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Gauging the Performance of CEOs from Nonprofits and Government

Some troubling signs are found on the financial front when CEOs’ experience comes from beyond the corporate world.

Title: In Search of Responsible CEOs: The Case of CEOs with Non-Profit Experience (Fee or subscription required)

Author: Stanley Peterburgsky (Polytechnic Institute of New York University)

Publisher: Journal of Business Research, vol. 65, no. 9

Date Published: September 2012

Does having a background in the nonprofit world or in government make a difference in running a for-profit company? In terms of financial management, the answer appears to be yes, according to this paper, which takes a dour view of the performance of this group of executives.

A sample of companies run by CEOs with experience outside the for-profit sector issued twice as many financial restatements during the period under study as did comparable firms led by executives who had always been in the corporate world, the author found — and almost all of the revisions were negative, an unsettling indicator of lax controls. The sample companies also suffered significantly steeper declines in stock returns after being named in class-action lawsuits.

In the wake of the financial downturn, as investors continue to search for ways to ensure that their wealth is in safe hands, little research has explored the relationship between CEOs’ prior nonprofit and government work and the financial reliability of the for-profit firms they go on to lead. This paper addresses the question by advancing and testing two competing hypotheses.

The first, a compensation hypothesis, holds that CEOs with nonprofit or government experience should be less likely to oversee fraudulent activities because people taking jobs in those sectors usually aren’t in it for the money. (Prior studies have shown that nonprofit and government lawyers earn about 15 percent less, and CEOs and COOs of nonprofit hospitals about 25 percent less, than their counterparts in the for-profit world.) According to this view, these individuals would be less likely to commit white-collar crimes.

On the other hand, an accountability hypothesis posits that the often “bureaucratic and chaotic” nature of nonprofit and government work tends to attract or mold leaders with less-than-optimal managerial skills. Several prior studies have shown that nonprofit nursing homes and hospitals operate less efficiently than their for-profit counterparts. In the nonprofit world, some have argued, the need to satisfy multiple stakeholders, rather than concentrate on maximizing profits, tends to bog operations down in red tape. Therefore, the thinking goes, nonprofit experience could lead to the development of subpar managerial habits.

To find out which argument might carry weight, the author examined all firms in the Center for Research in Security Prices and ExecuComp databases, which cover companies in the S&P 1500. Using data from Bloomberg, the author identified CEOs with prior nonprofit or government experience as of 1999 (a year when more comprehensive data became available) and tracked the performance of their for-profit firms from 1996 through 2005.

The resulting sample contained 90 CEOs who headed 91 corporations (one CEO served in two firms), with a combined market value of more than US$1.4 trillion at the end of 1999. Most of these CEOs had moved into the corporate world after working at universities and government agencies; a few had previously been employed by nonprofit hospitals, labs, and foundations.

The author paired the companies in the sample with a set of control firms, matching them in market capitalization, specific industry, and book-to-market value. In line with previous research, the author examined financial restatements, using data from the U.S. Government Accountability Office and using class-action lawsuits as proxies for corporate negligence.

The author controlled for 20 variables that have been shown to affect financial disclosures, including leadership, board characteristics, and the length of an auditor–client relationship. The analysis showed that companies led by a CEO with a nonprofit or government background were significantly more likely to revise their financial statements than those headed by a CEO with exclusively corporate experience.

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