What Doesn’t Kill You Will Only Make You More Risk-Loving: Early-Life Disasters and CEO Behavior
Singapore Management University – Lee Kong Chian School of Business
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University of Oregon
P. Raghavendra Rau
University of Cambridge
September 1, 2015
The literature on managerial style posits a linear relation between a CEO’s past experiences and firm risk. We show that there is a non-monotonic relation between the intensity of CEOs’ early-life exposure to fatal disasters and corporate risk-taking. CEOs who experience fatal disasters without extremely negative consequences lead firms that behave more aggressively, whereas CEOs who witness the extreme downside of disasters behave more conservatively. These patterns manifest across various corporate policies including financial leverage, cash holdings, and acquisition activity. Ultimately, the link between CEOs’ disaster experience and corporate policies has real economic consequences on firm riskiness and cost of capital.
What Doesn’t Kill You Will Only Make You More Risk-Loving: Early-Life Disasters And CEO Behavior – Introduction
“I know of no one who has achieved something significant without also in their own lives experiencing their share of hardship, frustration, and regret…if you’re like me and you occasionally want to swing for the fences, you can’t count on a predictable life.” Tim Cook, CEO of Apple Inc., Auburn University Spring 2010 Commencement
Chief executive officers’ (CEO) managerial styles explain a large fraction of the variation in firm capital structure, investment, compensation, and disclosure policies (e.g., Bertrand and Schoar (2003), Bamber, Jiang, and Wang (2010), Graham, Li, and Qiu (2012)). Moreover, the evidence indicates that at least part of the heterogeneity in CEOs’ managerial styles reflects the variation in individual life and career experiences (e.g., Graham and Narasimhan (2005), Malmendier and Tate (2005), Malmendier, Tate, and Yan (2011), Benmelech and Frydman (2014), Lin, Ma, Officer, and Zou (2014), Schoar and Zuo (2013), Dittmar and Duchin (2015)).
A common thread underlying this line of research is the existence of a monotonic relation between treatment and effect. Specifically, existing studies indicate that exposure to a particular macroeconomic, personal, or career-specific event has a unidirectional effect on risk-taking by the CEO and consequently on corporate policies. In this study, we test whether the intensity of early-life experiences has a non-monotonic impact on CEOs’ attitudes toward risk and thus on the corporate policies that they influence. In medical terms, this is the possibility that the strength of the dosage, in addition to whether a treatment is administered, also affects the outcome of the treatment. This hypothesis, relatively unexamined in the finance and economics literature, is a standard prediction in the psychiatry literature (e.g., Yerkes and Dodson (1908)).
Early-life exposure to the consequences of environmental risk may affect a CEO’s risk-taking in several ways. CEOs with exposure to fatalities from natural disasters may be more sensitized to the consequences of risk, and therefore be wary of decisions that increase firm risk. However, it is also plausible that childhood exposure to natural disasters may give the CEOs experience in dealing with risky situations and increase their confidence when making decisions involving firm risk. Hence, the effect of exposure to natural disasters on subsequent behavior may be non-monotonic, as Castillo and Carter (2011) find with respect to trust and reciprocity between individuals. CEOs with disaster experience that is not significantly fatal would develop a higher risk tolerance, whereas those with exposure to major fatal disasters would be sensitized to the negative consequences of risk and therefore tend to behave more conservatively.
To test this conjecture, we examine the relation between CEO early-life exposure to fatal disasters and subsequent corporate financial and investment policies adopted by the firms that employ the CEOs. Specifically, we identify the name, date, and place of birth of 1,711 U.S.-born CEOs in a sample of S&P1500 firms from 1992 to 2012. We also assemble a unique database of U.S. county-level natural disaster events over the period 1900–2010, including earthquakes, volcanic eruptions, tsunamis, hurricanes, tornadoes, severe storms, floods, landslides, and wildfires. Then we combine the two databases to infer the CEOs’ likely exposure to the consequences of natural disasters during their formative years, i.e., age 5 to 15 (Nelson (1993)).
In our baseline tests, we group CEOs based on the number of disaster-related fatalities scaled by the birth-county population during the formative years of their childhood. We then examine the relation between CEO early-life disaster experience and several firm decisions and outcomes pertaining to capital structure, acquisition activity, and return volatility.
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