The Superstar CEO Curse

There may be an executive suite parallel to the saying that when an athlete is featured on the cover of Sports Illustrated, he or she is doomed for a slump. When BusinessWeek and Forbes name their lists of “Best Managers” or “Best Performing CEOs,” the intention is to highlight CEOs whose successes suggest they have an innate ability that puts them a step ahead of other managers. To put that to the test, Ulrike Malmendier, assistant professor of economics of the University of California, Berkeley, and Geoffrey Alan Tate, assistant professor of finance at UCLA’s Anderson School of Management, compiled a list of over 250 CEOs who won awards from any of 10 different sources, going back as far as 1975, to capture those who won more than one award in their careers. They then examined the performance of the CEOs’ companies after awards were granted between 1993 and 2002.

The researchers’ March 2007 working paper, Superstar CEOs, concludes that award winners’ companies underperformed the broader market, both in terms of stock returns and returns on assets, over the one-, two- and three-year periods following the award. But the CEOs themselves did just fine: Award winners tended to receive higher compensation, mostly equity based, than other CEOs.

The authors go on to demonstrate that the underperformance is more than just a simple reversion to the mean. They identified a peer group of CEOs who had similar characteristics and performance to the award winners — in terms of company size, book-to-market and returns over the year leading up to an award — but who had not won awards. If the post-award underperformance represented a reversion to the mean, then these unheralded CEOs, who were similar to the award winners but didn’t win, should also revert to the mean.

After examining the data, Malmendier and Tate discovered that the unheralded CEOs’ companies indeed underperformed — but to a much smaller degree than the award winners’ companies. The stock market returns of award-winning CEOs’ companies lagged those of their unheralded peers by about 4% per year over the three years following an award.

All this suggests that glowing profiles have a real effect on CEOs. One explanation is that award-winning leaders could be distracted by an increasingly crowded plate of outside interests, including writing books and sitting on boards. Malmendier and Tate demonstrate that winning an award doubles the odds of the CEO penning a book, and winning as many as five awards makes a CEO four times as likely to sit on five or more outside boards.

Of course, that could be a simple function of the fact that CEOs who win awards are more likely to be offered book contracts, or to receive attention from more nominating committees as a likely board candidate. Indeed, the authors concede there may be harder-to-measure factors, such as charisma, that make a CEO simultaneously more attractive to the business press, more likely to pursue outside interests and prone to more volatile performance. It’s also possible, Mal mendier notes with some irony, that “the journals could simply be good at picking people who are going to underperform.”

Yet, the data are certainly suggestive that the awards themselves change CEO behavior in some way; the underperformance of award winners is very real, whatever the cause. And when Malmendier and Tate studied the propensity of award-winning CEOs to manage earnings, they disturbingly found that “the frequency of earnings management increases quickly with the number of awards a CEO has won.”

Malmendier points out there is likely to be a countervailing motivating effect, one that is less potent for CEOs. “Getting an award or recognition may mean you are on track to reach higher levels of the organization. So there is much more of an incentive effect than if you are already at the top, like the CEO.” Perhaps, then, Sports Illustrated could lift its curse by featuring minor league athletes instead of superstars.

Superstar CEOs, which is currently being revised, can be downloaded. For more information, contact Ulrike Malmendier at Ulrike@econ.berkeley.edu or Geoffrey Tate at gtate@anderson.ucla.