Suspect CEOs, Unethical Culture, and Corporate Misbehavior

Lee Biggerstaff

Miami University of Ohio – Department of Finance

David C. Cicero

University of Alabama – Culverhouse College of Commerce & Business Administration

Andy Puckett

University of Tennessee, Knoxville

Journal of Financial Economics (JFE), Forthcoming


We show that firms with CEOs who personally benefit from options backdating are more likely to engage in other corporate misbehaviors, suggestive of an unethical corporate culture. These firms are more likely to commit financial fraud to overstate earnings. They acquire more private companies, which could perpetuate their frauds, and their acquisitions are met with lower market responses. These misbehaviors are concentrated in firms with externally-hired suspect CEOs, consistent with outside CEOs having greater discretion to shape firm culture. The costs of these misbehaviors are reflected in larger stock price declines during a market correction and increased CEO replacement.

Suspect CEOs, Unethical Culture, and Corporate Misbehavior – Introduction

Scandals at firms such as Enron, WorldCom, Tyco, and HealthSouth exposed numerous corporate executives who were complicit in perpetuating fraudulent activities that ultimately resulted in billions of dollars in shareholder losses. As a result, the topic of business ethics is receiving a dramatic increase in attention from the U.S. legislature, regulatory bodies such as the Securities and Exchange Commission (SEC), the popular press, and business schools around the world. Of particular importance in the current dialogue is an understanding of (and potential means to mitigate) the forces that drive firms to mislead investors and cause the misallocation and destruction of scarce societal resources.

Anecdotal evidence suggests that fraudulent firms are often characterized by an unethical culture that permeates a nexus of employees, whose cooperation is necessary to perpetrate extensive corporate malfeasance (Langevoort, 2006). For instance, approximately thirty employees at Heathsouth and Peregrine Systems were convicted or pled guilty to charges related to financial statement fraud. But where does an unethical culture originate? The above quotation by Linda Thomsen, a former head of the Division of Enforcement at the SEC, represents a seasoned insiders’ view that an unethical culture emanates from the actions and attitudes of those at the very top level of corporate leadership; in particular the CEO. Her top-down perspective is echoed in the influential academic “upper echelons theory” of corporate behavior (Chatterjee and Hambrick, 2007; Hambrick 2007). While numerous prior studies provide support for the upper echelons theory by establishing a relationship between certain executive characteristics and the economic outcomes of the firms that they manage (e.g., Bertrand and Schoar, 2003), 1 there is a clear deficiency of empirical work focused on the ethical dimension of a corporate culture.

The dearth of empirical work in this area could stem from the fact that the ethical values of corporate executives are difficult to empirically quantify. In this paper, we attempt to test whether executives with questionable ethics lead their firms to engage in broader corporate malfeasance. We propose a novel way to identify an unethical pattern of behavior, based on systematic participation in options backdating. In Section 2 we review employee stock option backdating practices at many U.S. firms in the 1990s and early 2000s. We submit that many of these cases are reasonably characterized as stealth activities undertaken by executives for their own personal gain and at an economic cost to other parties. However, we also recognize that there are disparate views regarding the ethics of backdating in general, and acknowledge that specific actions in some individual cases were not obviously inappropriate. On balance, we offer that it is reasonable to test our hypotheses using systematic participation in options backdating to identify executives with questionable ethics; although we concede that one could interpret our results with caution if they disagree with this characterization.

Suspect CEOs, Unethical Culture, Corporate Misbehavior

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