Eight Critical Factors for Business Success
Fortune has an interesting article this week titled “Sex, lies, and CEOs: The hefty price of executive indiscretions,” based on a study titled “The Agency Costs of Managerial Indiscretions: Sex, Lies, and Firm Value,” released last December by a number of universities. Both hit a chord with me as I’ve had to deal with a number of such indiscretions over the years. Most of them are funny at a distance and a nightmare up close. Here in the Silicon Valley, we have an inside joke that every CEO position comes with a mistress and this study showcases that such a practice is absolutely not a good thing.
My first personal experience was working for a guy in a cubicle farm office with windowed, enclosed offices for the executives. He’d bring his mistress in and they would quietly lower themselves to the floor, obviously thinking that no one in the office had any idea what they were doing. It pretty much killed the business when his wife found out, but I was long gone by then.
One of the worst was years later while working for Giga Information Group. Not only did the company have affairs going on in the highest ranks (and resulting lawsuits), it had an HR executive who was offering our very attractive sales reps special treatment if they gave him special favors. This was forgiven because, apparently, he was a guy. But behavior like this undermined the firm and helped set us up for the catastrophic acquisition by Forrester. Giga was a great company largely taken down by men who couldn’t keep it in their pants.
Let’s talk about sex, lies, and firm value this week and look underneath what this study found.
Firm Value Collapse
The CEO is typically the face of the company. What they do—or don’t do—personally becomes public and colors what employees, investors and customers think of the firm. The study showcased that operating performance decreased significantly after the disclosure of an indiscretion, and shareholder value decreased materially. The average loss in market capitalization of any public indiscretion is $110M, and when it is the CEO involved, the amount more than doubles to $226M. It doesn’t stop there. The study found that there was a long-term stock impact of 11 to 14 percent decrease during the year the indiscretion was made public, and a continued material decline in operating performance as well.
There is a cost to indiscretion and the folks who don’t do it pay the vast majority of it.
Anatomy of Indiscretion
The study found that indiscretions had a positive correlation with future malfeasance—in other words, the executive who cheats on his wife is more likely to cheat the company in a material and often criminal fashion, thus opening the door for a successful negligence charge against the firm’s board if the executive isn’t removed. And it is more an exception than a rule that the executive is removed for such an indiscretion. This correlation is tied to an increased likelihood of shareholder lawsuits and SEC and DOJ actions, which are generally and often connected to fraud.
While it could be assumed that much of the focus of this study was on sexual indiscretions, it crossed over into substance abuse, violence and dishonesty (e.g., falsified credentials, perjury and plagiarism). In the study, about 47 percent of the indiscretions involved sexual misadventure, but dishonesty accounted for 33 percent, substance abuse for 11 percent, and violence for 9 percent.
It was theorized that many of the indiscretions are leaked in order to get rid of an already underperforming CEO while nullifying the termination clause benefit in their contract (i.e., firing them for material cause). This exemplifies that the bad executives, at least some of the time, get hit with some of the cost.
In light of all of this, it is rather amazing that only 36 percent of executives who have had an indiscretion are terminated, even if they are repeat offenders. The termination rate is nearly identical for first time and repeat offenders, which suggests that a lot of boards and executives are acting negligently. And, unfortunately, 96 percent of offenders are male. (This makes one damn strong argument for women executives.) Also, substance abuse terminations are incredibly low, even for repeat offenders (20 percent).
The majority of offenses seem to happen at family managed or founder managed firms, which suggests an excessive level of entitlement and a lack of strong internal controls in those firms. This is something every CFO should take to heart as they’ll likely be held at least partially accountable.
One interesting, though not surprising, statistic is that well-monitored firms (i.e., those with strong active boards) more aggressively deal with the CEO. So choosing firms with strong boards for employment, investment and as vendors would seem to be a great way to ensure against dealing with problems like this.
Wrapping Up: Avoiding Negligent Boards and Out of Control Executives
With the evidence provided in this paper, almost any talented corporate law firm should be able to execute a stockholder class-action law suit against most companies that have misbehaving executives. It points to a level of negligence at the board level that to me is extreme and unforgivable for a huge number of public companies. It also likely showcases why a lot of these indiscretions aren’t reported. It does at least imply that female-run firms, those run by happily married executives, and firms tied to a religion tend to more aggressively disclose and be more intolerant of indiscretions.
This all suggests that as we look into places to entrust our career, our savings or our companies, maybe we should look a little harder at the companies from which we are buying. The study showcased that good professional investors avoid companies run by “executives with lots of ex-wives, messy divorces, visitors to strip clubs, marriages to bimbos, or even heavy drinking.” Maybe we should do the same.
Rob Enderle is President and Principal Analyst of the Enderle Group, a forward-looking emerging technology advisory firm. With over 30 years’ experience in emerging technologies, he has provided regional and global companies with guidance in how to better target customer needs; create new business opportunities; anticipate technology changes; select vendors and products; and present their products in the best possible light. Rob covers the technology industry broadly. Before founding the Enderle Group, Rob was the Senior Research Fellow for Forrester Research and the Giga Information Group, and held senior positions at IBM and ROLM. Follow Rob on Twitter @enderle, on Facebook and on Google+.
