Unlock Editor’s Digest for free
FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.
Imagine a CEO who is kind of an idiot. You know the type: self-centered, unconcerned about others, and demanding admiration. They use company advertisements to exercise their interests and fill every conference call with references to themselves.
Now imagine that your company is doing well. Sales are up, earnings expectations are rising, long-term investors are happy, and sentiment is good. Then, for no reason, the jerk CEO guy sells some shares. What could it mean?
That’s the question you ask “CEO Narcissism and Opportunistic Insider Trading,” an article published in this month’s Journal of Corporate Finance. Its authors consider two possibilities. There is the “inflated ego hypothesis,” in which the CEO overestimates the importance of non-public information and is indifferent to potential legal consequences. Then there is the “reputation protection hypothesis,” according to which the CEO’s vanity has been overwhelmed by his greed.
Option two makes sense. Confidence and charisma come naturally to narcissists, while the perception of integrity must be earned. A sufficiently self-aware narcissistic CEO would avoid anything that seems dubious because he prioritizes public image, reputation, and prospects for career advancement. It follows that, if they operate opportunistically, it will be only occasional and the non-public information on which they have acted will be significant.
Unfortunately, it’s option one. Narcissistic CEOs make more legally questionable transactions and their transactions are much less informative about future stock price performance, the study concludes.
“We find that CEOs with a higher level of narcissism engage more intensely in opportunistic (non-routine) insider trading.” Cheng Jiang of Boston College, lead author of the paper, told the FT Alphaville. “We also find that the impact of CEO narcissism on opportunistic insider trading is more pronounced among CEOs with limited legal knowledge, who face weaker external and internal monitoring pressure, who work in larger companies, and that they are men.”
The method involves rating CEOs on narcissism based on the number of first-person pronouns they use during the question-and-answer portion of earnings calls, with a backtest of total compensation relative to the next highest-paid executive. CEOs are considered narcissistic if their narcissism score exceeds the annual average within the same industry.
CEOs rarely have to buy on the open market since they are paid in stock, so the study focuses on insider sales. If a CEO’s sale does not repeat itself in the same month for three consecutive years, it is classified as opportunistic.
It identifies a clear correlation between selfishness and the inclination to engage in 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 his or her opportunism (i.e., quantity they sell in relation to their total participation). ). About 38 percent of stock transactions made by narcissistic CEOs are classified as opportunistic, compared to 32 percent of the rest.
Ego-driven risky trading is an exclusively male thing, and the paper finds no association between narcissism and opportunism among female CEOs. It’s also an issue for large companies, perhaps because “the greater number of board members and executives within larger companies provides cover for CEO insider trading activities,” the authors suggest.
Opportunism is less pronounced among narcissistic CEOs who have a law degree or who work with an influential general counsel, according to the study. Having shareholders among the investor base encourages greater caution, as does broad analyst coverage and gender diversity in the boardroom.
Restraint is protecting narcissists from themselves. The researchers found that a long and short portfolio of opportunistic trading by cocky CEOs produced an adjusted abnormal return of -0.15 percent per month. A shy CEO’s long and short portfolio yields 1.42 percent per month. Annualized, that’s a 17.3 percent difference.
The ego, business influencers agree, is a double edged sword. Previous studies have found that a narcissistic CEO is more likely to pursue transformative mergers and acquisitions and pivot strategyleading to superior performance by some measures. The evidence also suggests that They care less than average about product safety., CSR and workplace harassmentdodge taxes more aggressivelyand abandon their companies more vulnerable to lawsuits.
By focusing on insider trading, Jiang et al Add the helpful detail that narcissistic CEOs are conditioned to take unnecessary risks for ultimately disappointing returns. They seem to lack self-awareness or simply can’t help themselves.