CEOs are not the most trustworthy figures in society. They will lay off thousands of employees to beat analysts' estimates, and yet they have no trouble looting the stock to pay themselves millions while the company loses money. However, one theme that keeps coming up is that unethical behavior has a price tag. Layoffs do not always boost the stock price. Treating people as expenses instead of assets does not pay off in the long run. Corruption is a drag on stock performance. Now, a new study shows that CEOs who lie about poor performance end up crashing their company's stock.
Stephen Ferris, Don Chance, and James Cicon wrote a paper called, "Poor Performance and the Value of Corporate Honesty," which will be published in the next issue of the Journal of Corporate Finance. The authors scanned press releases for words like "apologize" and "regret" to find negative reports. They reviewed 150 company announcements from 1993 through 2009 when the company reported poor performance. When companies blamed external factors, they usually provided vague explanations. When they admitted mistakes, they used specific phrases like "bad acquisitions strategy," "accounting errors," and "manager mistakes."
Two-thirds of the announcements attributed the poor performance to external forces. The authors were careful to assess relative performance to account for industry-wide downturns. The University of Missouri reports,
Those companies accepting responsibility saw their share price stabilize over the next several months, while those that blamed others continued to experience falling share prices. Ferris said several factors could be the cause of trying to lay blame on external forces. Those factors include arrogance, pride, fear of litigation, and the inability of company leaders to see their own shortcomings. Of those companies that blamed external factors, 44 percent replaced their CEOs in the following year compared to only 32 percent of companies who accepted responsibility.
Don Chance cited BP as an example of a company failing to take responsibility. On April 20, 2010, the Deepwater Horizon exploded, which started an oil spill that lasted for months, eventually totaling about 5 million barrels. It was one of the largest environmental disasters in history, and CEO Tony Hayward's bumbling response to the emergency was quite memorable. Hayward said the oil spill was "relatively tiny" compared with the ocean. He also said, "You know, I'd like my life back." The eleven men who died in the explosion probably wanted their lives back too, but they weren't around to tell Tony Hayward.
As Don Chance noted, the BP spill was a textbook case of poor leadership. The stock crashed, and Hayward was eventually replaced by Bob Dudley a few months after the spill.
With this study in mind, consider the implications when the New York Fed tells us that economic activity declined because of the weather. Now that it's summer, it's not clear how cold weather is interfering. Perhaps the Fed has a South Pole subsidiary? When will the market crash and the Fed be replaced for lying about poor performance?