Taking a close look at the personal debt levels of chief executives might provide insight into the debt levels of their firms, according to a new study by researchers at Ohio State University's Fisher College of Business. The study found that the firms of chief executives who have home mortgages have, on average, four percentage points more debt than firms led by CEOs without mortgages. Those findings suggest that a chief executive's habits at home might influence the way he leads his business.
Anil Makhija, coauthor of the study and professor of finance at the business school, says the findings suggest it's useful to examine chief executives' personal debt situations when trying to understand a company's management. And that information, it turns out, is relatively easy to find. The researchers based their data on public data sources, which allowed them to gather mortgage information on over 1,300 chief executives of companies that comprise the S&P 1500.
The average chief executive bought a $1.65 million, four-bedroom home (as measured in 2005 dollars). Two in three used a mortgage to purchase the home and, on average, they borrowed about 66 percent of the total purchase price. (The average American borrows 75 percent of the purchase price.) Those numbers suggest that in general, chief executives borrow a lower percentage of their home price than the average American, which makes sense since they are more likely to be able to afford to do so.
After comparing CEO debt levels to the debt levels in their companies, the researchers found that chief executives with higher debt levels were more likely to lead companies with higher levels of corporate debt. (They controlled for other factors, including CEO age, interest rates, regional home prices, and firm characteristics.) Says Makhija, "Even controlling for all of that, we still find that that the personal traits of CEOs explain corporate debt."
The study also found that when a firm switches to a new chief executive with different debt habits, its debt structure tended to change to reflect the new CEO's debt profile. "When the new CEO seems to be more financially conservative based on his own personal leverage, the firm tends to reduce its corporate leverage," explains Makhija.
So, what does all this mean for individual investors? Should we start checking up on chief executives' personal habits and home mortgages before investing in companies? If you're the kind of person who takes the time to research company financial statements anyway, then this study suggests that searching for the chief executive's own financial records might be a worthwhile exercise.
- See also: Testosterone's Role in Investing Decisions.