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Don’t Sweat the Swanky Stuff

Matt Palmquist

Matt Palmquist is a freelance business journalist based in Oakland, Calif.

 

Bottom Line: C-suite executives with criminal records in their personal lives are more likely to commit fraud than their law-abiding but free-spending counterparts.

In an era of considerable distrust of corporations, popular culture is littered with depictions of wealthy CEOs living glamorous lives or indulging in questionable pursuits. Such portrayals also imply a certain devil-may-care attitude that could well spill over into the professional realm. But does a correlation really exist between top executives’ out-of-office behavior and their financial accountability at work?

According to a new study, executives who value fancy cars and sprawling mansions don’t necessarily lead their firms down a similarly indulgent path. CEOs and CFOs with criminal records, however, can have a decidedly deleterious effect on their companies’ fiscal integrity.

The authors combined several databases to construct a sample of firms on the S&P 1000 whose top executives had recently been accused of fraudulent corporate reporting charges by the U.S. Securities and Exchange Commission (SEC). They also compared each malfeasant company with a similarly profiled compliant firm.

Drawing on criminology research, the authors examined the relationship between executives’ professional accountability and any recent legal transgressions, including drug offenses and domestic violence. Similarly, the authors used research on psychology and management to consider how executives’ desire for luxury items — commonly interpreted as a sign of low frugality and weak self-discipline — affected their professional accountability. They also looked at county, state, and federal databases to determine whether the executives had bought expensive cars, boats, or homes within a year before an SEC complaint.

The authors found that CEOs and CFOs with recent legal violations in their personal life had a much higher propensity to perpetrate professional fraud. Whereas 20 percent of the CEOs in the fraud group had criminal records, only 4.6 percent of CEOs at non-fraudulent companies did. And the criminal executives tended to perpetrate their crimes independently of other insiders at the firm or a lax corporate governance culture.

CEOs with personal legal violations had a much higher propensity to perpetrate professional fraud.

In contrast, less frugal but law-abiding executives generally ran a tight ship. The authors did uncover a subtle red flag, though: CEOs who spent profusely in their personal lives tended to preside over a corporate setup that gradually experienced an uptick in other executives’ being named in fraud cases and reporting errors — crimes perhaps perpetrated by executives wanting to follow in the footsteps of their free-spending CEOs. This was accompanied by shifts in corporate culture that saw an increase in executives’ equity-based pay plans, less efficient board oversight, and the appointment of less disciplined CFOs.

The findings raise some intriguing questions. Could the behavior of self-indulgent or miscreant executives be curbed by offering them incentive packages that make it worthwhile, financially, to toe the line? Should boards of directors delve deeper than normal into potential candidates’ personal lives and criminal records before hiring them for top spots, and prize those with a relatively austere background? At the very least, the study points to a direct connection between certain personal behaviors and professional behaviors that could make all the difference for leading firms.

Source:Executives’ ‘Off-the-Job’ Behavior, Corporate Culture, and Financial Reporting Risk,” by Robert Davidson (Georgetown University), Aiyesha Dey (University of Minnesota), and Abbie Smith (University of Chicago), Journal of Financial Economics, July 2015, vol. 117, no. 1

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Don’t Sweat the Swanky Stuff