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UC Berkeley Press Release

Beware the superstar CEO, says economist

– The seemingly charmed life of a superstar CEO can be a double-edged sword - added power and prestige for the chief executive officer, but often bad news for his or her company and shareholders, according to a new study co-authored by a University of California, Berkeley, economist.

Ulrike Malmendier, a UC Berkeley associate professor of economics, and Geoffrey Tate, an assistant professor of finance at UCLA's Anderson School of Management, were curious about how common, cautionary tales about the delicate balance between the success and failure of prominent achievers might apply to the corporate world.

After all, the researchers said, there's the "Sports Illustrated Jinx," which holds that athletes featured on the magazine's cover fail to live up to their hype; the "Sophomore Jinx" that says new actors in the entertainment industry can't live up to the qualify of their debuts; and the "Nobel Prize Disease," which is said to lay intellectual waste to winners. A similar "CEO Disease" that causes CEOs to underperform after reaching the pinnacle of success also has been rumored.

"CEOs have become the faces of their corporations, starring in ad campaigns, courting regular media coverage, and making cameo appearances on prime time TV shows (i.e. Bill Gates in "Frasier" and Lee Iacocca in "Miami Vice")," they noted in their paper on the subject that was published in late June by the National Bureau of Economic Research.

Malmendier and Tate began their inquiry with the idea that all those jinxes are likely examples of the mean reversion model, in that award winners of any kind typically show extraordinary performance to win prizes, but such performance can't be expected every year.

Using a list of the winners of CEO awards between 1975 and 2002 - predominately from Business Week and Financial World (which ceased publication in 1997) magazines - the researchers found that after CEOs snare major media awards, they continue to look good - at least on the outside. They collect more compensation, become authors and are twice as likely as their peers to sit on five or more outside boards of directors. To top it all off, they boast a lower golf handicap than the non-celebrity CEO.

Back at work, a different picture emerged.

The researchers investigated superstar CEO performance by comparing earnings forecasts by the executives' companies and by outside analysts with actual results, as well as by comparing forecasts and actual returns for a control group.

For that control group, Tate and Malmendier chose non-award-winning CEOs with similar firms, similar recent stock performance and who resembled the superstars in age, job tenure and gender. Their information came from data covering CEOs and the four other highest-paid executives of the Standard & Poor 500, S&P Mid-Cap 400 and S&P SmallCap 600 firms since 1992.

What the researchers found was that the superstars didn't live up to their billing. They underperformed in terms of stock prices and returns on assets for three years following their receipt of an award, recording 15 to 26 percent drops in stocks prices and returns on assets, above and beyond mean reversion, although their compensation continued to climb during the same period.

By exploring what the celebrity CEOs did differently after winning their awards, the researchers discovered new distractions facing these superstars. The CEOs were writing books, and the number of their books increased as the number of their awards went up. They also were accepting more seats on outside boards of directors.

The CEOs also were spending more time on the back nine than in the board room, according to the researchers. Data on golf handicaps for CEOs published by "Golf Digest" magazine in 1998, 2000 and 2002 showed that superstars recorded lower handicaps than their counterparts - 14.29 compared to 15.46. "These ... patterns are consistent with powerful CEOs spending time on the golf course that shareholders would prefer them to spend on firm business," wrote Malmendier and Tate.

These executives also were more likely to engage in what is euphemistically known as "earnings management." Rather than exceeding earnings forecasts, they were meeting them or earning less than predicted. Further, the researchers found that award-winning CEOs were more likely than their non-award-winning counterparts to report negative earnings after five years had passed since their last prize. "One interpretation is that CEOs artificially inflate earnings numbers to maintain expected 'superstar performance' for as long as possible," wrote Malmendier and Tate.

The data seems to endorse stronger corporate governance to avoid the negative performance linked to superstar CEOs, the researchers said. Then, when a recently-honored CEO confidently demands more compensation, well-governed firms can note that recognition only puts the company at greater risk.

"A board can say, 'We're not too threatened because, chances are, you won't be doing that great (down the line),'" Malmendier said in an interview, adding that boards of directors should increase their monitoring of CEOs and company performance rather than reacting to the new superstars' status.

"There's nothing to be said against winning the award," Malmendier said, "but to keep that success going, make sure the CEO's doing his job rather than other stuff." Cautioning against blaming the media for the problems associated with superstar CEOs, Malmendier said the media do help to foster a celebrity culture and enable the changes in superstar CEO's once winning behavior.

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