcement.

That's if all goes smoothly.

Hasty Departures

It's never pretty when a CEO is ousted by a company board of directors. Investors generally jump to the conclusion that the business is doing very badly or is otherwise about to hit the skids. They're probably correct.

That's why companies will generally announce a replacement choice or an interim choice at the same time as the departure of the CEO is reported.

New CEOs with solid reputations and deep knowledge of the industry are least worrisome to investors.

The company may try to paper over the firing with nice words, but they cannot lie. If the CEO is departing because the company blew its sales target, or it's about to be hit with lawsuits from all sides because of safety violations, or $1 billion is missing from the accounts, the company must report it promptly to its shareholders.

In such cases, the company's stock will almost certainly tank, at least short-term. If a well-regarded person takes charge, it will probably recover over time.

First Impressions

The response to a new CEO is strictly based on shareholders' impressions of the new boss.

As a rule, a change in CEO carries more downside than upside risk. Investors worry that the newcomer will shift corporate strategy for the worse. Some shareholders may have a particular regard for the leader who just left.

In any case, they'll worry whether the transition will be smooth or rocky.

To some extent, this is a public relations task. The company will focus on the new leader's achievements at another company, or past successes in the industry, or reputation for re-energizing businesses.

What Investors Look for in a New CEO

Whether the new CEO is an insider or an outsider is always a key point, although shareholders will be divided on which is better.

Investors tend to be more comfortable with new CEOs who are familiar with the dynamics of the industry and the specific challenges the company may be facing.

Reputation is an important factor, particularly as investors assess the CEO’s track record for creating shareholder value. This pedigree could be reflected in a number of areas, including an ability to grow market share, reduce costs, or expand into new growth markets.

Despite initial investor concerns, there is no clear correlation between how the stock performs on the day the new CEO is announced and how it performs from that point forward.