‘Bad boy’ CEOs can cost their firms big bucks

Adam Yore

Most corporations tend to treat high-level executives who misbehave in their personal lives as a matter of “boys-will-be-boys.”

New research by a professor in the NIU College of Business reveals that such behavior comes at a high price, however.

In the paper, “The Agency Costs of Managerial Indiscretions: The Agency Costs of Managerial Indiscretions: Sex, Lies and Firm Value,” Adam Yore and his co-authors found that in the three days following the disclosure of misdeeds by a chief executive officer, the average firm lost 3.8 percent in shareholder value, or about $320 million in market capitalization.

The news gets worse for those firms. Looking out one full year, the average company in the study saw its stock under-perform by more than 14 percent. In some cases, those losses totaled in the billions.

And yet, only one-third of the executives in the sample lost their jobs, and more than a quarter (28 percent) of them were “repeat offenders” with a previous history of misdeeds in their past.

“The message, it seems, is that integrity matters more to Wall Street than it does to many corporate boards,” says Yore, who co-authored the paper along with Brandon Cline of Mississippi State University and Ralph Walking of Drexel University.

The study was designed specifically to examine misdeeds in the personal lives of executives, Yore says . “We were looking for behaviors that reflected negatively on the character of a top manager, but had nothing to do with his or her management of the business."

The research also showed that not all indiscretions were punished equally.

Specifically, the study looked at 325 instances of executives at publicly traded companies who were caught engaging in four categories of misbehavior: sexual misadventures, such as extramarital affairs and office romances (47 percent of the sample); dishonesty, such as resume fraud (33 percent); substance abuse, such as drugs, alcohol, DUI (10 percent); and displays of violent behavior, such as engaging in fights or spousal abuse (9 percent).

Those who engaged in violence were most likely to be replaced (53 percent), while only 20 percent of those whose indiscretion involved substance abuse were shown the door. One third of those who engaged in sexual misadventures were fired, while nearly 38 percent of those caught lying were dismissed.

“It seems that boards react far more negatively to dishonesty, resume fraud and affairs than substance abuse,” Yore says . “The thinking seems to be that if you are willing to violate a contract in your personal life you are demonstrating a willingness to lie that may spill over into your professional life, and if I don’t trust you, I probably won’t engage in business with you.”

There seemed to be some credence to that notion. Yore and his co-authors found that firms with executives willing to play fast and loose in their personal lives were also more likely to engage in “earnings management” (carefully crafting their earnings statements and other materials to paint an unduly rosy picture). Those companies are also more frequently the target of class action lawsuits from stockholders.

Because it is clear that Wall Street frowns on all of the behaviors studied in the paper, Yore is puzzled by how firms respond.

“Getting caught in an indiscretion certainly increases the odds that an executive may be fired, but it is by no means automatic. Considering the consequences, I would have expected at least half of these executives would have been fired because the market seems to punish these behaviors, even if the board does not.”

One possible explanation raised by the research is that companies with executives prone to misbehavior are overseen by weaker boards. “Our results indicate that companies with a lax board are more susceptible to these types of situations. We also found that these type of problems occur more frequently at companies where the CEO is the founder of the company, or a relative of the founder.”

The study sample was drawn from stories reported in public media between 1978 and 2012, with most instances coming to light after 1996, as the Internet made finding out about such things easier. The sample included not just CEOs, but also high level executives such as chief finance officers or chief operating officers, as well as corporate board members. However, negative consequences were about twice as severe in the instances of CEO misbehavior than others. Within the sample, 96 percent of the misbehaving executives were male, with an average age of about 52.

A link to the paper can be found online.