Managerial Attitudes and Corporate Actions

The follow post comes to us from John Graham, Campbell Harvey, and Manju Puri, all of the Fuqua School of Business at Duke University.

In our paper, Managerial Attitudes and Corporate Actions, forthcoming in the Journal of Financial Economics, we use a survey-based approach to provide new insight into the people and processes behind corporate decisions. This method allows us to address issues that traditional empirical work based on large archival data sources cannot. For example, we are able to administer psychometric personality tests, gauge risk-aversion, and measure other behavioral phenomena. Our mode of inquiry is similar to those of experimental economists (who often administer gambling experiments) and psychologists (who administer psychometric tests). As far as we are aware, no other study attempts to measure attitudes of senior management directly through personality tests to distinguish CEOs from others and U.S top level executives from non-US top level executives. We also relate CEO attributes to firm-level policies.

Our survey quantifies behavioral traits of senior executives and also harvests information related to career paths, education, and demographics. We ask these same questions of chief executives and chief financial officers, among public and private firms, and in both the US and overseas. We can thus compare traits and attitudes for US and non-US CEOs to see if there is indeed a significant difference in attitudes. We also ask questions related to standard corporate finance decisions such as leverage policy, debt maturity, and acquisition activity. This allows us to relate attitudes and managerial attributes to corporate actions. We also examine how managerial attributes such as risk-aversion and time preference relate to compensation at the firm level.

We use the survey responses to address the following broad questions. How do US CEOs differ from lay people, and also how do they differ from Chief Financial Officers (CFOs) and non-US CEOs in terms of behavioral and other characteristics? Are managerial psychological traits, career experiences, or education correlated with corporate decision-making? Do behavioral traits such as risk-aversion and time preference explain compensation packages (e.g., is risk-aversion related to lower pay-performance sensitivity as predicted by theory)?

We compare CEOs to CFOs and others in terms of personality traits and career characteristics, as well as make attitude comparisons of CEOs to established norms in the psychology literature. We find that CEOs are much more risk-tolerant than the lay population of similar age profile (studied in Barskey et al., 1997). It is notable that CEOs are also much more optimistic than the lay population as compared to the norms in the psychology literature (Scheier et al., 1994). We find, as might be expected, that CEOs and CFOs have different personal characteristics and career paths. Interestingly, we also find significant differences between CEOs and CFOs in terms of attitudes. In particular, our psychometric tests suggest that CEOs are much more optimistic than CFOs. Our results also suggest that US-based CEOs and CFOs are more optimistic than their non-US counterparts. This provides evidence on one channel through which US and non-US firms differ: their executives differ in terms of attitudes and traits, perhaps a reflection of firms outside the US having different norms or maximizing different objective functions (Allen, 2005).

Our paper focuses on CEOs because they are the principal corporate decision-makers. In particular, we focus on two key areas that CEOs feel they have the most influence on: mergers and acquisitions (M&A) and capital structure (see Graham et al., 2012). We investigate which factors and experiences (e.g., personality traits or career path) of the decision-maker (CEO) affect capital structure and acquisition decisions. We show that these corporate policies are significantly related to the personality traits of executives. For example, we find that companies initiate more mergers and acquisitions when their chief executive is more risk-tolerant. Beyond risk tolerance, one might expect that the level of a chief executive’s optimism might be related to the corporate decisions her company makes. For example, optimistic CEOs might expect that recent profitability will continue into the future, or that the future will be better than the recent past. Consistent with this view and the arguments of Landier and Thesmar (2009), we find evidence that optimistic CEOs use more short-term debt than do firms led by less optimistic CEOs. There is also a growing literature that suggests that males tend to be more overconfident than females. Correspondingly, we find that male CEOs are more likely to have higher debt ratios, and in particular, higher short-term debt ratios than their female counterparts.

We find that firms with high historical or future rates of growth are more likely to be run by risk-tolerant CEOs. These chief executives are likely to be younger. They are also more likely to be taller than average. To the extent that height corresponds to confidence, these results are consistent with more confident, more risk-tolerant, younger CEOs being more likely to run growth companies. We cannot determine the direction of causality between corporate growth and executive personality. Managers may self-select into companies (or companies may hire managers) who have the “right” personality traits for the particular company – what we document is that there is a significant relationship between CEO characteristics and company characteristics.

We also examine the CEOs’ target compensation in terms of the proportion due to fixed salary, and separately, the part that is performance-dependent, i.e., bonus, stock, and options. We find that risk-averse CEOs are significantly more likely to be compensated by salary and less likely to be compensated with performance-related packages. We further find that CEOs who are impatient (i.e., have a high rate of time preference) are more likely to be paid proportionately more in salary. These results are intuitive. Standard agency theory, including both screening/adverse selection models and moral hazard models, predicts a fundamental trade-off between increasing incentives and risk, i.e., the more risk-averse the agent, the more costly it is to provide pay-performance incentives. Despite this, it has been very hard to find support for this prediction in the empirical literature (see, e.g., Prendergast, 2002). Our finding that pay- performance sensitivity actually decreases with risk-aversion is, to our knowledge, one of the first direct pieces of evidence consistent with this theoretical prediction. Further, our findings that differences in time preference are also important for explaining compensation patterns is consistent with standard agency theory but is a prediction that has largely been ignored in the literature. Our results indicate that CEOs are, on average, much less risk-averse than the general population also fits well with this framework. Risk aversion makes incentive pay costly, and increases the participation constraint of the manager. As a result, firms prefer to hire less risk- averse agents as managers, all else equal.

While the survey approach allows us to ask many unique questions, it is not without potential problems. Surveys measure beliefs, not necessarily actions. Perhaps some of the survey questions are misunderstood or otherwise produce noisy measures of the desired trait or characteristic. Moreover, at least for some questions, executives can potentially parrot explanations that they think researchers want to hear, rather than state their true beliefs. In addition, field studies may face the objection that market participants do not necessarily have to understand the reason they do what they do in order to make (close to) optimal decisions. It is also possible that the respondents are not representative of the underlying population, an issue that we investigate below. Given that we conduct our survey at one point in time, it is not possible to determine causation for the most part. For example, we cannot say for sure whether risk-tolerant CEOs use less short-term debt or whether firms that have a policy of using short- term debt attract less risk-tolerant employees. Likewise, in most cases, it is not possible for us to distinguish whether the personality trait causes the corporate policy from whether an executive “learns” a trait on the job, nor can we separate a managerial fixed effect from a company fixed effect. In the latter case, a company might optimally seek out an executive with certain traits due to the needs of the business. Indeed, our results are consistent with such an interpretation.

Even with these considerations, our study provides new insights and contributes to several different research streams. First, we administer the first-ever psychometric tests of sitting executives and provide evidence that US CEOs differ significantly from non-US CEOs in terms of attitudes and attributes, from CFOs, and also from the lay population. The differences in attitudes help provide one possible rationale for differences in firm behavior across countries. Second, we contribute to the literature that investigates whether executives’ characteristics and psychological traits are related to corporate decisions. Third, our results provide direct evidence on a role for risk-aversion and time preference in executive compensation—a result predicted by standard agency theory but one on which direct evidence has been scarce.

The full paper is available for download here.

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