Over the years, there have been many attempts to explain why CEOs conduct their companies in situations that many outside observers would question. Although officially key decisions are the responsibility of all boards, there is no doubt that CEOs tend to dominate – with the result that the corporate landscape is littered with mergers and acquisitions. poorly designed, overambitious strategies, aggressive sales and marketing campaigns. etc
Commentators often identify two main types of CEO – the expansionist, visionary type that often comes from a marketing background, and the more stable, numbers-driven individual typically associated with a background in finance. They alternate frequently, with investors oscillating between a desire for vision and a preference for caution. But what if attitude to risk has less to do with training and background and more with character and general behavior? In 2019 Robert Davidson, Aiyesha Day and Abbie Smith published to research suggesting a link between how CEOs behave outside of work and attitudes toward risk and other aspects of culture in the companies they lead. Now, another team of researchers has spotted a link that could help ensure those hiring senior executives have a better idea of successful candidates’ likely future behavior. In an article published in a recent issue of Journal of the American Tax Association, Shuqing Luo, Terry Shevlin, Luring She, and Aimee Shih suggest that CEOs are more likely to engage in aggressive tax planning if they participate in high-risk sports. This sounds like a very specific problem, but the researchers point to academic work in psychology showing that individuals’ sporting activities reflect their tolerance or appetite for risk and suggest that although their focus is on taxation because they are academics in accounting, the findings have wider implications.
Terry Shevlin, a professor at the Paul Menage School of Business at the University of California, Irvine, said in a recent interview that while he wasn’t sure a candidate’s sports preferences would necessarily be a “red flag” for recruiters, he felt it was helpful in building an image of the individual. He added that it was “a pretty simple thing” for boards of directors or even auditors to ask the question in order to assess executives’ risk tolerance.
Shevlin admits some might say that high-risk sports, like skiing or rock climbing, are done by certain types of people because they can afford to participate or have access to the right places. But he insists that the methodology allows it and that the research is based on information about sports interests disclosed by the individuals themselves. In all, the team identified about 20 sports and ranked them by level of participation (golf, unsurprisingly, was the most popular) and injury risk data for each. The researchers also took into account that, in some cases, interest might involve watching rather than actually participating.
In the paper, Shevlin and colleagues say they “expect individuals to develop specific sports interests based on their personal risk preferences after trading the utility derived from participation in sports presenting a potential risk of injury”. Tax planning, they argue, is a useful measure because “a company’s tax aggressiveness is a unique and strategic decision made by its senior management, where such a decision is the result of cost-benefit trade-offs”. They add: “On the one hand, businesses can generate significant tax savings by adopting aggressive tax positions by structuring business transactions in the gray areas of tax laws or by operating in low-tax regimes that can test the limits of tax compliance; on the other hand, aggressive tax positions can expose businesses to compliance uncertainty and tax risks, including regulatory fines, penalties, and reputational risk. Ultimately, managers’ risk preferences likely play an important role in the trade-offs. »
The researchers say the study highlights the differences between decisions driven by individuals’ “innate preferences” and those driven by incentives, where companies want CEOs to behave more riskily. As such, they say, the findings could ultimately lead to more informed business decisions. For example, boards of directors seeking to fill senior management positions can ask respondents about their sports hobbies, as this can help identify their degree of risk aversion. Banks and lenders could ask senior company executives directly about their sporting hobbies to help them assess the risks associated with lending to corporate clients. Financial analysts and institutional investors could also ask senior management about their sports activities to assess management’s risk preferences and to assess the influence of these risk preferences on management’s tax planning decisions.