Main results of our paper

What a nicer way to end this blog then by showing the most relevant results from our paper titled: "The Impact of CEO Characteristics on Capital Structure"

Our results section gave us they main findings regarding descriptive statistics, the correlation between the independent variables and capital structure, as well as the independent variables among themselves, the distribution of capital structure, the relationships between the beta coefficients of the independent variables and the capital structure and the goodness of fit of the regression.

Our main focus of the paper was to study the capital structure as the dependent variable as a function of many independent variables, the most studied being the age of the CEO.

After taking into consideration the log form of the components that make the capital structure (Total Debt/Total Assets), we obtain 60% of the firms of our sample with gearing values between 2.50-2.75. Outliers above 3 and below 1.75 were almost inexistent. 

Regarding the age of the CEO's, 45% more or less is represented by the age group between 50-59. Not many CEO's exist in our sample below the age of 40.

While having a glance at the correlation figures between the variables, it is important to mention that all the independent variables are positively correlated with the capital structure. The highest figures are 0.50 for the market capitalization, as a measure of size, and the age of the company at 0.24. Variables like age of the CEO and market capitalization are negatively correlated but not significant.

While conducting normality tests like the Kolmogorov‐Smirnov and the Shapiro‐Wilk tests, we get statistics like 0.008 and 0.98 respectively, showing that the capital structure is not normally distributed.

When comparing the beta coefficients of the variables with capital structure, we see that all variables except profit margin are positively correlated. Market capitalization and the industry of the company are significant at a 1% level.

Finally, our regression gives us an R-squared of 0.272. This means that our independent variables explain 27.2% of the capital structure of our sample.

As a conclusion, we would like to mention that the findings we mentioned along the paper and stated here are mostly in line with the literature regarding this topic.

Overview

For the last five weeks, we have been decomposing the important characteristics of the CEO and exposing their impact on the CEO’s risk aversion. Today, we will summarize our findings in a structured way. Below, we list the considered four major characteristics of the CEO: age, gender, marital status and cultural heritage.

Age CEO

Many studies have been conducted to see if a younger CEO will take more risks than an older CEO or that the same CEO at an early stage of its leadership will take riskier investments or more leverage on their capital structure than if they were towards their retirement.

In 2014, J. Estrada (2014) did research on the strategies investors take regarding their ending wealth as a function of their age, stating that most of the investors tend to follow a so-called lifecycle strategy, which starts investing strong on risky assets and as the person gets closer to retirement, it fully invests on less riskier assets. The paper concluded that investors will end up with a higher ending wealth if they follow the contrarian strategies, investing in riskier assets early in their lifecycle. Whilst bearing more risk, which in fact is caused by a bigger volatility regarding the upside potential, the contrarian strategies outperformed the lifecycle strategy in a significant way. 

The conclusions from the Estrada paper suggest CEO’s should take higher risks closer to retirement. This raised the question of this also applies for companies and their capital structure. Do CEO's on average gear up their firm when getting closer to retirement? 

Gender CEO

Throughout the years, numerous parties (e.g. trade unions, governments, human rights associations) have shown interest in the proportion of men and women in leadership positions. In fact, the issue of gender differences in the behavior during the work process became more and more relevant as more women got in charge of big successful companies. Still, globally men occupy more seats in the board of directors than women.

The fight this inequality, procedural quotas are implemented by Belgian and European legislators to lock down a minimum portion of women in the board of directors. Since governments all over the world are attempting to achieve an equilibrium between men and women in leadership positions, many academics have wondered what the impact of gender diversity could be on the riskiness and overall profitability of a firm. Did the implementation of women quotas in boards actually do any good?

Numerous papers investigated the effect of gender differences in risk-taking dealing with corporate capital structure, proxied by debt-to-equity ratio. The results reject the hypothesis that CEO’s gender negatively influences riskiness of firm’s capital. That said, the share of female members in the board has a noticeable negative impact on the corporate capital structure. This is conforming the hypothesis that woman tend to be more careful and take less risks than men, resulting in a more cooperative feeling in the firm, a less leveraged capital structure and overall better performance. 

Marital status CEO

Academics have shown that the stocks of companies with CEOs who are single are riskier than companies with married CEOs. Single CEOs tend to spend more money on R&D and acquisitions. Both investments are risky, meaning that they can either result in growth or a lot of trouble. The stock is therefore more volatile and thus riskier. 

Cultural heritage CEO

Finally, we have raised the attention to the significant impact of the cultural heritage of the CEO its risk aversion. Overall, we have seen that on average developing countries are more risk averse than developed countries. Additionally, we have exposed a significant association between culturally (heritage) transmitted risk preferences of CEOs and corporate investments. CEOs of firms located in countries with higher levels of risk aversion, on average go for a less risky capital structure and policy by diversifying more, doing less takeover activities and restraining the gearing ratio.

The CEO characteristics listed above will helped us better understand the dynamics behind the relative risk aversion of a CEO in a company. A profound insight in the thoughts and feelings towards risk by the CEO was essential to obtain a sufficient optimal set of parameters for the regression of the CEO's characteristics on the capital structure. All in all, 

Risk profile of close-to-retirement CEOs

So far, we have looked into the age, gender, marital status and nationality of the CEO and whether there was a relation with risky activities. This week, we will uncover another CEO characteristic, namely whether he/she is close to retirement or not.

Elie Matta and Paul W. Beamish performed a study about this topic, looking at international acquisitions that were made by almost 300 major American firms. The focus were short-term CEO decisions. Although only acquisitions were examined, the authors denote that the arguments of the study can be applied to risk-taking activities in general.

The authors observed that CEOs with shorter career horizons are less likely to engage in international acquisitions. CEOs close to retirement are reluctant to take risky decisions, since returns cannot be predicted properly. A possible explanation can be that they don't want to ruin their reputation during their final years as CEO. Since people tend to remember only the recent results and forget about the past performance, bad decisions in the final years of a CEO can ruin his/her successful career. Therefore, CEOs tend to get more risk-averse when they approach retirement.
Another explanation can be that CEOs want to maintain their wealth. CEOs are compensated in various ways during their career, including in the form of stock options or shares. When they retire, they have the opportunity to cash-out. Of course, this means that they want to maximize the value of their shares, thus maximizing their "retirement package". As a result, CEOs close to retirement will avoid investments that could bring the share price of the company down.

As a consequence, a gap between the CEO and the shareholders occurs. CEOs close to retirement focus on maintaining the stability in the short to medium term, while shareholders are more interested in the long term and future growth of the company.
The most important question however, is whether the risk-aversion of close-to-retirement CEOs are harmful to the company's growth. Of course, the long-term growth of a company is linked to risk-taking activities. Two topics are important here. On the one hand, the career horizon and thus, number of years before retirement are important. On the other hand, the compensation structure of the CEO has a major impact on the amount of risk he/she will take. When the close-to-retirement CEO is paid in a large amount with company stocks, this can be harmful to the long-term growth of the company, since he/she will be reluctant to take a lot of risks. However, when the close-to-retirement CEO is paid mostly in a fixed salary, this will be less of an issue.

The impact of cultural heritage on the decision making of the CEO

We have seen so far that age, gender and marital status have a significant impact on the risk aversion of the CEO. This however, is not where this blog stops. We continue to look for more parameters that have a significant impact on the CEO’s capital structure decisions.

When doing research into the literature, we have noticed that a significant effort has been done in finding adequate measures and parameters of risk aversion, but that the majority of the papers focus on providing estimates for a limited set of (mostly developed) countries. A natural question to ask then is if the nationality of the company or the CEO has a significant impact on the firm’s risk appetite.

The paper of N.Gandelman and R. Hernández-Murillowe (2014) estimated the coefficient of relative risk aversion for a broad range of countries, including 52 developing countries. The estimates showed that on average developing countries are more risk averse than developed countries. The results of the paper of N. Gandelman and R. Hernández-Murillowe stress the importance to consider different parameterizations for developing and developed countries when constructing models about the risk aversion of CEO’s.

Click on the graph to see further details

In addition, the paper of Y. Pan, S. Siegel and T. Y. Wang (2014) examined and exposed a significant association between culturally (heritage) transmitted risk preferences of CEOs and corporate investments. Similarly, B. Frijns, A. Gilbert, T.Lehnert and A. Tourani-Rad showed in 2011 that CEOs of firms located in countries with higher levels of risk aversion, on average go for a less risky capital structure and policy by diversifying more, doing less takeover activities and restraining the gearing ratio.

The relevant paper listed above will help us better understand the dynamics behind the relative risk aversion of a CEO in a company. A profound insight in the thoughts and feelings towards risk by the CEO is essential to obtain a sufficient optimal set of parameters for the regression of the CEO's characteristics on the capital structure.

The influence of gender and marriage on taking risks

Last week, we focused on the age of the CEO and whether this influences the amount of risk he/she takes. In this blog article, we are getting a little more personal. We believe that personal characteristics of CEOs matter for the decisions they make on behalf of the firm(s) that they lead. Studies have researched different characteristics that might have an influence on taking risks, of which we will discuss two. First, we will illustrate gender differences. Second, we will look at the relationship status of the CEO.

Gender differences in taking risks

A lot of research has been done about the differences between men and women concerning taking risks. Generally, men tend to take more risks than women. Different studies conclude that this is because of economic and evolutionary reasons. This gender difference gets even larger when stress kicks in. Men tend to take more risks when they are under stress, while women tend to take less risks under stress.

People also perceive that women are more risk averse than men. This can result in women getting less support for risk-taking activities. Also, women tend to focus more on the effect the risk will have on the people involved, while men tend to focus more on the probability that the objectives will be hit. Because of this, it’s more likely that women take decisions that benefit everyone and not only the top level of the company. They involve others in the decision-making process, leading to a more cooperative feeling in the firm. A study by Chris Bart has shown that this results in better business decisions and concludes that companies with female directors perform better and have less risk to go into bankruptcy.

What about marital status? 

An American study by the National Bureau of Economic Research showed that the stocks of companies with CEOs who are single are riskier than companies with married CEOs. Single CEOs tend to spend more money on R&D and acquisitions. Both investments are risky, meaning that they can either result in growth or a lot of trouble. The stock is therefore more volatile and thus riskier. Single CEOs don’t let competition or other warning signs slow them down. However, married CEOs tend to scale down the investments when risk increases. The researchers argue that single CEOs tend to take more risk because they want to impress potential partners. Unfortunately, there were not enough female CEOs in their sample for the results to be significant, thus we are not sure whether there is a difference between single male and single female CEOs.

Age, a matter of importance in the CEO's decisions?

A question our team has asked and are curious to answer is whether the age of the CEO has an impact on how they assess risk and this being seen on the capital structure they apply regarding taking leverage or not.

Many studies have been taken place to see if a younger CEO will take more risks than an older CEO or that the same CEO at an early stage of its leadership will take riskier investments or more leverage on their capital structure than if they were towards their retirement.

A paper we had a look at called “The Glidepath Illusion: An International Perspective” by Javier Estrada (2014) shows the strategies investors take regarding their ending wealth as a function of their age. It states that most of the investors tend to follow a so-called lifecycle strategy, which starts investing strong on risky assets and as the person gets closer to retirement, it fully invests on less riskier assets.

On the other hand, we find the so-called contrarian strategies. These are mirror strategies to the lifecycle ones, meaning being more conservative at an early age and more aggressive towards retirement. Now, the question is: which of these strategies are best?

The paper concludes that investors will end up with a higher ending wealth if they follow the contrarian strategies. It is true that these strategies are more risky, having higher volatility figures, but this is regarding the upside potential. The downside potential gives better results for the contrarian strategies meaning these strategies must be taken place instead.

In our study we want to figure out the impact the CEO’s personal information such as age, gender, and nationality among others. What can be related between this paper and what we want to study?

Other papers that we will mention along the paper and later on this blog suggest that younger CEO’s take bigger risks than older CEO’s. One has less to lose at a younger age and less fear to failure. Conclusions from the Estrada paper suggest CEO’s take opposite strategies and that the CEO’s should take higher risks closer to retirement as this will make the company more profitable on average as the downside potential is more limited. Later with our findings we will see if Estrada and many other practitioners were correct or not with their results.

Please press the link below to have a better understanding of Estrada's paper.