When CEOs Get Superstar Status

Study reveals drawbacks for shareholders after CEOs become celebrities

Being featured on magazine covers and other media-driven channels after receiving a prominent award can elevate a chief executive to superstar status.

But what are the real consequences for the company and its shareholders?

The research study Superstar CEO by Professors Ulrike Malmendier at the University of California, Berkeley, and Geoffrey Tate at University of North Carolina at Chapel Hill, published in June 2009, uncovers how prestigious CEO awards combined with weak corporate governance can harm the company's performance.

Ulrike Malmendier is professor of Economics at the University of California, Berkeley, and holds a joint appointment in the Department of Economics and the Haas School of Business. Malmendier is a pioneer in behavioral economics and her work in this field has attracted widespread attention.

In 2013, Malmendier received the prestigious Fischer Black Prize for the Top Finance Scholar under 40 in 2013, which recognizes her work such as Superstar CEOs.

The study looks at data of CEO award winners between 1975 and 2002.

When winning CEOs turn into media darlings, they spend more time on non-firm related activities and consequently tend to underperform by up to 26% over the three years after the award was granted compared to their non-winning peers. And it doesn't stop there.

Malmendier and Tate analyzed a sample of national awards from Business Week and Financial World. These high-profile recognitions lead to an increase in equity-based compensation of 44% for the winners.

However, the spike in pay is not shared by other top executives in the same firm, nor by CEOs whose pre-awards performance was as strong as their winning peers.

Superstar CEOs get a substantial financial benefit out of these media-driven awards.

External Distractions and Weak Corporate Governance Harm Firm Value

Writing books, playing golf, and sitting on external boards are additional perks for celebrity CEOs.

The negative impact of these activities is strongest in firms with weak corporate governance. However, the frequency of obtaining superstar status is independent of corporate governance.

Most of these external activities increase with the number of awards received. The correlation is especially distinct between multiple awards received and books written by the winner.

When it comes to playing golf, winning CEOs have lower handicaps than their peers. Low corporate governance in the winning firm can quickly translate into more time on the golf course, hence a lower handicap.

"These cross-sectional patterns are consistent with powerful CEOs spending time on the golf course that shareholders would prefer them to spend on firm business."

Time spent on external boards is another significant distraction for CEOs and it becomes dominant when the CEO sits on five or more external boards. Malmendier and Tate's study shows that award- winning CEOs are twice as likely to sit on five or more boards than their non-winning peers (6.8% vs. 3.2%).

Superstar executives are also more likely to engage in earnings management as they are just meeting or barely exceeding earning expectations in the years following the award. As a consequence they get more involved in smoothing out bad results.

Ultimately, all these effects of becoming a media-darling highlight that increasing oversight through stronger shareholder rights after a CEO wins an award can mitigate, maybe even guard against, a decline in performance.

The Research

Malmendier and Tate worked with data of CEO award winners between 1975 and 2002 and constructed a nearest-neighbor matching estimator, using observable dimensions and characteristics between winners and their matches.

Only national awards are included in the sample. Superstar CEO looks at company characteristics, CEO characteristics, data on books written by Superstar CEOs, and CEO's golf handicaps, history from media sources such as Forbes and Golf Digest to systematically evaluate this celebrity behavior.

Looking at the Study Six Years Later

Six years after the study was published, Ulrike Malmendier believes that shareholders are more aware of the issues pointed out in the study, essentially that pushing a CEO too strongly to win awards without having the right oversight in place can actually cause more harm than good for the firm.

"However, looking at past corporate governance scandals such as Enron, we can see that these extreme cases affect companies at the time, they react by increasing control policies, but when the good times are back, this cautious behavior slowly fades away," says the professor.

Ulrike Malmendier's most current research called Institutional Memories looks at a related effect within the banking industry.

"Our new research aims to demonstrate that experiencing a crisis makes an imminent difference on the banks' risk-taking; capitalization is higher and loan-granting policies are stricter. But after a while, as the markets recover, this precautious behavior deflates again," says Malmendier.