CEO Indiscretions: Sex, Lies, and Firm Value

CEO Indiscretions: Sex, Lies, and Firm Value

October 10, 2014 Research Insights
Print Friendly
(Last Updated On: January 18, 2017)

The Agency Costs of Managerial Indiscretions: Sex, Lies, and Firm Value

Abstract:

We examine a sample of executives accused of indiscretions in their personal lives for actions explicitly unrelated to the operations of their firm. These include accusations of violence, substance abuse, dishonesty, and sexual misadventure. While these actions are personal in nature, we find that they signal substantial agency costs for the firm. Companies of accused executives experience significant short-term and long-term wealth losses, and reduced operating performance in the period surrounding the alleged indiscretion. These firms are also more likely to be involved in shareholder-initiated lawsuits, DOJ/SEC investigations, and are significantly more likely to manage their earnings. While a large proportion of our executives keep their jobs after an alleged indiscretion, we do find that CEOs are significantly more likely to be fired for their missteps.

Alpha Highlight:

“Everything a CEO says and does is no longer personal. It is attributed to the company,” said by Shelly Lazarus, CEO (Gordon, 2007). This statement is especially true in a world with a 24/7 media presence.

This paper examines the impacts of indiscretions in management’s personal lives on firm values and operational performance. These managerial indiscretions include allegations of sexual misadventure, substance abuse, violence, and dishonesty. While having no direct link to the business operations or financial decisions of the firm, these personal misconducts might put a corporation at risk.

Why? Personal indiscretions are signals to the market relating to an executive’s utility function (e.g., an executive may not highly value his reputation) the market is often responsive to such signals. Improprieties can be a big distraction as well, diverting management’s attention from the business both during an indiscretion, and when it is revealed. Another concern is whether such questionable activities may predict behavior in a corporate or financial setting. If a married executive is clandestinely dating a subordinate, is he also perhaps manipulating earnings?

To test the hypothesis that indiscretions affect corporations, the authors collect a sample of 301 indiscretions from 1978 to 2011. The improprieties studied were intentionally selected to be personal matters, and unconnected to firm operations.

Key Findings: 

  • Firm value and operating performance decrease significantly around the disclosure of an indiscretion. An immediate 3.8% loss in shareholder value occurs at the revelation of an indiscretion committed by CEO. This translates to an average loss of $320 million in market capitalization.
2014-09-11 11_37_52-The Agency Costs of Managerial Indiscretions Sex, Lies, and Firm Value.pdf - Ado
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
  • The negative effects are long-term rather than transitory. Sample firms experience a long-run decline in value of 9% to 12% during the year in which an indiscretion is announced.
2014-09-11 11_46_06-The Agency Costs of Managerial Indiscretions Sex, Lies, and Firm Value.pdf - Ado
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
  • A significant abnormal decline of 1.5% in operating performance (ROA) in the fiscal year in which an indiscretion implicating the CEO is disclosed.

Charlie Munger is right:

The right culture, the highest and best culture, is a seamless web of deserved trust…Good character is very efficient. If you can trust people, your system can be way simpler. There’s enormous efficiency in good character and dis-efficiency in bad character.

Warren Buffett is also right:

Passion is the number one thing that I look for in a manager. IQ is not really that important…I’d say intelligence, energy, integrity. If you don’t have the last one, the first two will kill you. All you have is a crook who works hard.”


Note: This site provides no information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.


Join thousands of other readers and subscribe to our blog.


Please remember that past performance is not an indicator of future results. Please read our full disclaimer. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.


Definitions of common statistics used in our analysis are available here (towards the bottom)




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.