Does a CEO’s penchant for personal thrill-seeking have any relationship to their companies’ corporate policies and risk? That’s what professors Matthew Cain of the University of Notre Dame and Stephen McKeon of the University of Oregon set out to find in their study “Cleared for Takeoff? CEO Personal Risk-Taking and Corporate Policies.” Their study included a group of CEOs identified as “risk-taking” based on their possession of small-aircraft-pilot licenses, as shown by Federal Aviation Administration data.
Below is a question-and-answer interview with Cain.
What are the differences between a risk-taker and an “overconfident” CEO? Are the acquisitions and other actions led by risk-taking CEOs generally successful?
An “overconfident” CEO is one who has too much faith in his or her own capabilities. Prior research has measured overconfidence in several ways. First, overconfident CEOs believe that their company’s stock price will perpetually rise under their leadership. Thus, they tend to habitually purchase their own firms’ stock despite the underdiversification this creates in the CEOs’ portfolio of wealth and future earnings. They also tend to delay the exercise of vested options, believing that the options will continue to rise in value over time. Second, overconfident CEOs tend to portray themselves in media articles as being very “optimistic” or “confident.”
In contrast, sensation seekers tend to exhibit novelty-seeking behavior. This often involves the pursuit of risks for the sake of stimulation, but the pursuit of risk in and of itself is typically not the ultimate objective. These individuals do not necessarily have a self-attribution bias whereby they believe everything they touch will turn to gold. However, some individuals may be both sensation seekers/risk-takers and overconfident. This could be a dangerous combination for a firm’s leader. … I would expect these types to engage in value-destroying acquisitions and other forms of suboptimal corporate activity.
Our research finds that in general, sensation-seeking CEOs are associated with value-creating acquisitions when they are employed at firms with few recognizable growth opportunities. It looks like these CEOs are able to use their creativity to find value where nobody else sees it, and that is good for their firms and ultimately shareholders.
Does it seem that “sensation-seeking” CEOs are leaving their mark on corporate policies or are boards pushing CEOs to lead their companies to take bigger risks?
Ultimately, this is a very difficult question to answer. If boards push individuals to take on bigger risks, one might expect them to incentivize this type of behavior through greater use of contingent compensation, i.e. stock and options grants. We don’t see this going on with the risk-taking CEOs, so it looks like the CEOs make their own mark on firms and corporate policies. Also, company policies tend to change when the sensation seeking CEOs take office, and then revert back when these CEOs exit. This implies a transient effect related to the CEOs and not to the more stable boards.
One caveat to this is that if a board desires a more risky corporate policy and they know that certain individuals are more comfortable taking on risk, they may not need to incentivize them through compensation structure. Hence it is difficult to conclusively state whether the policy changes represent the desires of the CEOs, the boards or some combination of the two.
Does compensation have any effect on a CEO’s risk-taking in the professional realm?
In general, compensation can be an effective tool in aligning CEO behavior with the desires of directors and shareholders. If the firm’s owners desire a more risky path, they can encourage this by granting the CEO more stock and options, which increase in value when the firm successfully takes on risky projects. But compensation is also a blunt tool when trying to accomplish this. Think of all the CEOs who were fired when the company’s performance tanked, but were still able to walk away with tens of millions of dollars in severance pay. It can also be difficult to induce risk-averse CEOs to adopt risky investments when they know their job is on the line if the investment doesn’t pan out. That’s why it can be useful to identify individuals who are more comfortable taking on risk. For them, it may be less important to structure the perfect risk-inducing compensation scheme. They are already willing to go out and make risky bets without any additional incentives.
How did you decide to use the small-aircraft-pilot licenses as an indicator of personal risk-taking behavior that could extend into the C-suite and corporate policy? Can companies and boards use other traits or behavior patterns to determine risk-taking tendencies in leaders?
Sensation seekers exhibit numerous forms of risk-taking behavior. Piloting is only one of them. We focused on piloting because we were able to take a large sample of several thousand CEOs and determine whether each one of them pursues flying as a hobby. The FAA provides a public database of airmen certificates, so that’s why we chose this behavior. It would be interesting to observe all other forms of risk-taking, from sky-diving to skiing. But we don’t have access to that sort of private information.
Directors can determine the risk-taking tendencies of candidates during the screening process. One way is through driving records. Sensation seekers are much more likely to have speeding tickets. A second way is through behavioral interviewing techniques and psychological profiling. Many private equity firms already do this when hiring CEOs. If the board thinks a certain character trait is either important or undesirable, they can ask questions or give surveys to get a sense of where a candidate lies on that spectrum.