CUHK Business School Research Reveals Local CEOs are Less Likely to Make Myopic Operating Decisions than Nonlocal CEOs

HONG KONG,
CHINA�- Media OutReach - 21 January
2019 – Chief Executive Officers (CEOs) are often hailed as superheroes for
businesses. Most companies are willing to provide highly competitive packages
to attract top CEO talents as it is believed that the talents and personal
values of individual CEOs can either make or break a company. Although salary
packages vary for different CEOs, the majority of their compensation is based
on the company’s performance. In other words, the more profits that the company
makes under a CEO’s leadership, the higher the salary the CEO receives.

 

This performance-driven compensation seems to be a
rational arrangement for CEOs. After all, they are hired to lead the companies
into profit-making paths. However, some CEOs may be good at making short-term
profits while others are keen to develop long-term plans balancing business
interests and community needs. A research study by Prof.
George Yang, Associate Professor of School of
Accountancy at The Chinese University of Hong Kong (CUHK) Business School sheds
some light on how CEOs prove their abilities by making different business
decisions.

 

His working paper entitled “East,
West, Home’s Best: Are Local CEOs Less Myopic?”
aims to find out whether CEOs working near their birthplaces are likely to be
more long-term oriented in terms of business development than the nonlocal
CEOs. The study was carried out in collaboration with Prof. Shufang Lai at
Southern University of Science and Technology; and Prof. Zengquan Li at
Shanghai University of Finance and Economics’ School of Accountancy.

 

“While monetary incentives play an important
role in curbing short-term decisions, social and cultural factors could also be
leveraged to reinforce this effect by imposing less financial burden on firms,”
says Prof. Yang.

 

Place
Attachment and Business Decisions

We all have attachments to certain places in our lives. It might be our
birthplaces or cities that we have lived in. How does this place attachment
influence business decisions, in particular among CEOs?

 

The researchers looked at S&P 1500 firms in the United States from
the period of 1992 to 2012 and observed over 2,000 unique CEOs.

Managerial myopia is measured by the likelihood of cutting the research
and development expenditure to avoid a potential earnings decrease from the
previous year. The team also calculated the likelihood of cutting R&D
spending to avoid potentially failing to meet analysts’ consensus forecasts as
a supplement measure.

 

Local versus Nonlocal CEOs

The
empirical results showed that the local CEOs in the study were less likely to
cut R&D expenditure to avoid earnings decreases or meet analyst consensus
forecasts.

 

According
to the study, the chances of local CEOs cutting R&D spending were 14.6
percent lower than the nonlocal CEOs in general circumstances.

 

However, in
situations such as firms experiencing small decreases in earnings that could be
salvaged by cutting R&D spending, the odds of the local CEOs that would
actually cut R&D were 25.5 percent lower than the nonlocal CEOs. This
effect was stronger when the CEOs were approaching their retirements. It echoes
the findings from previous studies stating that CEOs often behave myopically
and tend to spend less on R&D in their last years of office.

 

“We
found that the nonlocal CEOs in our study were 16.9 percent more likely to cut
R&D funding than the local CEOs near retirement,” Prof. Yang says.

 

In
addition, the researchers also looked at firms that experienced at least one
change in CEOs during the sample period. The results showed that a firm which
replaced a nonlocal CEO with a local CEO had lowered the tendency to cut
R&D to avoid earnings decrease.

 

Locality and Social Responsibility

To fully
understand how locality of CEOs affect their business decisions, the
researchers also studied whether local and nonlocal CEOs differed in terms of
their decisions in firms’ tax payments and corporate social responsibility (CSR)
measures. It is because paying more state taxes could contribute to the local
infrastructure while CSR initiatives could benefit the environment and local
communities.

 

And the
result showed that the firms paid 7.3 percent higher taxes to their home states
under the leadership of the local CEOs than the nonlocal CEOs; in other words,
the local CEOs were more willing to be socially responsible in improving the
environment, community and employment.

 

Apart from
locality, could there be other reasons in this difference between nonlocal and
local CEOs in making myopic business decisions? Some might wonder perhaps local
CEOs are just better at their jobs than nonlocal CEOs so that they don’t need
to cut spending to improve earnings.

 

However,
after examining the educational backgrounds and professional certifications,
the researchers could not find any substantial skill differences between the
two groups of CEOs.

 

“So it
all boils down to two fundamental factors: insufficient concern for long-term
reputation as well as information asymmetry between the CEO and stakeholders
regarding the CEO’s professional capability,” says Prof. Yang.

 

“For
instance, low concern for reputation would lead a CEO to narrowly focus on
near-term payoffs, which in turn would incentivize the CEO to manipulate
earnings and succumb to pressure from myopic investors,” Prof. Yang
explains.

 

“On
the other hand, high information asymmetry between the board of directors and
the CEO about the CEO’s skills would lead the board to shorten evaluation
periods to avoid potentially excessive damages that could be imposed by an
incompetent CEO. The CEO, in turn, would be preoccupied with proving himself by
delivering superior short-term profits.”

 

In
addition, the researchers also discovered that local CEOs are less myopic
especially when the company’s business involves more local interests — for
example, the firm’s operation is mainly concentrated in its home state or the
local residents are likely to invest in the firm.

 

In
addition, they found that local CEOs do not tend to develop myopia when the
state has a low population mobility and high social capital — when the
connections among local residents are enhanced by its religious organizations,
civic and social associations, political organizations, etc.

 

“Because
local CEOs run businesses in their home areas, their opportunistic behaviours
are likely to impair the interests of those with whom they are closely bound.
Their reputation and trustworthiness will then be tarnished, which will further
affect their social status in their social networks,” he says.

 

“As
local places feature more close-knit social bonds and hence more social
capital, local CEOs’ long-term reputation concerns will be greater and they are
less likely to be myopic,” he adds.

 

Advantage of Hiring Local CEOs

According
to Prof. Yang, hiring a local CEO can reduce the information asymmetry for the
board of directors regarding his or her character and skills. Coming from the
local community, the directors are likely to have more access for the
information about the CEO’s from their local social networks. The board and the
CEO will have a better mutual understanding so that the CEO will have less
pressure to prove his or her ability by making myopic decisions.

 

“Hiring
a local CEO gives an advantage to a firm by elevating the CEO’s long-running
concern for her reputation,” Prof. Yang comments. “This finding
should be of interest to investors, practitioners, boards of directors, and
market regulators.”

Reference:

Lai,
Shufang and Li, Zengquan and Yang, Yong George, East, West, Home’s Best: Are
Local CEOs Less Myopic? (October 3, 2017). Available at SSRN: https://ssrn.com/abstract=3047568
or http://dx.doi.org/10.2139/ssrn.3047568

 

This
article was first published in the China Business Knowledge (CBK) website by
CUHK Business School: https://bit.ly/2LDHGdi.

 

About CUHK Business School

CUHK
Business School comprises two schools — Accountancy and Hotel and Tourism Management — and four
departments — Decision Sciences and
Managerial Economics, Finance,
Management and Marketing. Established in Hong Kong in 1963, it is the first
business school to offer BBA, MBA and Executive MBA programmes in the region.
Today, the School offers 8 undergraduate programmes and 20 graduate programmes including MBA, EMBA,
Master, MSc, MPhil and Ph.D.

 

In the Financial
Times Global MBA Ranking 2018, CUHK MBA is ranked 43^rd. In FT‘s 2018 EMBA ranking, CUHK EMBA is ranked 29^th in the world. CUHK Business School has the largest number
of business alumni (35,000+)
among universities/business schools in Hong Kong
— many of whom are key business leaders. The School currently has about 4,400
undergraduate and postgraduate students and Professor Kalok Chan is the Dean of
CUHK Business School.

 

More information is available at www.bschool.cuhk.edu.hk or by
connecting with CUHK Business School on
Facebook: www.facebook.com/cuhkbschool
and LinkedIn: www.linkedin.com/school/3923680/.