Stoughton Wisconsin Tornado of 18 August 2005 (Source: NWS/NOAA, Wikimedia Commons)
Ideas for Leaders #561

The Connection Between Disasters and Less Risk-Averse CEOs

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Key Concept

CEOs who have lived through disasters resulting in significant loss of life are likely to be risk-averse executives. Those, on the contrary, who live through disaster that did not result in significant loss of life tend to be less sensitive to the consequences of risk — and thus more risk-tolerant than the norm.

Idea Summary

Previous research has explored the impact of life and career experiences and circumstances on CEO managerial styles. This past research shows a monotonic or unidirectional effect of a CEO’s life experiences on risk-taking. For example, CEOs rising from difficult economic circumstances might be more risk-averse while CEOs born in prosperous circumstances might be less risk-averse.

A new study reveals a relationship between life experiences — specifically, living through a disaster such as earthquakes or hurricanes — and subsequent managerial style that is more complicated than the typical linear correlation found in other studies. The study shows that living through a disaster will impact a CEO’s managerial style in not one but two ways, depending on the intensity of the experience.

According to the study, CEOs who as children experienced disasters in which there is significant loss of life are more risk-averse. On the other hand, CEOs who are exposed to disasters in which there is not significant loss of life — less intense disasters, if you will — tend to have less sensitivity to the consequences of risk. As a result, the CEO is less risk-averse as an executive.

The researchers based their conclusions on an analysis of the correlation among three sets of data:

  • The birth dates and places of 1700 CEOs who led major companies between 1992 and 2012
  • Historical records of natural and other disasters in the counties in which the CEOs in sample lived between the formative ages of 5 and 15
  • Corporate records of the companies led by the CEOs in the sample, focusing on debt, cash holdings, and acquisition activity — elements that measure a CEO’s risk tendencies

The results of the analysis are unequivocal. The corporations led by CEOs who had lived as a child in counties that had witnessed devastating disasters were more likely to have a lower leverage ratio (i.e. less debt and larger cash holdings), and were less likely to acquire companies — or if they did, to pay for such acquisitions with stock. The reverse was also true: CEOs exposed to moderate (less devastating) disasters during their childhood ran up more debt, were comfortable with smaller cash holdings, and rarely hesitated to acquire other companies — in short, they were more willing to take risks.

What about CEOs who had never experienced a disaster as a child? According to the study, they fell somewhere in the middle: they were less risk-asverse than those who had experienced extreme disasters, and more risk-averse than those who experienced ‘moderate’ disasters — disasters without a large loss of life and other extreme consequences.

This latter result is one of the significant insights of the study: living through a moderate disaster makes one less risk-averse than enjoying a childhood without disaster. The reason: having witnessed a disaster that doesn’t have grave consequences makes one less sensitive to the potential risks of disasters. This translates into having less sensitivity to the potential risks of other actions… such as a high leverage ratio or risky acquisitions.

Business Application

Boards of directors rarely examine a candidate’s life history when considering that person for a position as CEO. This study indicates that life history, and specifically the candidate’s exposure to natural disasters or other catastrophes, should be part of the vetting process.

After all, risk propensity is often a major consideration in the choice of the candidate, and with good reason: As part of this study, the researchers found that in the two years after the appointment of a new CEO whose approach to risk differs from the old CEO’s, the risk-related policies and actions of a company change significantly.

Selecting a new chief executive (or assessing the new CEO if you’re an investor) can be a challenge even with winning candidate’s professional history in hand. One of the by-product lessons of this study is that the data exists to better understand the personal history of a candidate; boards of directors would do well to take advantage of such data.

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Authors

Institutions

Source

Idea conceived

  • October 2015

Idea posted

  • October 2015

DOI number

10.13007/561

Subject

Real Time Analytics