Military CEOs

The following post comes to us from Efraim Benmelech and Carola Frydman, both of the Finance Department at Northwestern University.

In our paper, Military CEOs, forthcoming in the Journal of Financial Economics, we examine the effect of military service of CEOs and managerial decisions, corporate policies, and corporate outcomes. Service in the military may alter the behavior of servicemen and women in various ways that could affect their actions when they become CEOs later in life. Militaries have organized, sequential training programs that combine education with on-the-job experience and are designed to develop command skills. Evidence from sociology and organizational behavior research suggests that individuals may acquire hands-on leadership experience through military service that is difficult to learn otherwise and that they may be better at making decisions under pressure or in a crisis (Duffy, 2006). It is possible, therefore, that military CEOs may be more prepared to make difficult decisions during periods of industry distress. Moreover, military service emphasizes duty, dedication, and self-sacrifice. The military may thus inculcate a value system that encourages CEOs to make ethical decisions and to be more dedicated and loyal to the companies they run rather than pursue their own self-interest (Franke, 2001).

On the other hand, a large literature in psychology finds that military service leads to aggressiveness, overconfidence, and increased risk-taking. Thus, evidence from other disciplines does not provide clear-cut predictions on how service in the military affects individual decision-making later in life.

We find that firms run by military CEOs invest less, have lower expenditures on research and development (R&D), and pursue slightly lower leverage ratios than their nonmilitary peers. We do not find effects on other variables intended to capture investment and financial policies, such as acquisitions and dividend payments. Our findings, therefore, are suggestive but not conclusive of an association between military CEOs and more conservative investment and financial policies.

While the psychology and organizational behavior literature does not provide clear guidance for the effects of military background on the aforementioned policies, it does suggest that the military may instill a stronger sense of ethics. Consistent with the findings in this literature, we find that CEOs with military experience are significantly less likely to be involved in corporate fraudulent activity compared to CEOs who have not served in the military. Our estimates indicate that military service is associated with a 70% reduction in the likelihood of fraud compared to the unconditional mean. When we run a horse race between the effect of an MBA education and military experience on fraud, we find again that military experience—but not business education—is associated with fewer incidents of alleged financial fraud.

We also consider the effect of military background on CEO performance under pressure. We find that CEOs with a military background tend to perform better during periods of industry distress, as evident by higher market-to-book ratio. Thus, the management style of CEOs who served in the military appears to be more resilient to crisis and fraud in ways that do not seem to be provided to the same extent by academic programs in business schools.

Although we would like to interpret our findings as evidence for a direct effect of service in the military on executive decisions, our results could reflect unobserved personal characteristics correlated with both military service and corporate policies. Moreover, our estimates may be biased downward due to measurement error in determining military service. To alleviate some of these concerns, we use an instrumental variables (IV) strategy. We exploit the fact that demand for manpower during wartime exogenously increases the likelihood of service among certain cohorts. Results from approaches using variation in year of birth for the entire sample or from discrete changes in the likelihood of being drafted during the Korean War are consistent with most of our ordinary least squares (OLS) findings: we document negative correlations between military service and investment and R&D expenditures, as well as a positive correlation between military service and performance in times of industry distress.

It is important to note that military experience may relate firm outcomes through two possible channels. First, firms with a need either to reduce investment and R&D expenditures or to minimize the incidence of corporate fraud may choose to hire a CEO with military experience for this purpose. Alternatively, military background may not be part of the selection criteria in choosing a CEO. Under this scenario, the imprinting of military service exogenously affects executive decisions and is therefore reflected in corporate policies. These two interpretations are consistent with an effect of military experience on firm outcomes, whether by a matching mechanism or through random assignments.

The instrumental variables approach suggests that the sorting of future CEOs into military service due to unobserved innate characteristics does not drive our findings, but it cannot address a concern about the selection of military CEOs into particular firms. We control for industry fixed effects in all of our specifications, so our results are unlikely to be driven by specific trends in industries that disproportionately hire military CEOs. However, the low incidence of changes in the military type of the chief executives within firms does not allow us to control for firm fixed effects. We thus cannot rule out that our estimates reflect the sorting of military CEOs into firms with more conservative investment and financial policies, as well as lower incidence of fraud, within industries. We therefore urge caution when interpreting our results, which suggest that there is an association (but not necessarily a causal relation) between military experience and a variety of firm outcomes.

Our paper is related to a growing literature in corporate finance emphasizing the importance of the person in charge of an organization for a firm’s decisions and performance (Graham and Narasimhan, 2004, Malmendier and Tate, 2005, Pérez-González, 2006, Bennedsen et al., 2007, Bennedsen et al., 2008, Schoar and Zuo, 2011 and Kaplan et al., 2012). Likewise, Bertrand and Schoar (2003) show that top executives have person-specific managerial styles that contribute to differences in performance, financial, investment, and other organizational policies across firms. Understanding which experiences and individual traits shape these managerial fixed effects remains an open question. This paper explores the possibility that CEOs’ life experiences help shape the type of manager they will become and the type of firms they will lead by focusing on whether chief executives with a military background behave differently than their nonmilitary peers. Our paper is, therefore, complementary to Malmendier, Tate, and Yan (2011), who find that having lived through the Great Depression or served in the military affects CEOs’ financial decisions.

More broadly, our paper adds to the literature that emphasizes the role that culture plays in economic activity (Guiso et al., 2006, Guiso et al., 2008 and Tabellini, 2008), and, in particular, to the role that culture and ethics play in the theory of the firm (Kreps, 1990 and Erhard et al., 2007) and in corporate governance and valuations (Edmans, 2011 and Guiso et al., 2013).

The full paper is available for download here.

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