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This is the paper:
We will explore how selection bias in CEO promotion amplifies risk take. This uses prenatal contamination exposure as an exogenous shock to individual risk appetite.
The idea is that reckless CEOs are born like that. The questions that are seeking answers relate to whether companies with a high risk tolerance culture tend to choose CEOs with similar characteristics, or whether companies unintentionally promote risk takers based on their own luck.
If promotional systems reward executives with successful risky decisions in a low-stakes environment, companies may unconsciously raise individuals whose leadership style reflects survivor bias rather than skills. This concern is particularly relevant to internal candidates, who make up more than 70% of CEO appointments.
The authors of this study, P. Raghavendra Rau, Yilin Wu, and Richard Lok-Si Ieong, choose to measure the “biological shock” of prenatal contamination exposure. This is another approach to previous research on risk tolerance and childhood that has been concentrated after CEOs were born.
For example, children in Great Fear Presion show increased financial risk aversion to becoming CEOs, unless they are rich enough to protect their families from difficulties. Children exposed to fatal natural disasters in their childhood become risk-taking CEOs, which may be because they were raised by families who chose to live in disaster-prone areas. Having a rich or reckless parent affects a person’s career path in countless difficult ways, so it is difficult to remove the behavioral effect from the company’s choice effect. Returning to concepts is to remove these complex factors, the authors argue.
When babies are exposed to toxic chemicals in the uterus, there is plenty of evidence that they are more impulsive, aggressive, more likely to develop ADHD, and are at a higher risk of adult crime.
The paper’s method is to estimate the likelihood of developing these properties based on whether CEOs were born as super fund sites, an industrial pollution black spot born near the US. As of December 2018, there were over 1,800 such sites in the US.
This study could be biological or economic reasons, as if a person is born near a dangerous waste site, it is less likely to become CEO. However, exposure to contamination increases the likelihood that a person will be promoted to CEO.
The authors argue that almost every CEO in the dataset was born before the dangers of such environments were widely recognized, so the data provides a clean measure of innate risk appetite. The lines in the chart below show the influential exposure of Rachel Carson’s chemical industry, Silent Spring publication. Formation of the US Environmental Protection Agency. And the proposal for the Super Fund Act, passed by the law in 1980:
The study also finds that so-called superfund CEOs are not disproportionately represented in high-risk sectors. Employees who work top jobs in Superfund County tend to be hired locally, but CEOs outside of Superfund are more likely to be external appointments.
From this, the author makes some inferences about how prenatal toxicity burden affects management style.
Non-superfund CEOs may move forward through consistent, low-variable performance. In contrast, superfund CEOs are more likely to take high diversified internal risks, which can produce outstanding outcomes, such as offensive restructuring. Once these gamblings are rewarded, it is difficult to distinguish them from skills. Companies that observe only the outcomes may systematically promote risk takers whose actions are only revealed under high stakes pressure of exposed decisions. This survival-driven selection bias provides a novel explanation of why some CEOs work well in internal roles, but have been promoted in the past.
Empirically, we find that the CEO of a superfund is much more likely to be promoted internally than being hired externally, suggesting that companies place considerable weight on previous internal success. Upon office, these CEOs will pursue significantly higher risk external financial policies, including higher leverage, lower cash holdings and more irrelevant acquisitions. Their companies show greater stock revenue volatility, lower credit ratings, and higher borrowing costs.
There is quite a bit of speculation underlying this claim. This study does not directly observe executive decision-making before they become bosses. Peter’s principle is a compelling explanation, not a demonstrable trend.
Instead, the study measures the results. The company born in a county with a CEO with a single super fund site has found that it could add nearly 19% to its bankruptcy risk score and increase its default by more than 7%. Stock returns on purchases and holds have deteriorated slightly, but perhaps not enough to be a factor.
However, in Fortune’s top 50 most admired companies, there are a huge number of super fund CEOs leading the major companies.
The paper concludes:
Our findings help explain why internal success, not skills, systematically overabsorbs risk takers, which reflect luck. In doing so, we show how performance-based promotion systems inadvertently lead high-risk individuals to high-risk individuals in a position where they are misaligned in role demands.
Whatever you make arguments, the dataset casts one strange quirk. The most toxic county in America with 23 active super fund sites is Santa Clara County in California. Santa Clara is also the home of almost every US high-tech company.
A spiritual home of risk-taking and creative destruction, Silicon Valley was built around the toxic heritage of local operators, including Intel, HP, Applied Materials and National Semiconductor. I’m not saying there’s a connection. It would be very wrong to suggest that the US technological management culture is a by-product of becoming a CEO and gently addiction to the fetus so gently that it leads businesses to bankruptcy. It’s ridiculous, reductive, and borderline attacks. All we do is focus on correlations.
Read more:
– A narcissist CEO like high-risk insider trading, and I’m not good at it: Research (FTAV)
