CEOs and McMansions

It is a traditional exam question to ask whether a public company is required to disclose that the CEO is suffering from a fatal disease.  The case might turn on whether a company has a duty to disclose but most often it depends upon an analysis of the concept of materiality.  Is it important to a reasonable investor?  Often the answer is no.  While a CEO is important, the future of the business is often not so uniquely tied to a single individual.  Nonetheless, it is a question that, at its core, asks students to ponder the importance of the CEO. 

It was with this in mind that we noted the article in the WSJ on the development of data that shows links between the lives of the CEO and the success of the company.  Discussing a variety of studies, the Journal reported the following:

• That, over a decade, profitability slipped among Danish companies in the two years after the death of a CEO's child (15% after the death of a spouse; profits increased slightly after the death of a mother-in-law);
• That the stock of companies run by top officials who own mega homes (more than 10,000 square feet or 10 acres)  "sharply under perform" the market;
• That narcissistic executives (based upon such things as the size of the plot used in annual reports) "take greater risks" and cause "bigger swings in profitability";

With respect to the ownership of McMansions, the study appeared in the paper, Where are the Shareholders' Mansions?  CEOs' Home Purchases, Stock Sales, and Subsequent Company Performance, written by Crocker Liu at Arizona State and David Yermack at NYU. Their conclusion?

• "We find that CEOs who acquire extremely large properties exhibit inferior ex post stock performance, a result consistent with large mansions being proxies for CEO entrenchment.  We also find that the method of financing a home's acquisition is informative about future stock returns.  A general pattern of CEO sales of their firms' shares and options exists over the twelve months leading up to the date of home acquisition.  However, when the CEO does not sell any shares, his stock performs significantly better ex post than stocks of firms whose CEOs do liquidate equity to finance their houses.  The retention of company shares simultaneous with a new home purchase, despite the presence of an evident liquidity need, appears to send a signal of commitment by a CEO to his company."

The data suggests that in many cases the CEO is uniquely important and that events in the CEO's personal life can impact profitability.  Perhaps that means that the exam question should go less to a CEO's illness and more to the size of a CEO's home or the relationship with his/her children. 

Whatever the conclusions, one thing seems clear.  Don't select a CEO who was a former rock star.  See Study Affirms that Rock Stars Do Die Younger ("The report found that, between two and 25 years after the onset of fame, the risk of death was two to three times higher for music stars than for members of the general population matched for age, sex, nationality and ethnic background.").