If the CEO Owns a Yacht, Should You Sell the Stock?

If the CEO Owns a Yacht, Should You Sell the Stock?

Published: Monday, 11 Jun 2012 | 1:43 PM ET Text Size
By: Robert Frank
CNBC Reporter & Editor

In the past, investors rarely cared much about off-the-job spending by CEOs. Who cared if the top dogs indulged in a yacht or Ferrari? It's their money, they can do what they want, right?

New research suggests that the yacht and Ferrari habits of CEOs could indeed be relevant to investors.

A National Bureau of Economic Research working paper by Robert Davidson, Aiyesha Dey and Abbie J. Smith found that companies run by free-spending CEOs are more likely to have accounting fraud, financial restatements and value-destroying deals.

Specifically, the paper looked at CEOs who owned a boat larger than 25 feet, a car priced at more than $75,000 or a home valued at more than twice the local median average. These CEOs, labeled “un-frugals,” were more likely to have material reporting errors at the companies they ran or other financial problems.

Think Dennis Kozlowski of Tyco[TYC 52.68 -0.81 (-1.51%) ]
or Sanjay Kumar of Computer Associates, both of whom had large homes and yachts.

By contrast, frugal CEOs were more likely to have tighter financial controls and reporting systems at their companies, according to the research.

“Companies run by un-frugal CEOs are significantly more likely to engage in large acquisitions, to invest less in long-term organic growth, to operate assets in place less efficiently, to generate inferior subsequent accounting and stock-return per dollar of corporate investment, and to go bankrupt, suggesting a pattern of low frugality with regard to the stewardship of corporate resources,” the paper said.

The paper also found that un-frugal CEOs were more likely to have less independent corporate boards.

Granted, the research is preliminary. There are plenty of companies run by free-spending CEOs that do just fine. Consider Oracle[ORCL 26.81 -0.35 (-1.29%) ], whose CEO Larry Ellison is famous for his mansion-buying habit and his large yacht. Oracle is doing just fine.

What’s more, there's no evidence in the paper that non-frugal CEOs are personally involved in fraud more often. It’s just that their companies are more prone to restatements and financial problems.

Robert Davidson, one of the study’s authors, said that there are two possible explanations for why companies run by free-spending CEOs are more likely to have restatements.

The “leisure theory” is that CEOs are too busy driving their fancy cars or cruising on their yachts to bother with constant details at the office. Toys can be distracting. And while CEOs may think they can run the company just as well from the Feadship, oftentimes they can’t.

The other explanation is the “lifestyle” theory. A CEO who needs large wealth and income to sustain his personal spending might place huge demands on the company for growth and profits. Sometimes those demands might be unrealistic, causing the CFO or others to push the envelope when it comes to reporting or accounting standards.

Mr. Davidson said it’s easier to explain why companies run by “frugals” – CEOs who don’t buy luxury toys – tend to stay out of trouble.

“We find that if people carefully monitor their own spending and are restrained in their own decision making, they will do the same on the job,” he said. "They tend to run a very tight ship."

Warren Buffett would certainly agree.

Why do you think companies run by free-spending CEOs tend to get into trouble more?

-By CNBC's Robert Frank

http://www.cnbc.com/id/47767189

Hmm...

How about companies that splash out for their AGMs at 5 stars hotels with all the glitz versus those that held their AGMs at their own "ulu" industrial premises with cost-consciousness?

If you are a shareholder, which would you prefer?

I think having Yatch or not, holding AGM in 5-star hotel or industrial premise is not the important thing to consider when you invest in the company. The important thing is when the company is having losses, what does the management do? Do they still hold AGM in 5-star hotel? Does the CEO still uses the money to buy personal stuff? If yes, then it would not be a company that I consider.

(12-06-2012, 10:38 AM)Jared Seah Wrote: If you are a shareholder, which would you prefer?

Somewhere accessible. After all it's only once a year.

And well if you have the cash to pay out a decent dividend I don't see any harm in booking a meeting room in a comfortable hotel and letting shareholders enjoy the ambience.

Interesting question but not exactly relevant in our context since our CEOs tend to be more conservative and private and less 'showy' compared to their Western counterparts. Even the slightly more high-profile local CEOs like Dennis Foo and Kenny Yap cannot be accused of being not frugal.

I agree that it should also not be the main consideration when considering investing in the company. But if all else remains equal, I think this could be a 'tie breaker' factor in deciding which company to invest; but its

I remember a major shareholder of Poh Tiong Choon was unhappy with its lavish 60th anniversary celebration. (Read post here Personally, I think it was quite modest for a 60th year anniversary. Maybe he was just upset that a special dividend was not declared. Ultimately what is lavish or otherwise is subjective (vested in PTC)

I agree that AGM venue should be as accessible as possible and accessibility does not mean having it at a glitzy 5-star hotel. Having one at ulu location gives the impression that management is not interested in having shareholders to attend and sought to discourage participation. At least if you want to have it at an inaccessible location, provide shuttle buses from the nearest MRT stations (which is what Popular do). I dun rem other companies doing the same.

(12-06-2012, 10:57 AM)Some-one Wrote: I think having Yatch or not, holding AGM in 5-star hotel or industrial premise is not the important thing to consider when you invest in the company. The important thing is when the company is having losses, what does the management do? Do they still hold AGM in 5-star hotel? Does the CEO still uses the money to buy personal stuff? If yes, then it would not be a company that I consider.

IMO, holding AGM in 5-star hotel or industrial premises is not much a difference. The one that i pay most attention is the grandness of their HQ. The more grandness of their HQ, the less attractive it is.

One of my previous client in China, a new enterprise with a "hot" technology product been selling as hot cake then. A new HQ been build. After visited the HQ upon opening ceremony, we decided to scale down the biz with the client. The HQ is as grand as Ngee Ann city in Singapore with similar color of marble. Much bigger than Ngee Ann City, with a garden as big as half of football field in the center of the building. Full height class windows everywhere. Wow is the sound we make then.

Needless to say, 2 years after the ceremony, the company run into financial issue. I do not know the outcome now, did not bother to find out.

(12-06-2012, 11:27 AM)lonewolf Wrote: I agree that AGM venue should be as accessible as possible and accessibility does not mean having it at a glitzy 5-star hotel. Having one at ulu location gives the impression that management is not interested in having shareholders to attend and sought to discourage participation.

Saying on behalf on mgt, 1 reason for holding it at an inaccessible location is to have serious investors and not those coming for the free lunch buffet.Look at those investors spending all the money and time to go all the way to Omaha.from my personal experience attending AGMs, I find those AGMs that are inaccessible have a better investor crowd...serious hard core type

I think the core argument of the article is that management's thinking and managing of personal finance will often be reflected in the way they manage the company. Someone who's wary of taking on debt should have a similar conservative approach when handling the company's finance since personal finance is more important than company's finance (excluding cases where CEO is majority shareholder).

As for AGM, I wonder how much does it cost to hold it at a 5-stars hotel?

(12-06-2012, 12:12 PM)shanrui_91 Wrote: I think the core argument of the article is that management's thinking and managing of personal finance will often be reflected in the way they manage the company. Someone who's wary of taking on debt should have a similar conservative approach when handling the company's finance since personal finance is more important than company's finance (excluding cases where CEO is majority shareholder).

As for AGM, I wonder how much does it cost to hold it at a 5-stars hotel?

I agreed with your view. Management team is always important factor to consider before investment

I do not know the cost, but we do have staff meeting at 5-star hotel conference room. Normally for budget planning or strategy meeting, once or twice a year, last for one (1) full day. Our GM is not those generous type, so i guess the cost is not too high, probably lower few Ks. AGM probably take only half a day which cost lower

(12-06-2012, 11:44 AM)Jacmar Wrote: Saying on behalf on mgt, 1 reason for holding it at an inaccessible location is to have serious investors and not those coming for the free lunch buffet.Look at those investors spending all the money and time to go all the way to Omaha.from my personal experience attending AGMs, I find those AGMs that are inaccessible have a better investor crowd...serious hard core type

This bit always come up but this is a manageable issue. Do away with buffet altogether and just have packed lunch or food coupons.

Saying that only serious investors turned up at ulu AGM locations implies that those who attends at accessible locations are not. Dun think its so clearcut.

Simple fact is that inaccessible locations discourage investors from attending - even the serious one. Of cos having over-lapping AGMs happening at the same thing dun help.