Defond and Hung - Investor Protection and Corporate Governance Evidence From Worldwide CEO Turnover 2004

Journal of Accounting Research
Vol. 42 No. 2 May 2004

Printed in U.S.A.
Investor Protection and Corporate

Governance: Evidence from
Worldwide CEO Turnover
MARK L. DEFOND∗ AND MINGYI HUNG∗
Received 9 January 2003; accepted 25 November 2003
ABSTRACT
Recent research asserts that an essential feature of good corporate gover-

nance is strong investor protection, where investor protection is defined as
the extent of the laws that protect investors’ rights and the strength of the
legal institutions that facilitate law enforcement. The purpose of this study is
to test this assertion by investigating whether these measures of investor pro-
tection are associated with an important role of good corporate governance:
identifying and terminating poorly performing CEOs. Our tests indicate that
strong law enforcement institutions significantly improve the association between
CEO turnover and poor performance, whereas extensive investor protection laws
do not. In addition, we find that in countries with strong law enforcement,
CEO turnover is more likely to be associated with poor stock returns when
stock prices are more informative. Finding that strong law enforcement in-
stitutions are associated with improved CEO turnover-performance sensitivity
is consistent with good corporate governance requiring law enforcement in-
stitutions capable of protecting shareholders’ property rights (i.e., protecting
shareholders from expropriation by insiders). Finding that investor protection
∗ University of Southern California. The authors thank the following persons for their helpful
comments: Fran Ayres, Ray Ball, Anne Beatty, Walt Blacconiere, Qiang Cheng, Richard Frankel,
Rebecca Hann, Paul Healy, Steve Huddart, Bin Ke, S. P. Kothari, Richard Leftwich, Bob Lipe,
Mical Matejka, Karl Muller, Kevin Murphy, Abbie Smith, Monica Stefanescu, and workshop
participants at Hong Kong Polytechnic University, Indiana University, the Journal of Accounting
Research conference, Massachusetts Institute of Technology, Northwestern University, University
of Oklahoma, the Penn State University, Temple University, University of Southern California,
and University of Washington. We thank Mei Cheng for her capable research assistance.
269
Copyright
C , University of Chicago on behalf of the Institute of Professional Accounting, 2004
270 M. L. DEFOND AND M. HUNG
laws are not associated with improved CEO turnover-performance sensitivity

is open to several explanations. For example, investor protection laws may
not be as important as strong law enforcement in fostering good governance,
the set of laws we examine may not be the set that are most important in
promoting good governance, or measurement error in our surrogate for
extensive investor protection laws may reduce the power of our test of this
variable.
1. Introduction
Recent research finds that countries with better developed capital mar-
kets have stronger investor protection (La Porta et al. [1997, 2000a]). This
research argues that the association is because investor protection fosters
good corporate governance that in turn instills investor confidence. Because
an essential role of good corporate governance is to identify and terminate
poorly performing CEOs, one implication of this research is that firms in
countries with strong investor protection are more likely to institute gov-
ernance systems that successfully terminate poorly performing CEOs. For
example, extensive investor protection laws give minority shareholders vot-
ing rights that facilitate their ability to replace directors who fail to termi-
nate unfit CEOs; and strong law enforcement curtails insider expropriation of
shareholder wealth (through mechanisms such as collusive self-dealing),
which in turn reduces directors’ incentives to retain poorly performing
CEOs. Therefore, we hypothesize that CEO turnover is more likely to be
associated with poor firm performance in countries with strong investor
protection, measured as extensive investor protection laws and strong law
enforcement institutions.1
We also predict that the metrics used to assess performance in CEO
turnover decisions vary across countries as a function of how well the met-
ric captures management performance. Specifically, in choosing between
stock returns and earnings to measure CEO performance, we expect good
governance systems to rely most heavily on the metric that best captures
firm performance. Because the information content of stock prices varies
across countries (Morck, Yeung, and Yu [2000]), we hypothesize that among
countries with strong investor protection, CEO turnover is more likely to
be related to poor stock returns (as opposed to poor earning) in coun-
tries where stock prices impound relatively more information about firm
performance.
We test our hypotheses on a sample of 21,483 firm-year observations
in 33 countries from 1997 through 2001. Descriptively, we find that the
proportion of observations with CEO turnovers varies widely across coun-
tries. For example, although 15% of the observations in our sample expe-
rience CEO turnovers worldwide over the five years examined, 4% of the
1 For ease of exposition we use the term CEO to refer to the top executive officer, irrespective
of the country, even though countries often use other titles (such as managing director) to
describe this position.
INVESTOR PROTECTION 271
observations in Portugal and 28% of the observations in South Korea replace

their CEOs. This is consistent with a wide variation in CEO turnover.2
Consistent with prior CEO turnover research, we investigate our predic-
tions using a logit model with CEO turnover as the binary dependent vari-
able, and lagged stock returns and changes in earnings as independent
variables capturing firm performance (Murphy [1999]). We test our first
hypothesis by interacting our two performance measures with two metrics
that are used in prior research to capture the attributes of strong investor
protection: (1) extensive investor protection laws and (2) strong law enforce-
ment institutions (La Porta et al. [2000a], Denis and McConnell [2003]).
We measure the extent of a country’s investor protection laws using an in-
dex that combines factors such as the extent of formal voting rules favoring
minority shareholders and the ability of minority investors to make claims
against directors (La Porta et al. [1997], Hung [2001]). We measure strong
law enforcement using an index that captures factors such as the extent of
government corruption and the efficiency of the judiciary (La Porta et al.
[1998], Leuz, Nanda, and Wysocki [2003]).
We find strong support for our first hypothesis when we measure investor
protection using law enforcement institutions, but little support when we mea-
sure investor protection using extensive investor protection laws. Specifically,
we find that CEO turnover is negatively associated with firm performance
in countries with strong law enforcement and unrelated to performance in
countries with weak law enforcement. In contrast, we find that the associ-
ation between CEO turnover and performance is unrelated to whether a
county has extensive or limited investor protection laws. Finding that strong
law enforcement institutions are associated with improved CEO turnover-
performance sensitivity is consistent with increased property rights protec-
tion facilitating good corporate governance. Finding that investor protec-
tion laws have no association with CEO turnover-performance sensitivity
may be explained by several factors. For example: (1) extensive investor
protection laws may not be as effective as strong law enforcement in foster-
ing good governance, (2) the set of investor protection laws we examine
may not be the set that are most critical in fostering good governance, or
(3) measurement error in our surrogate for extensive investor protection
laws may reduce the power of our test of this variable.
We test our second hypothesis by including an interactive dummy term
for high stock price informativeness in the regression used to test our first
hypothesis. We capture stock price informativeness using a stock returns syn-
chronicity statistic that assesses how well a country’s stock prices reflect firm
performance (Morck, Yeung, and Yu [2000], Dyck and Zingales [2003]).
In addition, because our first hypothesis test finds that extensive laws do
2 As in the prior CEO turnover literature, we do not distinguish routine from nonroutine
turnovers, and we do not expect routine CEO turnovers to be related to firm performance
(i.e., Warner, Watts, and Wruck [1988], Weisbach [1988], Murphy and Zimmerman [1993],
Denis and Denis [1995], DeFond and Park [1999]).
not affect the association between CEO turnover and firm performance, we
only include the law enforcement measure to test our second hypothesis.
These tests generally support our second hypothesis. Specifically, we find
that in countries with strong law enforcement and high stock price infor-
mativeness, CEO turnover is negatively associated with firm performance
as captured by stock returns, but not with firm performance as captured
by earnings changes. Complementing these results, we also find that in
countries with strong law enforcement and low stock price informativeness,
CEO turnover is negatively associated with firm performance as captured by
earnings changes, but not with performance as captured by stock returns.
However, although our second hypothesis is robust to several sensitivity tests,
we find that it is not robust to the use of an alternative measure of stock price
informativeness.
In addition, we explore the effects of earnings informativeness by per-
forming again our second hypothesis test after including an interactive
dummy variable for tax-book conformity, where low tax-book conformity
surrogates for more informative accounting earnings (Hung [2001]). This
analysis finds that (among countries with strong law enforcement) CEO
turnover is negatively related to stock price performance when prices are
more informative and negatively related to earnings when stock prices
are less informative and earnings are more informative. However, because
the results of our second hypothesis are sensitive to our measure of stock
price informativeness, and because data restrictions significantly reduce our
sample size for this test, these results should be interpreted with caution.
Finally, we find that our hypotheses continue to be supported after the
following sensitivity tests: including year dummies; controlling for cross-
country variation in CEO turnover rates by including country dummies and
deleting countries with unusually high CEO turnover rates (≥20% over
our sample period); controlling for potential cross-sectional correlation by
applying Fama-MacBeth (1973) statistics and a robust standard error esti-
mation method that treats countries as clusters; controlling for the effects of
capital market development, legal origin, and firm size; deleting countries
with large numbers of observations and active takeover markets; excluding
firms with large blockholders; controlling for the effect of public opinion
pressure on CEO-turnover sensitivity; eliminating loss firm-years; using an al-
ternative partitioning of our law enforcement institutions measure; using an
alternative measure of law enforcement institutions; testing two alternative
explanations of what our stock price informativeness measure may capture;
using an alternative partitioning of our stock price informativeness measure;
using an alternative surrogate for stock price informativeness; restricting the
sample to industrial firms; including industry dummy variables; including
industry-adjusted performance measures; and controlling for stakeholder-
oriented countries.
Our findings contribute to the literature in several ways. First, our study
adds to La Porta et al. [1997, 2000a] by finding results that indicate strong
law enforcement institutions are more important than extensive investor
protection laws in fostering a corporate governance environment capable

of eliminating dysfunctional CEOs. Strong law enforcement environments
may be capable of unseating unfit CEOs despite limited investor protec-
tion laws because all countries have company laws that grant investors a
minimum level of protection against expropriation from insiders (La Porta
et al. [1998]). As long as countries have strong institutions that enforce these
laws, and effectively curb insiders’ expropriation of minority shareholders’
wealth, insiders are less likely to enjoy large private benefits through their
affiliation with the corporation (Dyck and Zingales [2003]). Large private
benefits accrue to insiders in countries with weak law enforcement because
the insiders (including directors and CEOs) are more likely to engage in
collusive behavior that expropriates minority shareholder wealth. Profiting
from collusion with other insiders, including the CEO, reduces directors’
incentives to dismiss poorly performing CEOs. In addition, because expro-
priation of shareholder wealth is likely to impair firm performance, the
directors themselves are likely to bear at least partial responsibility for firms
that perform poorly. Thus, in countries with weak law enforcement, CEO
turnover is less likely to be sensitive to poor performance.
Second, our results complement the recent international accounting
research that finds that the institutions determining managers’ financial
reporting incentives dominate countries’ formal accounting rules (Ball,
Robin, and Wu [2003], Francis, Khurana, and Pereira [2003]). Consistent
with this research, our findings provide some evidence that countries’ le-
gal enforcement institutions dominate the formal set of company laws that
govern investor protection. Thus, the evidence suggests that both financial
reporting and corporate governance behavior are more heavily influenced
by country-level institutional factors than by formal rules.
Third, we add to a small but growing literature that examines CEO
turnover outside of the United States. Although there is an extensive lit-
erature on CEO turnover in the United States (Warner, Watts, and Wruck
[1988], Weisbach [1988], Murphy and Zimmerman [1993], DeFond and
Park [1999], Engel, Hayes, and Wang [2002]), studies examining this issue
outside of the United States are scarce and primarily focus on one country
or a small number of similar countries.3 This literature suggests that despite
the large differences in corporate governance mechanisms across countries,
CEO turnover is generally associated with poor firm performance. We con-
tribute to this literature by analyzing a large sample of countries with varying
institutional features, specifically by addressing whether investor protection
(and its components) affect CEO turnover.
Fourth, we contribute to the literature by examining whether stock price
informativeness affects the use of performance measures in CEO turnover
3 For example, see Kaplan [1994a] for German companies, Kaplan [1994b] and Kang and
Shivdasani [1995] for Japanese companies, Dahya, McConnell, and Travlos [2002] for U.K.
companies, Volpin [2002] for Italian companies, and Gibson [2003] for the analysis of seven
emerging countries.
decisions (Morck, Yeung, and Yu [2000]). By doing so, we provide insight

into the relation between institutional factors and the role of market and
accounting information (Fan and Wong [2002], Lang, Lins, and Miller
[2002], Young and Guenther [2003]). As Bushman and Smith [2001] point
out, there is little work exploring where earnings information has relatively
more or less importance than stock returns in explaining CEO turnover. We
address this issue and add to our understanding of the role of market and ac-
counting information in corporate governance across different institutional
settings.
Finally, our findings have implications for the recent and growing debate
regarding the convergence of international corporate governance systems
toward a best-practices set of governance rules.4 One finding in this litera-
ture is that although there is some evidence of convergence toward countries
adopting a common set of what are considered to be the best governance
practices, there is little evidence that these standards are actually being im-
plemented (Khanna, Kogan, and Palepu [2002]). Complementing this lit-
erature, our findings suggest that (at least with respect to the CEO-turnover
decision), the specific governance rules per se may not be of primary impor-
tance. Thus, a possible policy implication of our findings is that international
regulators who wish to improve corporate governance may find it more ben-
eficial to expend resources on strengthening law enforcement institutions
rather than on adopting additional laws.
We also acknowledge that our investigation is subject to several potential
limitations. First, by using stock returns and earnings to assess CEO per-
formance, we implicitly assume the objective function of our sample firms
is shareholder maximization. Stock returns and accounting earnings, how-
ever, are likely to be inferior measures of CEO performance in stakeholder-
oriented economies where firms’ objective functions explicitly include
maximizing the interests of constituents such as banks and labor unions.
For example, labor unions are likely to evaluate CEOs using metrics that
correlate with high employment levels.
Although using returns and earnings to capture performance biases
against finding support for our hypotheses in stakeholder economies,
we note that our hypotheses are supported in many of the stakeholder
economies we analyze, such as Japan and Germany. Kaplan [1994a, b] and
Kang and Shivdasani [1995] also find that CEO turnover is associated with
stock returns in Japan and Germany, suggesting that stock returns are either
correlated with performance measures that capture stakeholders’ interests
or that stakeholders also evaluate CEOs on stock price performance because
poor returns can lead to other unfavorable outcomes (such as financial dis-
tress) that harm stakeholders as well as shareholders. In addition, we report
sensitivity tests that find that our results are not explained by partitioning
4 For example, see Shleifer and Vishny [1997], DeJong et al. [2001], Hansmann and
Kraakman [2001], Liu [2001], Dahya and McConnell [2002], Dahya, McConnell, and
Travlos [2002], and Khanna, Kogan, and Palepu [2002].
our sample on variables that measure the extent to which an economy is

stakeholder oriented. However, because the variables in our analysis are
measured with error, and because small sample sizes limit the power of our
tests, we cannot completely rule out the possibility that our results are at
least partially explained by countries that evaluate CEO performance using
metrics other than stock returns and accounting earnings.
A second limitation of our study is that we cannot completely control for
the numerous environmental factors that are likely to affect the optimal
CEO turnover-performance sensitivity in each country. These factors in-
clude cross-country differences in the CEO’s ability to affect performance,
the CEO’s risk aversion, and the extent to which stronger CEO turnover-
performance sensitivities are likely to affect the CEO’s actions. For example,
CEOs have limited ability to affect firm performance when the firm is a state-
owned enterprise or a state-controlled bank, or when there is a high risk of
government expropriation, corruption, or weak law enforcement. Similarly,
firms are likely to use a variety of selection techniques to hire the optimal
CEO, and routine CEO retirement ages are likely to vary across countries.
Although these (and other) country-specific variables may affect our anal-
ysis, our sensitivity tests suggest that our findings are robust to many of these
factors. For example, we find that our results hold after dropping firms with
blockholders that have direct ownership greater than 20% (which excludes
the effects of state-owned enterprises); restricting our analysis to industrial
firms (which removes the effects of state-controlled banks); and including
variables such as legal origin, stakeholder orientation, and country-specific
dummies (which may be correlated with differences in CEO risk aversion,
selection criteria, and routine retirement ages). However, because we are
unable to rule out all cross-country differences that may influence our find-
ings, we acknowledge that our results should be interpreted as suggestive
(Bushman and Smith [2001]).
2. Hypotheses Development
2.1 INVESTOR PROTECTION AND CEO TURNOVER
Recent research argues that strong investor protection is the most impor-
tant element in fostering capital markets with good corporate governance
(La Porta et al. [1997, 1998, 2000a]), where corporate governance is de-
fined as the set of mechanisms designed to protect minority shareholders
from expropriation by insiders (La Porta et al. [2000a]).5 These studies ar-
gue that strong investor protection deters managers from opportunistic and
inefficient behavior and thereby increases investors’ willingness to partici-
pate in the capital markets (La Porta et al. [2000a]). For example, La Porta
5 However, acknowledging the importance of legal institutions that efficiently enforce con-
tracts is not new to the literature. For example, the Coase [1960] theorem relies on the en-
forceability of private contracts.
et al. [1997] find that both extensive investor protection laws and strong
law enforcement institutions are associated with valuable capital markets,
large numbers of listed securities per capita, and a high rate of initial public
offering (IPO) activity. They conclude that this link between strong share-
holder protection and well-developed capital markets is driven by strong
investor protection’s creating an environment that fosters good corporate
governance. Because good corporate governance reduces the risk of man-
agers expropriating shareholder wealth (through theft, shirking, or simple
mismanagement), shareholders have greater confidence investing in such
markets.
However, the evidence in prior studies such as La Port et al. [1997] pro-
vides only indirect evidence that shareholder protection encourages good
corporate governance. Therefore, we examine a more direct characteristic
of economies with good corporate governance: the propensity to eliminate
poorly performing CEOs. That is, if strong shareholder protection promotes
good corporate governance, we expect to observe outcomes that are consis-
tent with good corporate governance in countries with strong shareholder
protection.
We examine CEO turnover because prior corporate governance research
emphasizes that a critical element of effective corporate governance mech-
anisms is their ability to identify and terminate poorly performing exec-
utives (Kaplan [1994b], Coffee [1999], Murphy [1999], Volpin [2002]).6
For example, Gibson [2003] asserts that a primary purpose of corporate
governance mechanisms is to ensure that poorly performing managers are
replaced, and Macey [1997] states that a necessary condition for effec-
tive corporate governance systems is the elimination of poorly performing
managers. The importance of replacing unfit CEOs is also consistent with
Shleifer and Vishny [1989, 1997], who speculate that the most important
form of managers’ expropriating shareholders’ wealth may be managers
staying on the job when they are no longer qualified, and with Jensen and
Ruback [1983], who argue that poorly performing managers who resist be-
ing replaced might be the costliest manifestation of the agency problem.
Following the prior literature, we expect a greater tendency to shed poorly
performing CEOs in countries with strong shareholder protection. In con-
trast, we expect a greater propensity to retain poorly performing CEOs and
terminate CEOs for reasons unrelated to performance in countries with
weak shareholder protection. For example, the Straits Times recently re-
ported that the CEO of a Thailand steel company “retired to make way for
the ‘new generation,’ who just happens to be the son of the parent com-
pany’s CEO” (W. Thongrung, “Steel Industry: Win a Step Closer,” The Nation,
6 Volpin [2002] observes that the prior literature takes two empirical approaches to evaluat-
ing the effectiveness of corporate governance. One is to test whether CEO turnover is associated
with poor performance (Kaplan [1994a], Coffee [1999]), and the other is to analyze relative
firm value (Morck, Shleifer, and Vishny [1988], McConnell and Servaes [1990]).
May 29, 2002), suggesting that nepotism, rather than performance, explains
this CEO turnover.
More specifically, we expect strong shareholder protection to facilitate
identifying and eliminating unfit CEOs in one or both of two ways. First,
as suggested in La Porta et al. [1997], we expect extensive shareholder
protection laws to make it easier for minority shareholders to protest man-
agement actions that destroy shareholder value. For example, La Porta et al.
define shareholder protection laws (which they term anti-director rights) as
including shareholders’ rights to call extraordinary shareholder meetings
and legal guarantees of a judicial venue for shareholders to challenge man-
agement decisions—all mechanisms for protecting minority shareholders’
rights. Although anecdotally we observe that minority shareholder voter
turnout tends to be low, simply the potential for shareholders to oust di-
rectors may provide an incentive for directors to act in the shareholders’
interests. In addition, because extensive shareholder protection laws give
shareholders greater recourse in court, the threat of litigation may also in-
duce directors to terminate poorly performing CEOs.
Second, we expect strong law enforcement institutions to facilitate removing
incompetent CEOs by reducing the private benefits insiders receive because
of their affiliation with the corporation (Dyck and Zingales [2003]).7 To un-
derstand this causal relation, consider directors’ incentives in countries with
weak law enforcement. A distinguishing feature of such countries is that the
managers and directors (collectively known as insiders) receive large per-
sonal benefits from their controlling positions through various forms of
self-dealing, such as additional stock issuance to the insiders and sophisti-
cated transfer pricing schemes (Shleifer and Vishny [1997]). For example,
in some countries it is common for corporations to routinely sell assets to
insider-controlled companies at below-market prices and for corporations
to purchase assets from insider-controlled vendors at above-market prices.
Thus, directors in these countries frequently profit from their affiliation
with the firm through activities that involve colluding with other insiders,
including the CEO. Obviously, this reduces directors’ incentives to dismiss
poorly performing CEOs. Furthermore, because self-dealing is not consis-
tent with profit maximization, the directors themselves are likely to bear
at least partial responsibility for firms with poor earnings and stock price
performance. As a result, we expect that CEO turnover is less likely to be
sensitive to poor firm performance in countries with weak law enforcement.
Consequently, our first hypothesis is (in alternative form):
H1: CEO turnover is more likely to be associated with poor firm per-
formance in countries with stronger investor protection (i.e., those
with extensive investor protection laws or strong law enforcement).
7 Dyck and Zingales [2003] refer to this as the “private benefits of control.”
Because La Porta et al. [1997] conclude that both extensive investor pro-
tection laws and strong law enforcement institutions are important deter-
minants of good corporate governance, we test our first hypothesis using
measures that individually capture each of these characteristics. In addi-
tion, we design our tests to capture any potential interaction effects between
our investor protection measures (Kothari [2000], Bhattacharya and Daouk
[2002]).
2.2INVESTOR PROTECTION, CEO TURNOVER,

AND PERFORMANCE MEASURES
In countries where firms’ corporate governance mechanisms are capa-
ble of terminating poorly performing CEOs, we also predict that the met-
rics used to assess firm performance in CEO turnover decisions vary across
countries as a function of how well stock prices reflect firm performance.
Multiple-performance-measure agency models predict that optimal con-
tracts should rely more on performance metrics that are relatively more
precise (Holmstrom and Milgrom [1991]). Although several prior stud-
ies test this prediction in the context of executive compensation, few ex-
amine this issue in the context of CEO turnover decisions (Engel, Hayes,
and Wang [2002]). Furthermore, the U.S. and international evidence on
the relative importance of stock returns versus accounting earnings in
explaining CEO turnover is generally inconclusive (Bushman and Smith
[2001]). For example, Weisbach [1988] finds that earnings changes are
more important than stock returns in explaining CEO turnover, whereas
Kaplan [1994b] finds that stock returns are more important than earnings
changes.
Based on the implication of multiple-performance-measure agency mod-
els, we predict that, among countries with strong investor protection, CEO
turnover decisions are likely to rely more on stock returns when stock prices
are relatively more informative regarding firm performance. Recent re-
search finds that stock prices in many countries provide little information
about firm performance, suggesting that stock returns in many countries are
noisy measures of management performance (Morck, Yeung, and Yu [2000],
Wurgler [2000]). Thus, we expect that in countries with governance mech-
anisms capable of terminating poorly performing CEOs, companies are less
likely to use stock returns to evaluate CEO performance if stock prices are
less informative (Lambert and Larcker [1987]). Consequently, our second
hypothesis is (in alternative form):
H2: In countries with strong investor protection (i.e., those with gov-
ernance mechanisms capable of terminating poorly performing
CEOs), CEO turnover is more likely to be related to poor stock
returns when stock prices are relatively more informative.
3. Research Design
We test our first hypothesis—that CEO turnover is more likely to be
associated with poor firm performance in countries with strong investor
protection—by examining the effects of our investor protection measures
both alone and in combination with each other, using logit models of the
following form:
Turnover = α0 + β1,n (Firm performance measures)
+ γ1,n (Investor protection measures)
+ δ1,n (Firm performance measures ∗ Investor protection measures) + ε.
(1)
Following prior research, we measure CEO turnover as a binary dummy
variable and firm performance as lagged stock returns and lagged earn-
ings changes (Weisbach [1988], Murphy and Zimmerman [1993], Volpin
[2002]). As previously noted, we measure investor protection as the extent
of a country’s investor protection laws and the strength of its law enforce-
ment institutions. We measure the extent of a country’s investor protection
laws using the anti-director rights index developed in La Porta et al. [1997].
La Porta et al. construct the index based on a set of corporate governance
attributes that attempt to capture the essential elements of minority share-
holder rights (American Bar Association [1989, 1993], Investor Responsi-
bility Research Center [1994, 1995], Vishny [1994]). Specifically, the index
measures whether the country’s company law or commercial code explicitly
allows: (1) investors to vote by mail, (2) investors to keep control of their
shares during the annual shareholders’ meeting, (3) investors to vote for
directors cumulatively, (4) investors to easily call an extraordinary share-
holders’ meeting, and (5) minority investors a judicial venue to challenge
management decisions. As in La Porta et al. [2000b], each item is coded 1
or 0, with higher index values equal to more extensive investor protection
laws, and we classify countries that fall above the median value of the index
as having extensive laws.
Following Leuz, Nanda, and Wysocki [2003], we measure the strength
of a country’s law enforcement institutions using the mean score of three
law enforcement variables identified in La Porta et al. [1998]. The three
variables are based on assessments from risk rating agencies (Business In-
ternational Corp. or International Country Risk) that attempt to capture:
(1) the efficiency and integrity of the country’s judicial system; (2) the tra-
dition of law and order in the country; and (3) the degree of government
corruption, indicating whether high-level officials are likely to demand spe-
cial payments and whether low-level officials generally expect illegal pay-
ments (in the form of bribes). The index ranges from 0 to 10, with higher
scores representing stronger law enforcement institutions, and we classify
countries that fall above the median as having strong law enforcement
institutions.
We test our second hypothesis with a measure used in the prior liter-
ature to capture the extent to which stock prices are likely to impound
information about firm performance (as opposed to noise) (Morck, Yeung,
and Yu [2000], Wurgler [2000], Dyck and Zingales [2003]). Specifically, we
use the index constructed by Morck, Yeung, and Yu [2000] that measures
the propensity for stock prices in a country to move in the same direction—
termed synchronicity. After testing several alternative explanations, Morck,
Yeung, and Yu conclude that a primary factor explaining high stock price
synchronicity in poor economies is the lack of informed traders in countries
with poor property rights protection because risk arbitrageurs find it more
costly to keep their profits in such economies. They observe that this expla-
nation is consistent with theoretical work by De Long et al. [1989, 1990], who
argue that stock markets dominated by noise traders are characterized by
large synchronous price swings that are unrelated to economic fundamen-
tals. Thus, Morck, Yeung, and Yu conclude that stock returns reflect more
information about firm performance when synchronicity is low and reflect
less information about firm performance (and therefore are noisier) when
synchronicity is high. For purposes of our tests, we classify a country as hav-
ing high stock price informativeness if its stock price synchronicity measure
is lower than or equal to the median score among our sample countries.
4. Sample Selection and Descriptive Statistics

4.1 SAMPLE SELECTION
We obtain our data from Worldscope, a database that contains financial
information and general profiles on publicly traded companies worldwide.
Worldscope indicates that it prioritizes inclusion of companies with high
market capitalization, and although coverage of primary stock markets in
many developed countries is nearly complete, it only includes U.S. firms
that belong to the S&P 500 index (Leuz, Nanda, and Wysocki [2003]).
Using the June edition of Worldscope CD-ROMs from 1996 to 2002, we
compile annual data on company officers and financial performance (stock
returns and changes in earnings) for the fiscal years 1997 to 2001. Our
initial sample consists of countries with at least 100 companies in the last
year of the Worldscope database and with necessary data to compute each of
the country-level variables in our analysis. We exclude firm-year observations
with unidentifiable CEOs or with missing data on our financial performance
variables. In addition, we trim the top and bottom 1% of the sample with
respect to each performance variable. These restrictions result in a total
sample of 21,483 firm-year observations in 33 countries.
Because top executive titles vary both across countries and within coun-
tries, we identify CEOs using the following procedures: First, we iden-
tify whether companies have executives with the title chief executive officer,
chief executive, or CEO.8 Second, for companies without officers with the
8 We exclude titles with deputy, vice, or assistant in them. For example, we exclude the title
deputy chief executive in identifying the top executive officer.

preceding titles, we search prior studies and the business press to identify
the most common title for CEOs in each country. Third, if we cannot find
the most common title for the CEO in a country from other data sources,
we examine the title of each company’s officer listed in Worldscope and
infer the title of the top executive. We do not include the title chairman
because it is unclear whether the person with that title has management
power, unless it is chairman, board of management for countries with a two-tier
board structure such as Austria, Germany, and the Netherlands (Gregory
and Simmelkjaer [2002]).9 Table 1 presents the titles used to identify CEOs
in each of our sample countries based on the preceding procedure. For ex-
ample, we identify the CEO as the person with the title chief executive officer,
CEO, chief executive, or president for Japanese companies. We note that our
procedure results in data omission for companies that do not use the titles
reported in table 1 for their CEOs. However, we do not expect this to bias
our results.10
After identifying each company’s CEO, we classify a firm-year as a turnover
year if the name of the CEO changes between successive fiscal years. For
example, if the CEO in 1996 is Smith and the CEO in 1997 is Jones, we classify
1997 as the turnover year.11 When there is a team of executives sharing the
same titles for CEO, we code a firm-year as a turnover year only if there is
a change in the entire executive team (Volpin [2002]). Panel A of table 2
discloses the number of observations in our sample and the number and
proportion of observations with CEO turnover in each of the 33 countries
we analyze.12 This panel shows that the proportion of CEO turnover ranges
9 For example, in Sweden, the chairman of the unitary board is a nonexecutive director by
law (see Gregory and Simmelkjaer [2002, p. 58]).
10 It is possible that investor protection laws and law enforcement institutions are correlated
with companies’ propensity to disclose the CEO’s identity and, hence, our ability to identify
CEO turnovers. To explore this possibility, we calculate the relative frequency of cases of missing
CEO identity for each country in our analysis. We find that the correlation coefficients between
this variable and our variables capturing investor protection laws and law enforcement are
−0.09 and −0.17, respectively. Thus, systematic failure to disclose the CEOs identity is not
likely to confound our analysis.
11 Given our large sample size, we generally compare the last name of the CEOs to reduce
the cost of data collection. We pay special attention to differentiate names with suffix such as II
or Jr. In addition, we make an effort to resolve two issues regarding the Worldscope database.
First, Worldscope is not consistent with the placement of family names for countries such as
Taiwan and Korea, in which the sequence of first name and last name differs from the Western
convention. For these countries, we manually check all turnover years in the sample to ensure
that we properly identify the family name. Second, there appear to be data errors caused by
“unfamiliar” foreign names in countries such as Thailand and Japan. For these countries, we
manually check all turnover years in the final sample, and if the last names in two consecutive
years differ just by one letter and the first names are the same, we treat both names as the
same.
12 Table 2 shows that there are fewer U.S. firms than Japanese and U.K. firms. This is because
the Worldscope database includes only U.S. firms belonging to the S&P 500 index (Leuz,
Nanda, and Wysocki [2003]). Thus, we report a sensitivity test excluding the U.S. firms in a
later section.
TABLE 1
Title Used to Identify the CEO in Each Country, in Addition to Chief Executive Officer, Chief Executive,
and CEO a
Country Management Titleb

Australia Managing Director
Austria Chairman, Board of Management
Belgium Managing Director
Brazil President
Canada None
Chile General Manager
Denmark Managing Director
Finland Managing Director
France None
Germany Chairman, Board of Management
Greece Managing Director
Hong Kong Managing Director
India Managing Director
Indonesia President Director
Italy Managing Director
Japan President
Korea President
Malaysia Managing Director
Mexico President
Netherlands Chairman, Board of Management
Norway President
Pakistan Managing Director
Philippines President
Portugal President
Singapore Managing Director
South Africa Managing Director
Spain Managing Director
Sweden Managing Director
Taiwan President
Thailand President
Turkey General Manager
United Kingdom Managing Director
United States None
a
We exclude the titles with deputy, vice, or assistant in them. For example, we exclude titles such as deputy
chief executive and vice president in identifying the top executive officer.
b
Source: Austria, Germany, and Netherlands (Gregory and Simmelkjaer [2002]); Brazil, Chile,
India, and Korea (Gibson [2003]); Indonesia (National Committee on Good Corporate Governance
[2000]); Japan (Kang and Shivdasani [1995]); United Kingdom (Hoover’s Handbook of World Business [1997]).
from 4% in Portugal to 28% in Korea, with the average being 15%.13 Panel
B of table 2 reports the number and proportion of observations with CEO
turnover in total and by year over the period we analyze. The panel indicates
that the proportions of CEO turnover remain fairly constant across the years,
ranging from 14% to 16%.
13 We note that the proportion of CEO turnovers in Brazil and Portugal is around 5%, much
lower than the average. Although we do not expect the mean proportion of CEO turnover
to affect the sensitivity of CEO turnover to firm performance, we repeat our analyses after
dropping firms in these two countries. We find that the results of our hypotheses tests are
invariant to excluding these two countries.
TABLE 2
Frequency of CEO Turnover in Each Country
Number of Number of CEO Proportion of CEO

Country Observations Turnovers Turnovers
Panel A: By country
Australia 540 88 16%
Austria 98 15 15%
Belgium 174 21 12%
Brazil 19 1 5%
Canada 643 87 14%
Chile 144 30 21%
Denmark 288 46 16%
Finland 163 17 10%
France 624 75 12%
Germany 398 75 19%
Greece 135 19 14%
Hong Kong 524 56 11%
India 618 78 13%
Indonesia 195 31 16%
Italy 351 45 13%
Japan 8,542 1,206 14%
Korea 355 101 28%
Malaysia 631 105 17%
Mexico 106 11 10%
Netherlands 148 25 17%
Norway 82 14 17%
Pakistan 121 28 23%
Philippines 144 27 19%
Portugal 27 1 4%
Singapore 320 43 13%
South Africa 299 49 16%
Spain 179 26 15%
Sweden 204 41 20%
Taiwan 387 58 15%
Thailand 229 28 12%
Turkey 43 8 19%
United Kingdom 2,962 480 16%
United States 1,790 244 14%
Total 21,483 3,179 15%
Panel B: By year
1997 5,472 771 14%
1998 5,242 848 16%
1999 5,286 739 14%
2000 3,573 525 15%
2001 1,910 296 15%
Total 21,483 3,179 15%
4.2 DATA AND DESCRIPTIVE STATISTICS

Panel A of table 3 reports the values of the country-level variables and
the mean, median, and standard deviation for each variable. This panel
shows that, for example, the United Kingdom and United States have ex-
tensive investor protection laws, strong law enforcement institutions (i.e.,
TABLE 3
Descriptive Statistics
Panel A: Data and descriptive statistics for country-level variables (N = 33 countries)
Investor Protection Law Enforcement Stock Price
Country Laws Institutions Informativeness
Australia 4 9.5 61.4
Austria 2 9.4 66.2
Belgium 0 9.4 65.0
Brazil 3 6.1 64.7
Canada 4 9.8 58.3
Chile 3 6.5 66.9
Denmark 3 10.0 63.1
Finland 2 10.0 68.9
France 2 8.7 59.2
Germany 1 9.1 61.1
Greece 1 6.8 69.7
Hong Kong 4 8.9 67.8
India 2 5.6 69.5
Indonesia 2 2.9 67.1
Italy 0 7.1 66.6
Japan 2 9.2 66.6
Korea 1 5.6 70.3
Malaysia 3 7.7 75.4
Mexico 0 5.4 71.2
Netherlands 2 10.0 64.7
Norway 3 10.0 66.6
Pakistan 4 3.7 66.1
Philippines 4 3.5 68.8
Portugal 2 7.2 61.2
Singapore 3 8.9 69.7
South Africa 4 6.4 67.2
Spain 2 7.1 67.0
Sweden 2 10.0 66.1
Taiwan 3 7.4 76.3
Thailand 3 4.9 67.4
Turkey 2 4.8 74.4
United Kingdom 4 9.2 63.1
United States 5 9.5 57.9
Mean 2.48 7.58 66.53
Standard deviation 1.28 2.15 4.43
Q1 2.00 6.13 64.70
Median 2.00 7.72 66.60
Q3 3.00 9.44 68.90
higher than the median scores of the respective indexes), and high stock
price informativeness (i.e., lower than or equal to the median score of the
corresponding index), whereas Greece and Korea have limited investor
protection laws, weak law enforcement institutions, and low stock price
informativeness.
Panel B of table 3 presents descriptive statistics for our two firm-level per-
formance variables, partitioned on whether a CEO turnover occurs in the
T A B L E 3 — Continued
Panel B: Descriptive statistics for firm-level variables (N = 21,483 firm-years)
Standard t-test p-value,
Variable N Mean Deviation Q1 Median Q3 Wilcoxon p-value
RET t −1
Turnover 3,179 −0.063 0.375 −0.292 −0.100 0.102 <0.01
No turnover 18,304 −0.032 0.368 −0.256 −0.068 0.133 <0.01
E t −1
Turnover 3,179 0.001 0.065 −0.018 0.001 0.022 0.01
No turnover 18,304 0.005 0.059 −0.013 0.002 0.022 <0.01
Investor protection laws is an index based on the extent of the laws that protect investors, as used in
La Porta et al. [1997]. This index ranges from 0 to 5 and aggregates the following components of investor
rights: (1) ability to vote by mail, (2) ability to gain control of shares during the investors’ meeting, (3)
possibility of cumulative voting for directors, (4) ease of calling an extraordinary investors meeting, and
(5) availability of mechanisms allowing minority investors to make legal claims against the directors. Law
enforcement institutions is an index based on the mean score of three legal enforcement variables reported in
La Porta et al. [1998] and used in Leuz, Nanda, and Wysocki [2003]. The three variables are (1) efficiency
of the judicial system, which assesses the efficiency and integrity of the legal environment; (2) rule of law,
which assesses the rule and order tradition in a country; and (3) corruption, which assesses the corruption
in government. The index ranges from 0 to 10, with higher scores for greater law enforcement. Stock price
informativeness is percentage of stocks moving in step, from Morck, Yeung, and Yu [2000]. The index measures
the extent that stock prices move in the same direction in a country, with higher scores for lower stock price
informativeness. Turnover is a dummy variable equal to 1 if the name of the CEO changes in year t, and 0
otherwise. RET t−1 is market-adjusted stock returns over the fiscal year before the top executive turnover. The
measure equals a firm’s total investment returns minus the average total investment returns for all firms in
the country.
E t−1 is change in earnings divided by beginning-of-year total assets over the fiscal year before
the top executive turnover. Earnings are measured as earnings before interest and taxes (EBIT).
firm-year. We measure the two firm performance variables over the year
before the CEO change as follows: (1) market-adjusted returns (RET t −1 )
equal the total investment return minus the average total investment return
for all firms in the country, and (2) the changes in earnings (
E t −1 ) equal
the changes in earnings before interest and taxes (EBIT) scaled by total as-
sets at the beginning of the year.14 The far right column in panel B presents
univariate tests with p-values for t-tests and Wilcoxon two-sample tests com-
paring the central tendencies of the firm-years with and without turnover.
All differences across the groups are significant at p < 1% (two-tailed). The
results suggest that, when compared with firm-years without CEO turnover,
those with turnover have poorer returns and earnings before the departure
of the CEO.
Table 4 presents Pearson correlation coefficients for the variables used in
our analysis. Panel A reports the correlation among country-level variables
and reveals a positive association between strong law enforcement and high
stock price informativeness. This is consistent with the idea that strong law
enforcement encourages informed arbitrage, which in turn causes prices to
better reflect firm performance (Morck, Yeung, and Yu [2000]). Panel B
reports the correlation among firm-specific variables. As expected, it
14 Following prior U.S. and international studies, we use EBIT to measure earnings because
it prevents changes in capital structures or tax treatment from obscuring the performance
measure (Weisbach [1988], Volpin [2002], Gibson [2003]).
TABLE 4
Pearson Correlation Coefficients
Panel A: Correlation coefficients among country-level variables (N = 33 countries)
Strong Law Enforcement High Stock Price
Institutions Informativeness
Extensive investor protection laws 0.03 −0.03
Two-tailed p-values 0.87 0.87
Strong law enforcement institutions 0.58
Two-tailed p-values <0.01
Panel B: Correlation coefficients among firm-level variables (N = 21,483 firms-years)

E t−1 Turnover
RET t−1 0.24 −0.03
Two-tailed p-values <0.01 <0.01
E t−1 −0.02
Two-tailed p-values <0.01
Extensive investor protection laws is a dummy variable equal to 1 if a country’s investor protection laws
index is above the median, and 0 otherwise. Strong law enforcement institutions is a dummy variable equal to
1 if a country’s law enforcement institution index is above the median, and 0 otherwise. High stock price
informativeness is a dummy variable equal to 0 if a country’s stock price informativeness index is above the
median, and 1 otherwise. See table 3 for other variable definitions.
shows a positive association between the two performance measures (stock

returns and the change in earnings) and a negative association between
CEO turnover and the performance measures.
5. Hypotheses Tests
5.1 INVESTOR PROTECTION AND CEO TURNOVER
Table 5 presents a series of logistic regressions that test our first hypoth-
esis. Panel A reports the coefficients from four logistic regression models,
with the dependent variable equal to 1 for CEO turnover observations (and
0 otherwise), and independent variables consisting of our two firm perfor-
mance measures (RET t −1 and
E t −1 ), interacted with various combinations
of our investor protection measures (extensive investor protection laws and
strong law enforcement institutions). Model 1 in panel A is a benchmark
regression of CEO turnover regressed on returns and earnings. This regres-
sion is significant at p < 1% and indicates that CEO turnover is negatively
related to both of our performance measures (the coefficient on lagged
stock returns is significant at p < 1%, two-tailed, and the coefficient on
lagged change in earnings is significant at p < 10%, two-tailed). Thus, we
find that, on average, CEO turnover is negatively related to performance
across our entire sample.
Models 2 through 4 are also significant at p < 1% and include terms
that interact firm performance with our investor protection measures. The
interaction terms in these three regressions allow us to test whether the in-
vestor protection measures are important in CEO-turnover decisions both
TABLE 5
Logistic Regression of CEO Turnover on Firm Performance Measures and Investor Protection Components (N = 21,483 Observations, Including 3,179 with CEO Turnover)
Panel A: Logit regression for the entire sample (dependent variable = Turnover)
Model 1 Model 2 Model 3 Model 4
Two-Tailed Two-Tailed Two-Tailed Two-Tailed

Coeff. p-values Coeff. p-values Coeff. p-values Coeff. p-values
Intercept 0.15 <0.01 −1.78 <0.01 −1.64 <0.01 −1.66 <0.01
Extensive laws 0.05 0.18 0.03 0.73
Strong enforcement −0.15 <0.01 −0.15 0.03
Extensive laws ∗ Strong enforcement 0.02 0.87
RET t−1 −0.03 <0.01 −0.21 0.01 −0.05 0.62 0.05 0.74
E t−1 −0.07 0.08 −0.09 0.87 −1.05 0.10 −0.71 0.46

RET t−1 ∗ Extensive laws −0.02 0.87 −0.19 0.35
RET t−1 ∗ Strong enforcement −0.24 0.05 −0.37 0.04
RET t−1 ∗ Extensive laws ∗ Strong enforcement 0.25 0.30
E t−1 ∗ Extensive laws −0.77 0.26 −0.53 0.68
E t−1 ∗ Strong enforcement 0.65 0.38 0.87 0.46
E t−1 ∗ Extensive laws ∗ Strong enforcement −0.33 0.83

Significance of model, p-value 0.01 0.01 0.01 0.01
INVESTOR PROTECTION
287
288
Panel B: Coefficients from panel A partitioned by Investor protection laws and Law enforcement institutions
Law Enforcement Institutions
Investor Protection Laws Variable Weak Strong Row Totals

(i) (ii)
Limited RET t−1 0.05 −0.32∗∗∗ −0.21∗∗∗

E t−1 −0.71 0.16 −0.09
(iii) (iv)
Extensive RET t−1 −0.14 −0.26∗∗∗ −0.23∗∗∗

E t−1 −1.24 −0.70 −0.86∗∗
Column totals
M. L. DEFOND AND M. HUNG
RET t−1 −0.05 −0.29∗∗∗ −0.03∗∗∗

E t−1 −1.05 −0.40 −0.07∗
Panel C: Countries in each panel B partition

Investor Protection Laws Weak Strong

(i) (ii)
Limited Greece, India, Indonesia, Italy, Korea, Mexico, Portugal, Austria, Belgium, Finland, France, Germany, Japan,
Spain, Turkey (N = 2,009) Netherlands, Sweden (N = 10,351)
Extensive (iii) (iv)
Brazil, Chile, Malaysia, Pakistan, Philippines, South Africa, Australia, Canada, Denmark, Hong Kong, Norway,
Taiwan, Thailand (N = 1,974) Singapore, U.K., U.S. (N = 7,149)
See tables 3 and 4 for variable definitions. ∗∗∗ p < 1% (two-tailed); ∗∗ p < 5% (two-tailed); ∗ p < 10% (two-tailed).
alone (models 2 and 3) and in combination with one another (model 4).15
However, to examine these relations we must first combine some of the
coefficients in panel A and test the significance of the aggregated coeffi-
cients. Therefore, for ease of exposition, panel B reports the reconstructed
coefficients and the significance levels on RET t −1 and
E t −1 (using Wald
chi-square tests) in a two-by-two analysis. The columns of panel B partition
the data by the strength of the law enforcement institutions and the rows
partition the data by the extent of the investor protection laws. The grand
totals (the intersection of the row and column totals) are constructed from
model 1 of panel A, the row totals are constructed from model 2, the column
totals are constructed from model 3, and the individual cells (i) through (iv)
are constructed from model 4.16 In addition, panel C lists the countries that
fall into each cell of panel B.
The reconstructed coefficients in panel B provide little support for our
hypothesis with respect to extensive investor protection laws but relatively
strong support for our hypothesis with respect to strong law enforcement in-
stitutions. Specifically, the row totals show that the association between CEO
turnover and our lagged performance measures is significant and negative
in both rows. However, the differences between the coefficients on lagged
returns and lagged change in earnings across the two rows are not significant
at conventional levels. In other words, the extent of investor protection laws
does not affect the association between CEO turnover and performance. In
contrast, the column totals show that the association between CEO turnover
and lagged returns is significant and negative only in countries with strong
law enforcement institutions. Furthermore, the difference between the co-
efficients on lagged returns across the two column totals is significant at p <
5% (two-tailed). Thus, unlike investor protection laws, the strength of law
enforcement institutions can discriminate between countries where CEO
turnover is associated with poor returns and those where it is not.
An analysis of the individual cells in panel B also provides evidence that
strong law enforcement countries drive the significant and negative asso-
ciations between CEO turnover and lagged stock returns in the row totals.
15 We include the dummy variables for our investor protection measures so that the intercept
is not constrained to be the same for all firms in the sample. We note that the coefficient on the
strong law enforcement institutions dummy is significant and negative in panel A of table 5.
Although we argue that companies in countries with weak law enforcement are less likely to
terminate poorly performing CEOs, these companies can have a higher CEO turnover rate for
reasons unrelated to performance.
16 For example, the row total in panel B for lagged returns among firms with extensive in-
vestor protection laws (−0.23) equals the sum of the following two coefficients from model 2 of
panel A: the coefficient on lagged returns (−0.21) and the coefficient on lagged returns inter-
acted with extensive investor protection laws (−0.02). Similarly, cell (iv) in panel B for lagged
returns (−0.26) equals the sum of the following four coefficients from model 4 of panel A: the
coefficient on lagged returns (0.05), the coefficient on lagged returns interacted with extensive
investor protection laws (−0.19), the coefficient on lagged returns interacted with strong law
enforcement institutions (−0.37), and the coefficient on lagged returns interacted with both
extensive investor protection laws and strong law enforcement institutions (0.25).
Specifically, CEO turnover is not significantly associated with lagged returns

in countries with weak law enforcement (cells (i) and (iii)), whereas CEO
turnover is significantly and negatively associated with lagged returns in
countries with strong law enforcement (cells (ii) and (iv)) at p < 1% (two-
tailed).17 Thus, analyses of the individual cells in panel B find that CEO
turnover is only related to poor stock returns in countries with strong law
enforcement institutions. In addition, though not reported in table 5, we
find that the lagged return coefficients in cells (i) and (ii) are significantly
different from one another at p < 1% (two-tailed), whereas the lagged re-
turn coefficients in cells (iii) and (iv) are not significantly different from
one another at conventional levels. This means that although strong law
enforcement significantly improves the association between turnover and
poor returns, this improvement is concentrated among countries with lim-
ited investor protection laws.
Panel C indicates that our results are consistent with prior studies that
find an inverse relation between CEO turnover and firm performance
in Japan, Germany, the United Kingdom, and the United States (Kaplan
[1994a, 1994b], Kang and Shivdasani [1995], Dahya, McDonnell, and
Travlos [2002]). That is, we find that Japan and Germany (in cell (ii)) and the
United Kingdom and the United States (in cell (iv)) are in cells with a signifi-
cant and negative association between CEO turnover and firm performance.
In addition, the finding that CEO turnover is only negatively associated with
stock returns (and not with the earnings changes) in countries with strong
law enforcement suggests that, on average, corporate governance mecha-
nisms tend to use stock returns to assess management performance across
the set of countries we examine. (We further investigate the choice of per-
formance metric within the countries with strong shareholder protection
when we report the tests of our second hypothesis.)18
In summary, the results in table 5 suggest that strong law enforcement is
the dominant investor protection characteristic in achieving good corporate
governance with respect to identifying and terminating poorly performing
CEOs. Although strong law enforcement institutions are most effective in
17 For each cell, we also test the hypothesis that the coefficients on stock returns and earnings
changes both equal zero. The test result is insignificant at conventional levels for cells (i) and
(iii) and significant at p < 1% for cells (ii) and (iv).
18 We also replicate the analysis in table 5 after individually including stock returns and
earnings changes. Consistent with the results reported in table 5, this analysis finds that CEO
turnover is negatively associated with stock returns in countries with strong law enforcement
institutions (p < 1% for cells (ii) and (iv)), regardless of whether investor protection laws are
extensive or limited. Unlike the results in table 5, we also find that CEO turnover is negatively
associated with earnings changes in countries with extensive investor protection laws (p < 10%
for cell (iii) and p < 5% for cell (iv)), regardless of whether law enforcement institutions are
strong or weak. However, because earnings and stock returns are positively correlated (see table
4), the coefficients on earnings are likely to capture the relation between stock returns and
CEO turnover. Thus, we draw our conclusions based on the analysis in table 5 that combines
both earnings and returns in a single regression.
the presence of weak investor protection laws, there is little evidence that ex-
tensive investor protection laws are effective in facilitating the CEO turnover
decision. Good corporate governance may exist in the absence of extensive
laws because, as La Porta et al. [1998] indicate, all countries have company
laws that grant shareholders a minimum level of protection against expro-
priation by insiders. As long as such laws are enforced, insiders are less likely
to engage in collusive behavior that expropriates shareholder wealth (Dyck
and Zingales [2003]). In contrast, in countries with weak law enforcement,
insiders (including directors and CEOs) are more likely to benefit from
collusive behavior, thereby reducing directors’ incentives to dismiss unfit
CEOs.
5.2 USE OF MARKET PRICES AND ACCOUNTING MEASURES
IN CEO TURNOVER DECISIONS
Table 6 presents the results from testing our second hypothesis. Panel A
reports the coefficients from four logistic regression models that essentially
add a measure of high stock price informativeness to the regressions used
to test our first hypothesis.19 Because our first hypothesis test finds that
extensive investor protection laws do not affect the association between CEO
turnover and firm performance, we only use our law enforcement measure
to test our second hypothesis.20 Panel B of table 6 presents a two-by-two
analysis constructed from the coefficients in the regressions in panel A, with
the columns partitioning the data by the strength of the law enforcement
institutions and the rows partitioning the data by the level of stock price
informativeness. The grand totals (the intersection of the row and column
totals) in panel B are constructed from the coefficients in model 1, the row
totals are constructed from model 2, the column totals are constructed from
model 3, and the coefficients in cells (i) through (iv) are constructed from
model 4. In addition, panel C lists the countries that fall into each cell of
panel B.
Consistent with our second hypothesis, the row totals in panel B report
that CEO turnover is significantly and negatively associated with lagged stock
returns in countries with high stock price informativeness (at p < 1%, two-
tailed), but not in countries with low stock price informativeness. Comple-
menting these results, the row totals also indicate that in countries with
low stock price informativeness, CEO turnover is significantly and nega-
tively associated with the lagged change in earnings (at p < 1%, two-tailed).
Also consistent with our prediction, the individual cells in panel B indicate
that the row total results are driven by firms in countries with strong law
enforcement institutions. That is, CEO turnover is only significantly associ-
ated with lagged stock returns in countries with both strong law enforcement
19 Models 1 and 3 in table 6 are identical to models 1 and 3 in table 5 and are duplicated
here for ease of exposition.

20 Sensitivity tests find that the association between poor performance and CEO turnover
does not differ among firms in countries with limited and extensive investor protection laws,
irrespective of the informativeness of the stock market.
292
TABLE 6
Logistic Regression of CEO Turnover on Firm Performance Measures, Stock Price Informativeness, and Strength of Legal Institutions (N = 21,483 Observations, Including
3,179 with CEO Turnover)

Intercept 0.15 <0.01 −1.71 <0.01 −1.64 <0.01 −1.62 <0.01
High stock price informativeness −0.07 0.14 −0.14 0.31
Strong enforcement −0.15 <0.01 −0.47 <0.01

High stock price informativeness ∗ Strong enforcement 0.45 0.01
RET t−1 −0.03 <0.01 −0.05 0.59 −0.05 0.62 −0.08 0.43
E t−1 −0.07 0.08 −1.79 <0.01 −1.05 0.10 −0.96 0.15

RET t−1 ∗ High stock price informativeness −0.24 0.04 0.34 0.31
RET t−1 ∗ Strong enforcement −0.24 0.05 0.20 0.46
RET t−1 ∗ High stock price informativeness ∗ Strong enforcement −0.77 0.07
E t−1 ∗ High stock price informativeness 1.72 0.02 −1.17 0.64
E t−1 ∗ Strong enforcement 0.65 0.38 −5.43 <0.01
E t−1 ∗ High stock price informativeness ∗ Strong enforcement 7.55 0.01

Panel B: Coefficients from panel A partitioned by Stock price informativeness and Law enforcement institutions
Stock Price Informativeness Variable Weak Strong Row Totals
(i) (ii)
Low RET t−1 −0.08 0.11 −0.05

E t−1 −0.96 −6.38∗∗∗ −1.79∗∗∗
(iii) (iv)
High RET t−1 0.26 −0.32∗∗∗ −0.29∗∗∗

E t−1 −2.13 −0.00 −0.07
Column totals RET t−1 −0.05 −0.29∗∗∗ −0.03∗∗∗

E t−1 −1.05 −0.40 −0.07∗

Stock Price Informativeness Weak Strong

(i) (ii)
Low Chile, Greece, India, Indonesia, Korea, Malaysia, Mexico, Finland, Hong Kong, Singapore (N = 1,007)
Philippines, South Africa, Spain, Taiwan, Thailand,
Turkey (N = 3,465)
High (iii) (iv)
Brazil, Italy, Pakistan, Portugal (N = 518) Australia, Austria, Belgium, Canada, Denmark, France,
Germany, Japan, Norway, Sweden, U.K., U.S. (N = 16,493)
INVESTOR PROTECTION
293
institutions and high stock price informativeness, and is only significantly

associated with the lagged change in earnings in countries with both strong
law enforcement institutions and low stock price informativeness.
In summary, consistent with our second hypothesis, the results in table 6
find that in countries with strong investor protection, corporate governance
mechanisms that are concerned with identifying poorly performing CEOs
seem to evaluate CEO performance using stock returns when stock prices are
more informative, and using accounting earnings otherwise. Furthermore,
countries with weak investor protection show no evidence of associating
CEO turnover with firm performance, irrespective of the level of stock price
informativeness.
5.3ADDITIONAL ANALYSIS OF MARKET PRICES AND ACCOUNTING

MEASURES IN CEO TURNOVER DECISIONS
In addition to stock price informativeness, earnings informativeness also
potentially affects the performance metrics used in CEO turnover decisions.
In particular, we speculate that when stock prices are less informative, firms
are more likely to use earnings to evaluate CEO performance. However,
we note that one potential reason for low stock price informativeness is
that earnings are less informative (and hence it is more difficult for returns
to impound firm-specific information). Therefore, one reason for not sup-
porting the preceding prediction is that low stock price informativeness is
correlated with low earnings informativeness.
We explore the role of earnings informativeness by including a dummy
variable for high earnings informativeness in the regression testing our sec-
ond hypothesis. We measure earnings informativeness using the tax-book
conformity index in Hung [2001], with low tax-book conformity indicating
high earnings informativeness. A large body of research documents that
earnings are less useful in countries with high tax-book conformity because
the major goal of accounting systems in these countries is unlikely to be
decision usefulness (Ali and Hwang [2000], Hung [2001]). In addition,
conformity in these countries provides managers with the incentives to re-
port low earnings to reduce taxes (Joos and Lang [1994]). Because tax-book
conformity data on most countries with weak law enforcement institutions
are not available from prior studies (e.g., Alford et al. [1993], Hung [2001]),
we restrict this analysis to countries with strong law enforcement.
Panel A of table 7 reports the results of four logistic regression models
in which we replace strong law enforcement institutions with high earn-
ings informativeness in the regression we use to test our second hypothesis.
Similar to the analysis in tables 5 and 6, panel B reports the reconstructed
coefficients on stock returns and changes in earnings from the regression
coefficients in panel A in a two-by-two analysis, with the columns partition-
ing the sample by earnings informativeness and the rows partitioning the
data by stock price informativeness. Panel C lists the countries that fall into
each cell of panel B.
TABLE 7
Logistic Regression of CEO Turnover on Firm Performance Measures, Stock Price Informativeness, and Earnings Informativeness for Countries with Strong Law Enforcement
Institutions (N = 17,500 Observations, Including 2,533 with CEO Turnover)a

Intercept −1.79 <0.01 −2.10 <0.01 −1.81 <0.01 −2.16 <0.01
High stock price informativeness 0.32 <0.01 0.36 0.19
High earnings informativeness 0.05 0.23 0.08 0.79
High stock price inform. ∗ High earnings inform. −0.01 0.98
RET t−1 −0.29 <0.01 0.11 0.65 −0.31 <0.01 −0.18 0.78
E t−1 −0.40 0.30 −6.38 <0.01 −0.17 0.81 −6.36 0.26

RET t−1 ∗ High stock price informativeness −0.43 0.09 −0.14 0.83
RET t−1 ∗ High earnings informativeness 0.04 0.75 0.35 0.62
RET t−1 ∗ High stock price inform. ∗ High earnings inform. −0.34 0.63
E t−1 ∗ High stock price informativeness 6.38 <0.01 6.33 0.26
E t−1 ∗ High earnings informativeness −0.40 0.64 −0.02 1.00
E t−1 ∗ High stock price inform. ∗ High earnings inform. −0.05 0.99
INVESTOR PROTECTION
295
296
Panel B: Coefficients from panel A partitioned by Stock price informativeness and Earnings informativeness
Earnings Informativeness
Stock Price Informativeness Low High Row Totals

(i) (ii)
Low RET t−1 −0.18 0.17 0.11

E t−1 −6.36 −6.38∗∗∗ −6.38∗∗∗
(iii) (iv)
High RET t−1 −0.32∗∗∗ 0.31∗∗∗ −0.32∗∗∗

E t−1 −0.03 −0.10 0.00
RET t−1 −0.31∗∗∗ −0.27∗∗∗ −0.29∗∗∗

Column totals
E t−1 −0.17 −0.57 −0.40

Earnings Informativeness
Stock Price Informativeness Low High

(i) (ii)
Low Finland (N = 163) Hong Kong, Singapore (N = 844)
(iii) (iv)
High Belgium, France, Germany, Japan, Sweden (N = 9,942) Australia, Austria, Canada, Denmark, Netherlands,
Norway, U.K., U.S. (N = 6,551)
a
Earnings informativeness is low for countries with a strong link between tax accounting and financial reporting, and high otherwise (Hung [2001]).
The row totals in panel B report that the coefficient on lagged stock re-
turns is significant and negative when stock price informativeness is high
and that the coefficient on the lagged change in earnings is significant and
negative when stock price informativeness is low. The column totals indicate
that the coefficients on lagged stock returns are significant and negative, re-
gardless of whether earnings informativeness is low or high. Examination
of the individual cells indicates that the coefficients on lagged stock returns
are always significant and negative when stock price informativeness is high
(cells (iii) and (iv)) and that the coefficient on lagged earnings change is sig-
nificant and negative when stock price informativeness is low and earnings
informativeness is high (cell (ii)). Thus, the results in panel B are consistent
with boards’ basing the turnover decision on stock prices whenever they are
informative and basing the turnover decision on earnings only when stock
price informativeness is low and earnings informativeness is high. We also
note that, contrary to the concern expressed earlier, the presence of two
countries in cell (ii) indicates that some countries with low stock price in-
formativeness also have high earnings informativeness, suggesting that low
stock price informativeness is not (completely) explained by low earnings
informativeness.
In addition, we acknowledge two caveats with respect to our analysis in
table 7, panel B. First, our variables capturing both earnings and returns
informativeness are measured with error, and second, data restrictions cause
the samples in some of our panel B cells to become small. In particular,
because cell (i) has only 163 observations from one country (Finland), the
lack of significance in cell (i) may be due to reduced statistical power. Thus,
inferences from the analysis in table 7 should be made with caution.
6. Robustness Tests
6.1 INCLUDING YEAR DUMMIES
To control for marketwide shocks over time, we repeat our analysis af-
ter including year dummy variables. This analysis finds that the results of
our hypotheses tests as presented in tables 5 and 6 remain qualitatively un-
changed.21 Thus, our hypotheses continue to be supported after including
year dummy variables.
21 We define qualitatively unchanged with respect to table 5 to mean that in panel B of
table 5, we continue to find: (1) the coefficients on the performance measures in cells (i)
and (iii) are not significantly different from zero, (2) the coefficients on lagged returns in cells
(ii) and (iv) are significant and negative at p < 10% (two-tailed) and that the coefficients on the
lagged change in earnings are not significantly different from zero, (3) the difference between
the row total coefficients on the performance measures is not significant at conventional levels,
and (4) the difference between the column total coefficients on lagged returns is significant at
p < 10% (two-tailed). Qualitatively unchanged with respect to table 6 means that in panel B of
table 6: (1) the coefficient on lagged earnings changes in cell (ii) is significant and negative at
p < 10% (two-tailed), and (2) the coefficient on lagged stock returns in cell (iv) is significant
and negative at p < 10% (two-tailed).
6.2CONTROLLING FOR CROSS-COUNTRY VARIATION IN CEO

TURNOVER RATES
The substantial cross-country variation in CEO turnover rates reported
in table 2 is consistent with large differences in voluntary CEO turnover
rates across countries. Although our inability to discern involuntary from
voluntary CEO turnover is likely to simply reduce the power of our tests,
it is also possible that voluntary turnovers are correlated with our variables
of interest, thereby biasing our results. To explore this latter possibility,
we perform two additional analyses. First, to control for factors that might
explain cross-sectional differences in CEO turnover across countries, such
as higher voluntary turnover, mandatory retirement rules, and CEO age, we
repeat our analysis after including country dummy variables.22 This analysis
finds that the results of our hypotheses tests as presented in tables 5 and
6 remain qualitatively unchanged, with one exception: the coefficient on
earnings becomes significant and negative at p < 10% in cell (iv) of table 5.
Second, we sequentially drop the four countries with turnover rates that
are greater than or equal to 20% (Chile, Korea, Pakistan, and Sweden).
This analysis finds that the results of our hypotheses tests as presented in
tables 5 and 6 remain qualitatively unchanged, with one exception: when
we drop Chile, the difference between the column total coefficient on stock
returns becomes significant at p = .101 instead of p < 10% (two-tailed).
Thus, although adding country dummies causes earnings changes to be-
come negatively associated with CEO turnover in countries with extensive
investor protection laws and strong law enforcement institutions, and drop-
ping Chile weakens the difference between countries with strong and weak
law enforcement, the results are still consistent with our conclusion that
CEO turnover is negatively associated with firm performance in countries
with strong law enforcement institutions.
6.3 CONTROLLING FOR POTENTIAL CROSS-SECTIONAL CORRELATION
A potential problem with pooling firms within years and countries is that
the significance levels of the regression statistics may be overstated because
of cross-sectional correlation among the error terms. To control for poten-
tial cross-sectional correlation within years, we perform sensitivity tests that
examine Fama-MacBeth statistics equal to the mean of the estimated coeffi-
cients across the five regressions, divided by the standard error of the coef-
ficients (Fama and MacBeth [1973]). Because the Fama-MacBeth statistics
are based on the coefficients from the annual regressions, they are unaf-
fected by the potentially inflated t-statistics in the annual regressions. This
analysis finds that the results of our hypotheses tests as presented in tables 5
and 6 remain qualitatively unchanged, with three exceptions: (1) the coeffi-
cient on earnings becomes significant and negative at p < 10% in cell (iii) of
22 We drop the noninteractive terms on extensive investor protection laws, strong law enforce-
ment institutions, and stock price informativeness to avoid collinearity between the country
dummy and country-level variables.
table 5; (2) the coefficient on earnings becomes significant and negative at

p < 10% in cell (iv) of table 5; and (3) the coefficient on returns becomes
significant and positive at p < 10% in cell (iii) of table 6. A positive coefficient
on our performance measures is consistent with CEO turnover increasing
with good performance (perhaps because successful CEOs are hired away by
other firms) or with CEO turnover decreasing with poor performance (per-
haps because the firm allows entrenchment of poorly performing CEOs).
Thus, although earnings become negatively associated with CEO turnover
in countries with extensive investor protection laws and weak law enforce-
ment institutions, the evidence from the row and column totals continues
to support our conclusion that CEO turnover is more likely to be negatively
associated with firm performance in countries with strong law enforcement
institutions.
To control for potential cross-sectional correlation within countries, we re-
peat our hypotheses tests using the robust standard error estimates method
suggested in Allison [1999], which corrects for this correlation by treating
each country as a separate cluster. This analysis finds that the results of
our hypotheses tests as presented in tables 5 and 6 remain qualitatively un-
changed, with one exception: the difference between the column total coef-
ficients on lagged returns becomes significant at p = 11% (two-tailed). Thus,
although the difference between the column totals weakens, the findings
still generally continue to support our overall conclusions after adjusting
for potential correlation among firms in a country.23
6.4CONTROLLING FOR DEVELOPMENT OF CAPITAL MARKET
AND LEGAL ORIGIN
One concern for our study is that cross-country differences in CEO
turnover might depend on factors found in prior research to differ across
countries, such as capital market development or legal origin. Thus, we
repeat our analysis after including variables to capture these factors. We
measure capital market development as a country’s market capitalization
divided by its gross national product (GNP) and a country’s legal origin
using three dummy variables indicating French, German, and Scandinavian
legal origins (La Porta et al. [1997, 1998]).24 This analysis finds that the
results in tables 5 and 6 remain qualitatively unchanged. It also finds that,
for the model 4 regression in table 5, the coefficient on capital market de-
velopment is insignificant, the coefficient of the dummy variable indicating
German legal origin is significant and positive at p < 1% (two-tailed), and
the coefficient on the dummy variable indicating Scandinavian legal origin
is significant and positive at p < 5%. Furthermore, this analysis also finds
that, for the model 4 regression in table 6, the coefficient on the dummy
variable indicating Scandinavian legal origin is significant and positive at
23We also note that because we use two-tailed t-tests, our p-values are conservatively stated.
24La Porta et al. [1997, 1998] classify countries into four legal origins: English, French,
German, and Scandinavian.
p < 5% and the other control variables are insignificant. Thus, although
legal origin helps explain CEO turnover across countries, our hypotheses
continue to be supported after controlling for capital market development
and legal origin.
6.5 CONTROLLING FOR FIRM SIZE

To the extent that the frequency of CEO turnover might depend on firm
size, we repeat our analysis after including log(Assets in $USD) for each firm.
We measure assets at the beginning of the year before the turnover year and
use exchange rates in the Worldscope database to convert the total assets
to U.S. dollars. This analysis finds that the results in tables 5 and 6 remain
qualitatively unchanged and that the coefficient on firm size is significant
and positive at p < 1% (two-tailed). Thus, although firm size helps explain
CEO turnover across countries, our hypotheses continue to be supported
after controlling for firm size.
6.6 DELETING JAPAN, THE UNITED KINGDOM, AND THE UNITED STATES
Table 2 reports that Japan, the United Kingdom, and the United States
have large numbers of observations compared to other countries. Thus, the
large weight on these countries might drive the results in table 5. To address
this concern, we repeat our analysis after sequentially excluding Japanese,
U.K., and U.S. firms from our sample. This analysis finds that the results
in tables 5 and 6 remain qualitatively unchanged, with one exception: the
coefficient on the lagged change in earnings in cell (iv) of table 5 becomes
significant and negative at p < 10% (two-tailed) after dropping the United
Kingdom or the United States. Thus, although lagged earnings changes be-
come significant and negative in countries with extensive investor protection
laws and strong law enforcement institutions, our hypotheses continue to be
supported after deleting Japanese, U.K., and U.S. firms from our analysis.
6.7 ALTERNATIVE CORPORATE GOVERNANCE MECHANISMS

In addition to investor protection, other corporate governance mecha-
nisms include the external takeover market, concentrated ownership, and
board of director composition (Denis and McConnell [2003]). Because
these other mechanisms are also expected to influence the association be-
tween CEO turnover and performance, we consider whether they are likely
to affect our findings. With regard to the external takeover market, prior re-
search finds that the United Kingdom and the United States tend to be
the only countries with active takeover markets. Therefore, as noted in
section 6.6, we sequentially delete the United Kingdom and the United
States from our sample and continue to find results that are qualitatively
unchanged. Thus, takeover activity does not appear to explain our findings.
Prior studies document that concentrated ownership is more prevalent
in countries with weak investor protection (La Porta, Lopez-de-Silanes, and
Shleifer [1999]). Thus, it is possible that our finding in table 5 may result
from the presence of large blockholders. It is unclear, however, how large

blockholders are likely to affect the association between CEO turnover and
firm performance. On the one hand, large blockholders may provide bet-
ter monitoring because they have more incentives to maximize firm value
and have more ability to influence management decision making (Shleifer
and Vishny [1997]). On the other hand, large blockholders may have in-
terests that conflict with shareholder value maximization and may collude
with management to pursue these interests (Gibson [2003]). For example,
large shareholders may enjoy private benefits of control by exploiting busi-
ness relationships with affiliated companies through transfer pricing (Volpin
[2002]).
To explore whether our findings in table 5 result from the presence of
large blockholders, we exclude observations with large shareholders that
have direct holdings greater than 20% of firm equity. We identify these
firms using the ownership data from the June edition of the 1997–2000
Worldscope CD-ROM.25 This analysis finds that the results of our first hy-
pothesis test presented in table 5 remain qualitatively unchanged, with one
exception: the coefficient on stock returns becomes significant and positive
at p < 5% in cell (i). Thus, although stock returns become significant and
positive in countries with limited investor protection laws and weak law en-
forcement institutions, our first hypothesis continues to be supported after
excluding firms with large blockholders.
Finally, prior research finds evidence that independent board members
are more likely to dismiss CEOs (i.e., Weisbach [1988], Renneboog [2000],
Suchard, Singh, and Barr [2001]). In our setting, this suggests that firms
may use independent board members to either substitute for or complement a
strong investor protection environment. Although lack of data prevents us
from directly testing these possibilities, we believe they are unlikely to alter
our conclusions. If firms use independent board members to substitute for
the lack of strong investor protection institutions, it would bias against our
findings. That is, if independent board members are used to achieve good
corporate governance outcomes in countries with weak investor protection,
we would not expect to see the lack of association between CEO turnover
and performance in countries with weak law enforcement institutions.
On the other hand, we expect independent boards to complement strong
investor protection because independent boards of directors are likely to
be a consequence of strong investor protection. This is because we expect
strong investor protection to lead to good corporate governance, which
should in turn cause firms to choose more independent boards. That is, we
view corporate governance factors such as board structure to be endogenous
choice variables, whereas the investor protection environment is exogenous.
25 We do not include the ownership data in the June 2001–2002 CD-ROM because the June
2001 CD-ROM does not include ownership data and the June 2002 CD-ROM changes the
disclosure of these data. In addition, as in Gibson [2003], we do not trace through indirect
ownership chains because of lack of data.
Thus, although we are unable to control directly for the possible effects of
independent board members in our analysis, we do not believe they are
likely to alter our conclusions.
6.8EFFECT OF PUBLIC OPINION PRESSURE
ON TURNOVER-PERFORMANCE SENSITIVITY
Dyck and Zingales [2003] find evidence suggesting that public opinion
pressure is an “extra legal” institutional factor that is at least as important in
fostering good corporate governance as strong investor protection. Specifi-
cally, they find evidence that stronger public opinion pressure (as surrogated
by higher levels of newspaper diffusion among the population) reduces the
private benefits of control to insiders. This finding is consistent with the
idea that insiders’ reputation concerns limit their expropriation of investor
wealth. Because countries with strong law enforcement institutions are also
likely to have a large free press, we perform additional tests that control for
the effects of newspaper diffusion in the tests of our first hypothesis. Follow-
ing Dyck and Zingales, we measure newspaper diffusion as daily newspaper
circulation divided by the population. The intuition behind this measure
is that the larger the free press, the greater is the likelihood the press will
expose insider expropriation to the public.
We obtain the data on newspaper diffusion as of 1996 from Dyck and
Zingales [2003] and the World Development Indicator (World Bank [2001]).
We use 1995 data for Greece and Pakistan because their 1996 data are not
reported, and we exclude India because it does not have such data available.
We replicate the four regressions reported in table 5 after adding a variable
for newspaper diffusion and two interaction terms: the newspaper diffusion
variable times lagged stock returns, and the newspaper diffusion variable
times the lagged change in earnings. This analysis finds that the results of
our hypotheses tests as reported in table 5 remain qualitatively unchanged.
Thus, as with our primary analysis in table 5, we continue to find little
support for our first hypothesis with respect to extensive investor protection
laws, but relatively strong support for our hypothesis with respect to strong
law enforcement institutions. One difficulty in making inferences from
the analysis just described, however, is that further investigation finds that
the model suffers from a multicollinearity problem, probably because the
Pearson correlation between strong law enforcement and newspaper dif-
fusion is 0.68 (p < 1%).26 Nonetheless, the consistent association between
CEO turnover and poor performance among the firms in countries with
26 We follow the procedure recommended in Allison [1999] to assess whether multicollinear-
ity likely affects the coefficient estimates in our logit model. The results indicate that we do
not have a multicollinearity problem with our independent variables in the model in table 5
because all tolerance statistics exceed the suggested cutoff of 0.4. However, the results suggest
a multicollinearity problem in the analysis that includes the newspaper diffusion variable. For
example, the tolerance statistic is 0.13 for the interaction term between stock return and news-
paper diffusion and 0.15 for the interaction term between accounting earnings and newspaper
diffusion.
strong law enforcement, and the consistent lack of such association among
the firms in countries with weak law enforcement suggest that our findings
in table 5 are not likely to be driven by public opinion pressure.
6.9 DROPPING LOSS FIRMS

Prior studies document that CEO turnover is related to reported losses
(Kang and Shivdasani [1995]). Because changes in earnings are less infor-
mative for loss firms, this could explain why we do not find significance on
the change in earnings in some of our tests. Therefore, we test the sensitivity
of our results to excluding loss-firm observations in our sample. This analy-
sis indicates that the findings in tables 5 and 6 are qualitatively unchanged.
Thus, our hypotheses continue to be supported after excluding loss-firm
observations.
6.10 ALTERNATIVE PARTITION OF LAW ENFORCEMENT INSTITUTIONS

Although prior studies frequently partition samples by medians of
country-level variables (e.g., La Porta et al. [2000b]), we repeat our analysis
after excluding countries whose values of the law enforcement institutions
variable falls in the middle 20% of the cutoff.27 This analysis indicates that
the findings in tables 5 and 6 remain qualitatively unchanged, with one
exception: the coefficient on earnings in cell (ii) of table 6 becomes in-
significant. However, further investigation finds that cell (ii) of table 6 only
includes Finland. Because Finland is a country with high tax-book confor-
mity, it is not surprising that reported earnings are not useful in monitoring
management performance. Thus, although earnings become insignificant
in cell (ii) in table 6, both of our hypotheses continue to be supported using
this alternative measure of law enforcement institutions.
6.11 ALTERNATIVE LAW ENFORCEMENT INSTITUTIONS MEASURE

Although the legal indexes constructed by La Porta et al. [1997, 1998]
are widely used in prior studies, one concern for our analysis is that these
indexes, especially those related to law enforcement, might not be repre-
sentative for our sample period. Specifically, La Porta et al. compile the
efficiency of judicial system index based on 1980–1983 data and measure
the rule of law and corruption indexes based on 1982–1995 data. Although
it is generally accepted that changing country-level institutions is a slow
process (North [1990]), we test whether our results are sensitive to an al-
ternative measure of law enforcement institutions based on more recent
data. We repeat our analysis after calculating the law enforcement institu-
tion measure as the mean score of World Bank governance indicators on
27 We do not perform this sensitivity test on the investor protection laws variable because
this variable only takes on a limited number of values. In addition, because the first quartile
and median of this variable have the same value, it is reasonable to classify countries as having
extensive (limited) investor protection laws when the investor protection law index is above
(equal to or below) the median.
rule of law and control of corruption, measured over 1997–1998 and 2000–
2001 (Kaufmann, Kraay, and Zoido-Lobatón [2002]).28 Our analysis finds
that the results in tables 5 and 6 remain qualitatively unchanged. Thus, our
hypotheses continue to be supported using a measure of law enforcement
institutions based on more recent data.
6.12 ADDITIONAL ANALYSIS OF STOCK PRICE INFORMATIVENESS
6.12.1. Alternative Explanations for Synchronicity Measure. Although Morck,
Yeung, and Yu [2000] conclude that their synchronicity measure captures
whether stock prices are likely to reflect firm performance, we perform
additional tests to rule out potential alternative explanations for what this
variable may be capturing.
The first alternative explanation we test is whether the synchronicity mea-
sure proxies for the homogeneity of firms within an economy, resulting
from factors such as common risk exposure because firms in the economy
are in related lines of business. Such homogeneity may result in a low vari-
ation of market-adjusted stock returns across firms in economies with high
synchronicity, reducing the power of our tests and resulting in the lack
of significance on the returns coefficients in cells (i) and (ii) in table 6,
panel B. To explore this possibility we compare the standard deviation of
stock returns among the four cells in panel B to see whether the variation of
returns in cells (i) and (ii) are unusually low. We find that the standard devia-
tions in cells (i) and (ii) are 0.45 and 0.42, respectively, whereas the standard
deviations in cells (iii) and (iv) are 0.40 and 0.35, respectively. Thus, con-
trary to our concerns, we find that the standard deviation of market-adjusted
stock returns is actually higher among countries with high synchronicity (i.e.,
low stock price informativeness) and therefore conclude that homogeneity
across firms in the highly synchronous countries is unlikely to drive our
findings in table 6.
A second alternative explanation for the lack of significance on the re-
turns coefficients in cells (i) and (ii) is that CEO performance might be
evaluated based on raw returns. If so, measuring performance based on
market-adjusted returns introduces measurement error. To address this con-
cern, we perform our analysis again in table 6 using raw stock returns and
find the results qualitatively unchanged. Thus, it does not appear that our
conclusions based on the synchronicity measure in table 6 are driven by
measurement error in our returns metric.
6.12.2. Alternative Partition of Stock Price Informativeness. We also investigate

the sensitivity of our stock price informativeness variable to our partitioning
scheme by repeating the analysis in table 6 after excluding countries whose
values of the stock price informativeness variables fall in the middle 20%.
28 We search various data sources but are unable to find more recent data on the efficiency of
the judicial system variable. Thus, we do not include this variable in our new law enforcement
institutions measure.
This analysis finds that the results in table 6 remain qualitatively unchanged.
Thus, our second hypothesis continues to be supported using this alternative
partition of stock price informativeness.
6.12.3. Alternative Stock Price Informativeness Measures. We also repeat our

analysis in table 6 after using two alternative measures of stock price in-
formativeness. The first measure, following Roll [1988], is the adjusted R 2
from regressing annual stock returns on market returns (i.e., the adjusted
R 2 from the market model). Specifically, we estimate the market model re-
gression for each firm in our sample from 1997 through 2001 and take the
average of the adjusted R 2 s for all firms in each country (where each firm
is required to have at least three observations to remain in the analysis). We
classify a country as having high stock price informativeness when its aver-
age adjusted R 2 is equal to or below the median of the sample countries.
This analysis finds that the results in table 6 are qualitatively unchanged,
with one exception: the coefficient on earnings is no longer significant at
conventional levels in cell (ii) of panel B. Thus, although earnings are no
longer significant in countries with weak stock price informativeness, we
continue to find support for our second hypothesis.29
Our second alternative measure of stock price informativeness is the mea-
sure used in our primary analysis after being orthoganlized to the log of the
number of listed stocks and the variables that Morck, Yeung, and Yu [2000]
consider as alternative explanations for (or correlated with) the extent to
which stock prices move together.30 Specifically, this measure is computed as
the residuals from regressing the Morck, Yeung, and Yu synchronicity mea-
sure on the log of the number of listed stocks, the comovement of return
on assets (ROA), industry and firm Herfindahl indexes, variance in gross
domestic product (GDP) growth, and log of geographical size (where these
variables are measured as closely as possible to the measures used in Morck,
Yeung, and Yu [2000]).31 This analysis finds that the results in table 6 are
qualitatively unchanged, with two exceptions: (1) the coefficient on stock
returns in cell (ii) becomes significant and negative at p < 10% (two-tailed),
and (2) although the magnitude of the negative coefficient on stock returns
in cell (iv) remains larger than the magnitude of the coefficient on stock
29 Recall that our second hypothesis predicts that returns are more likely to be used in
countries with more informative stock prices but does not make a prediction regarding the
coefficient on earnings.
30 We control for the number of listed stocks because countries with fewer listed stocks will me-
chanically have higher synchronicity because of the construction of the synchronicity measure
(Morck, Yeung, and Yu [2000]).
31 The comovement of ROA is the average of the adjusted R 2 s from regressing ROA for each
firm on the countries’ market ROA from 1997 through 2001, where each firm is required to
have at least three observations to remain in the analysis. The Herfindahl indexes are computed
as in Morck, Yeung, and Yu [2000] using data from the 1996 Worldscope CD-ROM. GDP growth
is based on 1990–1994 per capita GDP, and geographic size is based on 1994 square kilometers,
where the data are obtained from the Worldbank World Development Index (WDI). Taiwan is
deleted from the analysis because it is not covered in the WDI database.
returns in cell (ii) (−0.32 in cell (iv) vs. −0.19 in cell (ii)), the difference
is not significant at conventional levels (p = 33%, two-tailed). Thus, our
second hypothesis is not supported when we use this alternative stock price
informativeness measure.
6.12.4. Summary of Additional Analyses of Stock Price Informativeness. In sum-

mary, the additional analysis of the stock price informativeness measure
finds that our result is robust to two alternative explanations of what our
synchronicity measure captures, to an alternative partitioning of high and
low stock price informativeness, and to an alternative surrogate for stock
price informativeness. However, although most of our sensitivity tests find
support for our second hypothesis, we find that our stock price informative-
ness measure is not robust to one of our alternative surrogates for stock price
informativeness. Thus, inferences from the tests of our second hypothesis
should be interpreted with caution.
6.13 CONTROLLING FOR INDUSTRY EFFECTS

One possible explanation for our findings is that industry concentration
differs across our sample partitions. For example, if the composition of the
industries in the column total for strong law enforcement countries differs
significantly from the composition of the industries in the column total for
weak law enforcement countries, and CEO turnover-performance sensitivity
varies across industries, this could explain the significant difference across
the column totals. To evaluate this possibility, we examine the proportion
of firms in each column and row total that fall into each of the 48 industry
categories defined in Fama and French [1997].32 Although not tabulated,
this analysis finds that there does not appear to be any large industry cluster-
ing in the columns or rows and that the industry distribution is comparable
across the partitions. Specifically, the maximum industry proportions in the
left and right columns and top and bottom rows in table 5, panel B are 7.3%,
7.8%, 8.0%, and 6.1%, respectively. Furthermore, the largest difference in
the proportion of firms in a given industry between the two columns and
two rows is 3.9% and 4.4%, respectively. Thus, we find that there is little ev-
idence of large industry concentration in any of our partitions and that the
differences in concentration across the partitions for any given industry are
relatively small. Consequently, differences in industry concentration across
countries are unlikely to explain our findings in table 5.
Despite the preceding findings, we also perform two additional tests that
address the potential influence of industry differences on our findings. First,
as in Hung [2001], we repeat our analysis after restricting our sample to
industrial firms (SIC codes 2000–3999 or 5000–5999). Second, we repeat
32 Fama and French [1997] form industries by combining four-digit Standard Industrial
Classification (SIC) codes that have similar operating characteristics. They argue that forming
industries based on mechanical combinations of two-digit (or three- or four-digit) SIC codes
fails to capture the underlying similarities in operating characteristics across firms.
our tests after including industry dummy control variables. Both analyses
find that the results in tables 5 and 6 remain qualitatively unchanged. Thus,
our hypotheses continue to be supported after restricting our analysis to
industrial firms and including industry dummies.
6.14 ALTERNATIVE PERFORMANCE MEASURES

Although our performance metrics are measured as in prior research, we
also perform tests to see whether our results are robust to using industry-
adjusted performance measures. That is, we replace our lagged stock returns
and lagged change in earnings measures with measures that subtract the
mean industry lagged return and lagged change in earnings, respectively,
where industry is defined as the 48 industry categories in Fama and French
[1997]. The analyses from using industry-adjusted performance measures
to test our hypotheses find that our results in tables 5 and 6 remain qualita-
tively unchanged. Thus, our findings are robust to using industry-adjusted
performance measures.
6.15 CONTROLLING FOR STAKEHOLDER-ORIENTED ECONOMIES

A potential alternative explanation for finding insignificant coefficients
on returns and earnings in cells (i) and (iii) in table 5 is that our mea-
sure of weak law enforcement captures countries in stakeholder-oriented
economies. To test this alternative explanation, we repeat our analysis in
table 5 after sequentially replacing our partition based on investor protec-
tion laws with three different partitions based on whether the country is
stakeholder oriented. This research design tests whether our results using
the law enforcement partition are explained by whether the countries are
stakeholder oriented.
One of our three alternative partitions captures whether the country is
creditor oriented, another captures the extent to which the country is labor
oriented, and the third is a general measure of stakeholder orientation. The
partition on creditor orientation is the ratio of the total value of the external
equity markets to GNP (as used in La Porta et al. [1997]), where lower
values of the ratio capture creditor-oriented countries.33 The partition on
labor orientation uses the labor power index in Dyck and Zingales [2003]
(which is derived from Pagano and Volpin [2000]), where higher values
of the index capture labor-oriented countries.34 The general measure of
stakeholder orientation partitions the sample on whether the legal system
is based on code law or common law, where the code law partition captures
stakeholder-oriented countries (Ball, Kothari, and Robin [2000]).
33 We also use a ratio of the total value of the external equity markets divided by the total value
of debt in an attempt to capture a relative measure of stockholder versus creditor orientation

and find qualitatively identical results.
34 A limitation of this analysis is that the labor power index is only available for 15 of the 33
sample countries and that there are no observations in the cell for countries with labor-oriented
economies and weak law enforcement.
This analysis finds that our results in table 5 remain qualitatively un-
changed, with one exception: earnings are significant and negative at
p < 10% in the cell for countries with weak law enforcement and com-
mon law legal systems.35 Overall, we find that none of the three stakeholder
orientation partitions is able to discriminate between countries where CEO
turnover is sensitive to performance. Thus, our findings in table 5 do not
appear to be explained by the correlation between our law enforcement
partition and stakeholder-oriented economies.
6.16DICHOTOMOUS VERSUS CONTINOUS MEASURE OF SHAREHOLDER

PROTECTION VARIABLES
Coding our continuous investor protection measures as dichotomous
dummy variables is consistent with the prior corporate governance liter-
ature on CEO turnover that examines the interaction variables of interest
(such as board characteristics) and CEO turnover-performance sensitivity
(e.g., Weisbach [1988], Kang and Shivdasani [1995], Denis, Denis, and Sarin
[1997], Volpin [2002]). However, if the underlying relation between investor
protection and CEO turnover-performance sensitivity is actually linear, the
use of a dichotomous variable reduces the power of our tests. That is, if a con-
tinuous measure of investor protection better captures the relation we are
examining, our tests are biased against finding support for our hypotheses.
Thus, we perform a sensitivity test that replaces our dummy variables
for investor protection with continuous measures. This test finds that the
interaction terms using continuous measures are not significant at conven-
tional levels. Finding a lack of significance with the continuous measures
(along with finding significance when we use the dichotomous measures)
is consistent with (but not conclusive of) the proposition that the dummy
specification is better at capturing the effect of investor protection on CEO
turnover-performance sensitivity.36
A dummy specification of investor protection is likely to be appropriate
for our tests and superior to a continuous measure for the following reasons.
First, if the continuous variable is measured with error, agglomerating the
variable into two categories can reduce the variability associated with the
measurement error. Thus, the resulting dichotomized variable can actually
contain more information about the underlying construct being measured.
In our setting, this is the case if the rankings for investor protection laws
and enforcement are measured with noise (which we expect them to be).
Second, if the underlying variable has a threshold beyond which the effect
occurs, dichotomizing may better capture the variable’s effect. In our setting,
this would be the case if the effect of investor protection laws or enforcement
35 We note that the difference between the coefficients on earnings across the countries with
weak versus strong law enforcement remains insignificant, whereas the difference between the
coefficients on returns continues to be significant.
36 This is consistent with Denis, Denis, and Sarin [1997], who also report a sensitivity test that
finds that a continuous measure of board independence does not support their hypothesis.
“jumps” at some point near the median. As reported in section 6.10, we also
perform sensitivity tests after dropping 20% of the distribution surround-
ing the median values of our investor protection law variable, and we find
that our results do not change. This finding is consistent with (though not
conclusive of) the proposition that a threshold effect is somewhere near the
median. Third, Weisbach [1988] notes that a practical advantage for using
dummy variables in this literature is that it facilitates interpretation of the
findings by classifying firms into categories that correspond with those im-
plied by the hypotheses. As in Weisbach, our hypotheses suggest classifying
firms into categories (strong vs. weak investor protection), and without a
dichotomous classification it would be more difficult to interpret our find-
ings. For example, it would be impossible to identify the implications of our
results for specific countries as we currently do in panel B of table 5.
7. Summary
The purpose of our study is to investigate the effect of investor protection
on the association between CEO turnover and firm performance, and to
explore the metrics used to assess firm performance in the turnover deci-
sion. We find that CEO turnover is negatively associated with firm perfor-
mance in countries with strong law enforcement institutions and unrelated
to performance in countries with weak law enforcement. In contrast, we find
that the association between CEO turnover and performance is unrelated
to the extent of a country’s investor protection laws. Finding that strong
law enforcement institutions are associated with improved CEO turnover-
performance sensitivity is consistent with good corporate governance re-
quiring law enforcement institutions capable of protecting shareholders’
property rights (i.e., protecting shareholders from expropriation by insid-
ers). Finding that investor protection laws are not associated with improved
CEO turnover-performance sensitivity is open to several explanations. For
example, investor protection laws may not be as important as strong law
enforcement in fostering good governance, the set of laws we examine may
not be the set that is most important in promoting good governance, or our
surrogate for extensive laws may contain measurement error that reduces
the power of our test of this variable.
Finally, we find that CEO turnover is associated with poor stock returns in
countries with strong law enforcement, but only when stock prices are more
informative, suggesting that the characteristics of a country’s information
environment affect the relative usefulness of stock prices. However, because
this last result is sensitive to our measure of stock price informativeness, it
should be interpreted with caution.
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Journal of Accounting Research

Vol. 42 No. 2 May 2004

Investor Protection and Corporate

Received 9 January 2003; accepted 25 November 2003

Recent research asserts that an essential feature of good corporate gover-

laws are not associated with improved CEO turnover-performance sensitivity

observations in Portugal and 28% of the observations in South Korea replace

protection laws in fostering a corporate governance environment capable

decisions (Morck, Yeung, and Yu [2000]). By doing so, we provide insight

our sample on variables that measure the extent to which an economy is

2.2INVESTOR PROTECTION, CEO TURNOVER,

4. Sample Selection and Descriptive Statistics

deputy chief executive in identifying the top executive officer.

Country Management Titleb

Number of Number of CEO Proportion of CEO

4.2 DATA AND DESCRIPTIVE STATISTICS

shows a positive association between the two performance measures (stock

Two-Tailed Two-Tailed Two-Tailed Two-Tailed

E t−1 −0.07 0.08 −0.09 0.87 −1.05 0.10 −0.71 0.46

E t−1 ∗ Extensive laws −0.77 0.26 −0.53 0.68

E t−1 ∗ Strong enforcement 0.65 0.38 0.87 0.46

E t−1 ∗ Extensive laws ∗ Strong enforcement −0.33 0.83

Investor Protection Laws Variable Weak Strong Row Totals

RET t−1 −0.05 −0.29∗∗∗ −0.03∗∗∗

Panel C: Countries in each panel B partition

Investor Protection Laws Weak Strong

Specifically, CEO turnover is not significantly associated with lagged returns

here for ease of exposition.

Two-Tailed Two-Tailed Two-Tailed Two-Tailed

Strong enforcement −0.15 <0.01 −0.47 <0.01

E t−1 −0.07 0.08 −1.79 <0.01 −1.05 0.10 −0.96 0.15

E t−1 ∗ High stock price informativeness 1.72 0.02 −1.17 0.64

E t−1 ∗ Strong enforcement 0.65 0.38 −5.43 <0.01

E t−1 ∗ High stock price informativeness ∗ Strong enforcement 7.55 0.01

Panel C: Countries in each panel B partition

Stock Price Informativeness Weak Strong

institutions and high stock price informativeness, and is only significantly

5.3ADDITIONAL ANALYSIS OF MARKET PRICES AND ACCOUNTING

Two-Tailed Two-Tailed Two-Tailed Two-Tailed

E t−1 −0.40 0.30 −6.38 <0.01 −0.17 0.81 −6.36 0.26

E t−1 ∗ High stock price informativeness 6.38 <0.01 6.33 0.26

E t−1 ∗ High earnings informativeness −0.40 0.64 −0.02 1.00

Stock Price Informativeness Low High Row Totals

RET t−1 −0.31∗∗∗ −0.27∗∗∗ −0.29∗∗∗

Panel C: Countries in each panel B partition

Stock Price Informativeness Low High

21 We define qualitatively unchanged with respect to table 5 to mean that in panel B of

6.2CONTROLLING FOR CROSS-COUNTRY VARIATION IN CEO

table 5; (2) the coefficient on earnings becomes significant and negative at

6.5 CONTROLLING FOR FIRM SIZE

6.7 ALTERNATIVE CORPORATE GOVERNANCE MECHANISMS

from the presence of large blockholders. It is unclear, however, how large

26 We follow the procedure recommended in Allison [1999] to assess whether multicollinear-

6.9 DROPPING LOSS FIRMS

6.10 ALTERNATIVE PARTITION OF LAW ENFORCEMENT INSTITUTIONS

6.11 ALTERNATIVE LAW ENFORCEMENT INSTITUTIONS MEASURE

6.12.2. Alternative Partition of Stock Price Informativeness. We also investigate

6.12.3. Alternative Stock Price Informativeness Measures. We also repeat our

6.12.4. Summary of Additional Analyses of Stock Price Informativeness. In sum-

6.13 CONTROLLING FOR INDUSTRY EFFECTS

6.14 ALTERNATIVE PERFORMANCE MEASURES

6.15 CONTROLLING FOR STAKEHOLDER-ORIENTED ECONOMIES

of debt in an attempt to capture a relative measure of stockholder versus creditor orientation