Narcissist CEOs like risky insider trading and are bad at it: study

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Imagine a CEO who’s kind of an asshole. You know the type: self-centred, lacking concern for others, demanding admiration. They use company announcements to exercise hobby horses and litter every conference call with references to themselves.

Now imagine their company is doing well. Sales are up, earnings expectations are rising, long-term investors are happy, sentiment is good. Then, apropos nothing, the kind-of-an-asshole CEO sells some shares. What could it mean?

That’s the question asked by “CEOs’ Narcissism and Opportunistic Insider Trading”, a paper published in this month’s Journal of Corporate Finance. Its authors consider two possibilities. There’s the “inflated ego hypothesis”, where the CEO overestimates the significance of non-public information and is blasé about the potential legal consequences. Then there’s the “reputation protection hypothesis”, where the CEO’s vanity has been overwhelmed by their greed.

Option two makes sense. Confidence and charisma come naturally to narcissists, whereas perceptions of integrity have to be earned. A sufficiently self-aware narcissist CEO would shy away from anything that looks dodgy because they prioritise public image, reputation, and prospects for career advancement. It follows that, if they are trading opportunistically, it will be only occasional and the non-public information they have acted on will prove significant.

Unfortunately, it’s option one. Narcissist CEOs place more legally questionable trades and their dealings are much less informative about future share price performance, the study concludes.

“We find that CEOs with a higher level of narcissism engage in opportunistic (non-routine) insider trading more intensely,” Cheng Jiang of Boston College, the paper’s lead author, told FT Alphaville. “We also find that the impact of CEOs’ narcissism on opportunistic insider trading is more pronounced among CEOs with limited legal knowledge, facing weaker external and internal monitoring pressure, working at larger firms, and being male.”

The method involves scoring CEOs for narcissism based on the number of first-person pronouns they use during the Q&A section of earnings calls, with a backtest of total compensation relative to the next highest-paid executive. CEOs are marked as narcissists if their narcissism score surpasses the annual median within the same industry.

CEOs rarely have to buy in the open market as they are paid in stock, so the study concentrates on insider sales. If a CEO’s sale doesn’t repeat in the same month for three consecutive years, it’s classed as opportunistic.

It identifies a clear correlation between egotism and the inclination to do risky business, with a one-unit increase in a CEO’s narcissism score corresponding to a 48.2 percentage point increase in the intensity of their opportunism (meaning the amount they sell relative to their total holding). Some 38 per cent of share trades by narcissistic CEOs are classified as opportunistic, compared with 32 per cent for the rest.

Ego-driven risky trading is exclusively a male thing, with the paper finding no association between narcissism and opportunism among female CEOs. It’s also a big-company thing, maybe because “the greater number of board members and executives within larger firms provides cover for the insider trading activities of the CEO,” the authors suggest.

Opportunism is less pronounced among narcissist CEOs who have a law degree, or who work with an influential General Counsel, the study finds. Having blockholders among the investor base encourages greater caution, as does broad analyst coverage and gender diversity in the boardroom.

Restraint is to protect narcissists from themselves. A long-short portfolio of opportunistic trading by conceited CEOs yielded an adjusted abnormal return of -0.15 per cent per month, the researchers found. A diffident CEO long-short portfolio returns 1.42 per cent a month. Annualised, that’s a 17.3 per cent difference.

Ego, business influencers agree, is a double-edged sword. Previous scholarship has found that a narcissist CEO is more likely to pursue transformational M&A and pivot strategy, leading to superior performance by some measures. The evidence also suggests they care less than average about product safety, CSR and workplace bullying, dodge tax more aggressively, and leave their companies more vulnerable to lawsuits.

By focusing of insider dealing, Jiang et al add the useful detail that narcissist CEOs are conditioned to take unnecessary risks for ultimately underwhelming returns. It seems either that they lack self-awareness, or just can’t help themselves.

Read the full article here

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