Why Character Counts in CEO Candidates - CEO Recruiters - Cowen Partners

      Why Character Counts in CEO Candidates

      A great CEO can take a struggling company and make it a success. And if your company is already successful, the right CEO can build on that success, creating revolutionary gains for your business.

      Obviously, when you’re looking for your next CEO, you should focus on hiring someone with a great performance record. But recent research also suggests that you should be looking for something else: character.

      Good Character Matters

      You might assume you should look for good character simply because it’s the right thing to do. However, research by Aiyesha Dey, a professor at Harvard Business School, gives you another reason — CEOs with good character are less likely to commit fraud.

      Measuring Character

      But how do you measure character? Dey and her team narrowed it down to two metrics: materialism and rule-breaking. 

      The team defined materialism as “zealous pursuit of wealth and luxury regardless of the cost to others.” They closely examined existing research and found three measurable markers of materialism:

      • Owning a boat more than 25 feet long
      • Owning a car worth more than $75,000
      • Owning a home worth more than twice the median home value in its area

      Dey and her team had a somewhat simpler way to identify rule-breaking behavior. By working with private investigators, they looked into the backgrounds of different CEOs to find if they had any documented criminal infractions (even minor ones).

      The research into the CEOs proved to be illuminating. In short, the researchers found a couple of key insights:

      • Companies with materialistic CEOs experienced more fraud and had lower corporate social responsibility (CSR) scores
      • Companies whose CEOs had criminal records were more likely to be involved in fraud, and the CEOs were more likely to be personally implicated in that fraud

      Of course, this is a very general summary of the research. It is further explained below.

      The Link Between Materialism and Fraud

      Everyone is used to hearing about the lavish mansions and ultra-expensive cars of wealthy CEOs. After all, the CEOs of major companies earn so much that materialism comes with the package, right?

      Not necessarily. When Dey and her team used the criteria listed above, 58% of the CEOs they studied qualified as “materialistic” (meaning they had one or more of the three markers of materialism). The other 42% qualified as “frugal,” meaning they had none of the indicators.

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      The researchers found that in companies with materialistic CEOs, fraud happened more frequently. So did unintentional reporting errors. Upon closer inspection, they saw that if a CEO spent their own money excessively, they loosened the company’s internal controls, which in turn often led to more fraud.

      The researchers noticed a pattern in this loosening of controls:

      • Appointing CFOs who were also very materialistic
      • Having a board that monitored C-suite executives less intensely
      • Creating more equity-based incentives (which make it possible to deliberately inflate performance to mislead capital markets)

      Why is this particular pattern more closely related to fraud?

      Generally, loose controls make it easier for employees to commit deliberate fraud, but they also make it less likely that someone will catch instances of accidental misreporting.

      Research in other fields has long illustrated that people who are very materialistic tend to not care much about other people or their environment. The researchers tested this assumption in their own work and found it to be true.

      Various agencies that assign corporate social responsibility (CSR) ratings tend to give lower rankings to companies with materialistic leaders.

      Often, this is because the company excessively contributed to pollution or had especially low charitable contributions compared to similar organizations.

      Rule-Breaking and Corporate Misconduct

      Dey’s team of researchers looked into the backgrounds of 1,000 American CEOs and found that criminal behavior was more common than most might think.

      A full 18% of the studied CEOs had at least one criminal infraction on their record. These infractions included the following:

      • Drug crimes
      • Disturbing the peace
      • Sexual assault
      • Domestic violence
      • Driving under the influence
      • Various kinds of reckless behavior
      • Traffic tickets for minor offenses

      As you can see, these infractions ranged from serious to very minor. To get a sense of the connection between breaking rules and fraud, the researchers compared groups of companies that were similar — except for the fact that one group had been involved in fraud and one had not. This comparison yielded some interesting insights:

      • If a CEO had any kind of criminal infraction, the company was more than twice as likely to be somehow involved in fraud
      • If the above situation occurred, the CEO was seven times more likely to be personally implicated in the fraud
      • At companies that had been involved in fraud, the number of criminal offenses committed by CEOs was significantly higher

      The team also expanded the research into not only fraud but also (legal) insider trading. Dey noted that the trades studied were “the kind that are not necessarily illegal but whose outsized results and excellent timing suggest that the trader might have benefited unfairly.” 

      When comparing these trades to the criminal records of CEOs, the researchers discovered the following:

      • CEOs with criminal records earned significantly more when trading company stock
      • The more severe the CEO’s infraction, the more profitable the trade

      This particular result suggests that CEOs who are willing to break major rules just might be more willing to pursue unethical (and maybe illegal) advantages.

      Don’t Discount the Importance of Character

      Traditionally, many companies haven’t particularly cared what their CEOs did outside of the office (as long as that behavior didn’t lead to a major scandal). But Dey’s research suggests that companies might be better able to protect themselves if they take even a glimpse at a CEO candidate’s personal life.

      Dey clarifies that she isn’t saying you should turn down a CEO candidate because they have a traffic ticket or a large boat. But if you’re mindful of a potential CEO’s behavior inside and outside of the office, you might find you select someone who’s a better fit for your company.

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