A number of recent studies have focused on how the behavior of chief executives affects their firms’ financial decisions. We contribute to this literature by looking at the connections between CEOs’ personal finances and those of their firms. Unique data from the Finnish tax authorities allow us to examine these connections in detail. Our dataset contains information on the personal indebtedness and personal securities holdings of CEOs of all publicly-traded firms in Finland. We avoid the challenges typical of U.S. studies, where the data limit the analysis of managers’ wealth to their stock and option awards.
Our analysis finds a positive link between the market risk of a firm and that of its CEO’s personal portfolio. We also find that connection to be weaker in firms that have powerful block-holders among their shareholders, suggesting that shareholders may not benefit when there is correlation between a CEO’s personal risk taking and that of the firm. Our results further indicate that when a manager’s personal wealth is closely tied to his firm’s, he becomes more risk averse. Interestingly, CEOs’ demographic characteristics are also reflected in how much risk their firms take. Wealthier CEOs tend to run firms that tolerate more risk, and the level of risk drops as the CEO’s tenure lengthens. These findings suggest that Finnish managers’ risk aversion decreases with wealth, in both absolute and relative terms. The small size of Finnish CEOs’ stock portfolios limits the depth of our analysis.
Our study yields a number of interesting conclusions. In aggregate, the CEO’s personal indebtedness is strongly linked to her firm’s capital structure, measured by book leverage and market leverage. When we consider the determinants of that relationship, we find that only powerful CEOs exhibit that connection. Obviously, less powerful CEOs would find it more difficult to impose their personal preferences on firm behavior. According to our results, either a dual role as chairman and a CEO or longer CEO tenure seems to be a prerequisite for the connection. When we conduct our analysis separately for sub-samples of powerful and weak CEOs, we find that the connection between personal leverage and firm leverage does not exist in firms where the CEO does not serve a dual role, and in firms where the CEO has been in office for less than our sample median of four years. Our finding related to tenure is also consistent with earlier studies, which find that changes in corporate capital structure happen slowly. As in the study of wealth portfolios, we find that the level of personal wealth tied to the firm weakens the relationship between personal finances and firm finances. That is consistent with the idea that in the presence of strong economic incentives, behavioral preferences of the manager become muted.
Establishing direction of causality is a typical concern in studies of the connections between CEOs and their firms. The question is whether CEOs’ personal preferences determine the firm’s financial decisions, or whether firms recruit managers whose personal preferences match those of the firm. We find, for instance, that the personal financial attributes of newly-appointed CEOs often deviate significantly from those of the firm and their predecessors. That finding supports the notion that CEOs make the firm behave according to their personal preferences, instead of firms choosing managers whose preferences match those of the firms.
Our findings have important implications for corporate governance. As measured by personal investment portfolios and use of personal debt, we find support for the notion that CEOs impose their personal preferences on their firms’ financial decision-making. We further find that such behavior is most prevalent in companies with weaker corporate governance, as CEO power and lack of shareholder power strengthen the matching relationship. Our results suggest that firms should pay attention to their CEOs’ personal preferences, and either limit their power to make financial decisions or hire managers whose priorities match those of the firm and its shareholders.
This post comes to us from professors Timo P. Korkeamaki, Eva Liljeblom, and Daniel Pasternack at the Hanken School of Economics and, in Mr. Pasternack’s case, Elite Alfred Berg / Elite Asset Management Plc. It is based on their recent papers, “CEO’s total wealth characteristics and implications on firm risk,” available here, and “CEO power and matching leverage preferences,” available here.