Bottom Line: Older CEOs, who tend to make more conservative decisions, can be ideal stewards for firms seeking stability. But younger CEOs’ willingness to take on risky projects can pay off for shareholders in the long run.
In 2006, at only 30 years old, Michael Reger raised US$3 million from family and friends to help found Northern Oil & Gas Inc. The young CEO wanted to use breakthrough technologies such as fracking to drill in far-flung regions of North Dakota and Montana. Although his strategy has been criticized as a move that no older, (presumably) wiser CEO would make, the gamble paid off for the fledgling company: It unearthed huge oil reserves in the previously unexplored but now booming area.
Certain personal traits of CEOs have been shown to influence their firms’ strategic direction. The personal experiences they bring to the job, their confidence in their own abilities, and their tolerance for carrying debt, for example, can inform their professional decisions about financing and risk taking. Yet despite the prominent rise of younger CEOs like Facebook’s Mark Zuckerberg and Google’s Larry Page, researchers have so far failed to compile evidence for the influence of an even more obvious characteristic: a CEO’s age.
Some have speculated that younger CEOs, still building a reputation for their managerial ability, are more likely to avoid risky initiatives. They typically take a more conservative tack toward investments, the thinking goes, because they fear that a bold move could backfire early in their career and derail their future prospects. Others, however, have suggested that less mature CEOs, like Reger, want to signal their ambition by readily plunging into projects laced with both great uncertainty and huge potential.
The author of a new study analyzed firms on the S&P 1000 from 1992 through 2010 to determine whether age affected a CEO’s likelihood of championing risky endeavors. Combining several databases, the author scrutinized more than 2,300 companies and 4,400 CEOs, whose average age was 55. After controlling for several company and CEO characteristics, and using the firms’ stock price volatility as a proxy for its level of risk, the researcher found that CEOs do take fewer risks as they grow older. In fact, a 25 percent increase in a CEO’s age tends to drive down a firm’s stock return volatility by more than 4 percent.
How do these more cautious policies manifest themselves? For starters, older CEOs invest less in R&D and work harder to shed debt. (A 25 percent increase in a CEO’s age implied a decrease in R&D costs of 8 percent, the author found, and a reduction in operating leverage of almost 13 percent.) Companies headed by these CEOs also tended to dilute danger by diversifying their interests: A 25 percent increase in a CEO’s age corresponded to the operation of about five more separate business units for the firm. Even when acquiring other firms, older CEOs bought more diversified companies.
The CEO isn’t the only decision maker in the executive suite, and the author found that age played a powerful role even among his or her colleagues. Executives in the same age range as their CEO backed up the low-risk attitudes of their bosses: stock price unpredictability, R&D costs, operating debt, and financial leverage were lowest at firms where both the CEO and the next most powerful executive were older, and they were highest at companies with a younger CEO and similarly aged second-in-command. The author also found that less risk-taking companies tended to hire older (and thus more conservative) CEOs, whereas their more adventurous counterparts typically chose younger chief executives.
Investors pay close attention, as well. When firms with more stable market activity and less debt bring aboard a CEO who is younger than his or her predecessor, company stock returns tend to sink around the time of the succession news—presumably because shareholders anticipate that the less-experienced executive will chart a riskier course. And although that may be true in the very short term, sticking with the younger CEO seems to pay off later on: The author calculated that the risk-adjusted portfolios of companies helmed by the youngest CEOs in the sample outperformed those headed by their oldest peers. After all, older managers might be wary of changing the status quo for a variety of reasons. They may fear that making a sudden shift in their investment patterns will imply to others that their history of decision making has been faulty; they could simply be too personally financially secure to change what they’re doing; or they might be unwilling to tackle new ideas.
So although companies have used stock options, pension benefits, and deferred compensation as methods to control the risks taken by their CEOs, this study suggests that they should also pay attention to their leaders’ ages. Already, some of the biggest, fastest-growing companies in the world are ready to embrace risk by entrusting their fortunes to the younger set. In 2012, for example, Yahoo Japan appointed a 44-year-old CEO and a team of seven younger subordinates to its management team. As one key shareholder said, “It's important [for management] to stay young.” And the outgoing CEO agreed. “To take the next step, we need to focus more on offense rather than defense,” he said.
Source: CEO Age and the Riskiness of Corporate Policies, by Matthew A. Serfling (University of Arizona), Journal of Corporate Finance, Apr. 2014, vol. 25