Stock market analysts earn big money trying to predict the the potential success of a company. Now, it seems there might be a better and more economical way of achieving the same end. Find out how much the CEO owes on his/her mortgage. A new study finds that corporations with higher levels of debt tend to have CEOs who also owe more on their own homes.
By analysing home purchases and financings among S&P 1,500 CEOs, researchers found a strong positive relationship between personal and corporate debt, even after they took into account a wide variety of factors that could affect either kind of leverage, personal or corporate. The results suggest that the personal attitudes of CEOs toward debt have a strong effect on their firms’ financial decisions.
“It’s not just the characteristics of the firm or the industry that determine a company’s debt choices. Our findings suggest that you have to also look at the personal characteristics of the CEO to fully explain these financial decisions,” said Anil Makhija, co-author of the study and Rismiller Professor of Finance at Ohio State University’s Fisher College of Business.
While other studies have shown how a CEO’s personal characteristics shape management styles and some financial policies at a firm, Makhija said this is the first research to show how CEOs’ personal preferences can impact debt use — one of the most important financial decisions made by a firm.
Of course, that fact isn’t necessarily bad if corporate boards of directors are choosing CEOs because of their personal views on debt, and with the expectation that they will follow those preferences at the company.
To test that theory, the researchers also looked at what happened when firms changed CEOs. They found that firms generally hired new CEOs that were similar to their previous leaders in terms of personal preferences for debt on their homes.
But when boards did select new CEOs that had different personal views on debt than did their predecessors, the firm tended to change its own debt structure in ways consistent with the new CEO.
“So when the new CEO seems to be more financially conservative based on his own personal leverage, the firm tends to reduce its corporate leverage,” Makhija said.
“It is possible that the new CEO was selected precisely to change the firm’s capital structure in this direction.”
The results show that debt tolerance seems to be a strong personal trait that carries over from a CEO’s personal life into his or her work life.
In that sense, the behavior is consistent with the well-known psychological phenomenon of avoidance of cognitive dissonance. In this case, that would mean CEOs try to avoid the discomfort from a conflict between personal and work attitudes towards debt — aggressive in one and conservative in the other.
Reference
The study is available as a working paper at the Social Science Research Network.
