New research shows that when arrests, lies or extramarital affairs of CEOs and other top executives are disclosed, their companies will lose lots of money in the short- and long-term. The study—by Ralph Walkling, a professor at Drexel University’s LeBow College of Business and founder of the Center for Corporate Governance, Drexel alumnus Adam Yore of the University of Missouri and Professor Brandon Cline of Mississippi State University —shows that firms experience an average shareholder loss of $226 million in the three days after the announcement of an executive indiscretion.
The researchers studied 219 cases of executive indiscretions to better understand how signs of low integrity in an executive’s personal life impacted their firms. While the reaction to an announcement of a top executive’s extramarital affair or lying about qualifications would seem likely to cause immediate damage to the company’s stock price, the researchers found the impact of such an announcement actually lasted much longer. Stock prices of companies of accused executives fell in total between 11 and 14 percent in the subsequent 12 months. They also found that 65 percent of accused executives retained their positions, including those with repeated offenses.
Stock prices, however, were not the only thing affected by executive mess-ups. The study found that firms where executives behaved badly also performed poorly during the year in which the executive’s behavior was revealed. The firms were also more likely to manipulate earnings, be sued by shareholders and be accused of fraud by the government.
While many indiscretions were sexual in nature— about 96 percent of the executives were male and the most common occurrence was of sexual nature—these weren’t the most damaging to companies. The study found that shareholders’ reactions were much worse to an executive’s dishonesty. In all cases shareholders appeared concerned with the executive’s ability to manage. The results imply that the mishaps and lies not only distracted executives but also impacted their managerial character—basically once shareholders felt betrayed it was much more difficult for them and other stakeholders to trust the accused executive.
The research suggests that companies can help prevent executive mishaps with better corporate governance structures. The researchers found that companies where boards had more power and were closely paying attention were less likely to witness these kinds of executive indiscretions.