CFI Working Paper
"Superstar CEOs: Why to be Thankful if You're Not on the Cover of Time"
Is there nowhere to go but down after you become a superstar? According to a recent paper by finance professors Ulrike Malmendier (U.C. Berkeley) and Geoffrey Tate (UCLA), downhill appears to be the destiny of firms whose CEOs are "superstars" ? those who have won high-profile awards from the business press or other prominent organizations. The paper investigates the performance of CEOs who are superstars and finds that their companies subsequently underperform, both in terms of stock returns and accounting profits over the one to three years following the award.
Is it possible, though, that we are simply observing mean reversion as opposed to real underperformance? Previous academic papers (DeBondt and Thaler, 1985; Fama and French, 1988 among others) document mean reversion in portfolios of stocks with extreme performance over the past three to five years. In other words, past winners become losers, and vice-versa. Hence, it is plausible that this well-documented pattern of returns is what accounts for the underperformance of firms following CEO awards.
To test for this, the authors construct a control sample of "predicted award winners" ? firms similar to the award winners at the time of each award but ones in which the CEO did not win an award. The matching sample is formed by running a logit regression of CEO awards on firm and CEO characteristics, including size, book-to-market, and prior returns. The long run performance of actual award winners is then compared to that of the "predicted award winners." If the long-run performance of award winners is due to mean reversion, then there should be little difference across the two samples.
The results? Using data drawn from a variety of publications, including Business Week, Forbes, Time/CNN, amongst others, the authors first document that cumulative abnormal returns (CARs) following a CEO award are significantly negative over the three year window beginning five days after publication of the award. The sample period is 1975-2002.
Furthermore, they find that the additional underperformance of award winners relative to their control sample, is both significant and robust, providing evidence for underperformance beyond the effects of mean reversion.
As it turns out, award-winning CEOs are more likely to write books and their memoirs as well as sit on more boards of other firms than in years prior to winning an award. This is documented in a section of the paper entitled, "Distraction." Thus, part of the underperformance may be due to the new opportunities available to the CEO with newfound superstardom. These opportunities, while exciting, may distract him from the business of maximizing shareholder value.
While tournaments may be an effective way to extract maximal effort from executives, they do not appear to be the best mechanism for ensuring high performance after widespread recognition, such as winning a prestigious award. A question remains whether any such mechanism exists, or if human nature prevents any successful design.
As Mark Twain said, "?a man is a human being, and that is enough for me; he can't be any worse." - P. Yang
>>Read the paper, "Superstar CEOs" by Ulrike Malmendier and Geoffrey Tate (PDF)
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Joan Payden, CFA, is the President and CEO of Payden & Rygel, the global investment management firm that she founded in 1983. At Payden & Rygel, Joan has overseen the firm's international expansion and its growth to more than $50 billion in assets under management. In 1992, the firm launched Payden & Rygel Investment Group, a family of mutual funds, of which she is Chairman and CEO. Prior to founding Payden & Rygel, Joan was managing director of West Coast operations for Scudder, Stevens & Clark as a national partner of the firm.
Laurence D. Fink is the Chairman and CEO of BlackRock, an investment management firm that has in excess of $1.2 trillion under management. He is Chairman of BlackRock's Executive and Management Committees, as well as Chairman of the Board of Nomura BlackRock Asset Management, BlackRock's joint venture in Japan, and several of BlackRock's alternative investment vehicles. Prior to founding BlackRock in 1988, Larry was a member of the Management Committee and a Managing Director of The First Boston Corporation.
Robert Arnott, founder and CEO of Research Affiliates, established the firm in 2002 as a research-intensive asset management firm. Over $20 billion in assets are managed using investment strategies developed by Research Affiliates. A widely published financial thinker, Rob has been a frequent contributor to leading financial journals and books, including the Financial Analysts Journal, the Journal of Portfolio Management, the Harvard Business Review, amongst other respected journals. Rob is Editor Emeritus at the Financial Analysts Journal and former chairman of First Quadrant, LP, where he developed quantitative asset management products. He also served as global equity strategist at Salomon Brothers (now part of Citigroup), the president of TSA Capital Management (now part of Analytic), and as a vice president at The Boston Company (now PanAgora).
Edward Wedbush is the CEO of Wedbush Morgan Securities. Ed was fresh out of college when he and partner Robert Werner each pooled $5,000 to open the first office of Wedbush & Co. on Crenshaw Boulevard in 1957. A half century later, Wedbush Morgan Securities is worth more than $200 million and ranks as one of the top correspondent clearing services in the United States, executing trades for hundreds of small broker-dealers. At 73, Ed still gets to the office every day at 5:45a.m. and spends several hours on the firm's trading floor, gauging the market in front of a bank of computer monitors. His interest in stocks began when he made his first investment at the age of 17.
YuZhao Zhang is the recipient of the CFI 2006-2007 dissertation fellowship. The dissertation fellowship is awarded each year to an outstanding doctoral student performing interesting and relevant research. Before joining the doctoral program in finance at UCLA Anderson, YuZhao completed his master's degree in mathematical finance at the New York University Courant Institute. His current research interests include the information efficiency of financial markets and the behavior of institutional investors. One of his recent working papers focuses on the relative information efficiency of the stock market and the derivatives market, a subject that has been long debated among researchers and practitioners. Using data from the U.K., he and co-authors Rossen Valkanov and Pradeep Yadav find that information in the options market leads the underlying FTSE 100 index for up to three days. More specifically, they can predict the FTSE 100 index for up to three days using American options' early exercise premium. Their evidence supports Black's (1975) famous conjecture that informed investors prefer to trade on their superior information in the options market rather than in the underlying asset market. Download the paper (PDF).
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Hanno Lustig, UCLA
Alex Edmans, MIT
Adair Morse, Michigan
Bruce Carlin, Duke
Dimitris Papanikolaou, MIT
Hui Chen, University of Chicago
Nikolai Roussanov, University of Chicago
Christopher Malloy, London Business School
Ning Zhu, UC Davis
Pete Kyle, University of Maryland
Massimo Massa, INSEAD
Todd Milbourn, Washington University
Xavier Gabaix, MIT
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