Research Suggests Investor Benefit from More CEO Personal Scrutiny

“When you go to the track, you study the horse,” David Yermack, a New York University finance professor who worked on the study, told the Wall Street Journal. “Investing is not that different. You want to to know as much as you can about the jockey.”

The researchers looked at data on thousands of businesses and found that profitability fell by an average of about one-fifth in the years after the death of a chief executive’s child and by 15% after the death of a spouse.

The profitability, as measured by operating return on assets, was roughly an average of 21% lower in the two years after the death of a child than in the two years before it. The drop was sharper when the child was under 18 and greater still if it was the death of an only child, according to the newspaper report.

The study also shows that companies run by executives who build mega mansions greatly underperform the market, suggesting that these executives might be so consumed with enjoying their wealth that they stop working as hard.  

Yermack and Crocker Liu of Arizona State University looked at real estate records on the CEOs who were running all of the S&P 500 companies at the end of 2004, finding the addresses of 488 of 500 executives.

However, the researchers are not saying that CEOs’ desire to live lavishly directly causes the company to suffer.“It’s whatever is driving the CEO to want to live in a mansion, which to a certain extent is very hard to observe,” Yermack, told the Journal. The purchase might signal that the executive is entrenched in his position, he says, or may prefer leisure to work, he continued.  

According to Journal, the key finding was that stock performance tended to weaken after a CEO bought or built a 10,000 square feet house or a site on more than 10 acres. In these instances, companies’ stocks underperformed the S&P 500 index by 25% over the three years after the purchase.

Of course, some executives who bought mansions saw their stocks rise afterward.

Liu even suggested trading strategies that track CEO’s house purchases through public records, bet against the stocks of companies whose chiefs bought or built mega mansions, and buy the stocks of firms whose executives have more modest housing tastes. When the researchers ran this model, they calculated tracking such activity would have outperformed the market by about 15% a year.