How can you tell how much a chief executive officer (CEO) knows relative to her subordinates? Measure how much she speaks.
Chicago Booth’s Michael Minnis, working with Feng Li and Venky Nagar of the University of Michigan and Madhav V. Rajan of Stanford University, combed through thousands of earnings-call transcripts to identify who was speaking. Among the findings:
At big firms that have intensive R&D operations (think pharmaceutical firms), the CEO is more likely to delegate speaking on the call to someone else, perhaps an executive who knows more about the company’s research or products. CEOs with advanced degrees speak more often on calls. That is “either because they know more, inherently, or because they are good at absorbing knowledge and can just pick it up”, Minnis says. The more a CEO speaks, the more she gets paid relative to her subordinates.
CEOs who talk a lot and get paid a lot, and CEOs who talk little and get paid less, preside over the companies with the highest value, measured by a ratio known as Tobin’s Q (market value to book value). It’s when the balance between CEO talk and CEO compensation is off-kilter that company value lags.
“When there’s a proper match between CEO compensation and CEO talking, firm value is highest, on average,” Minnis says.
“What’s interesting is that there is not necessarily a straightforward answer to how much the CEO should get paid and how much the CEO should know relative to the management team; it’s the combination of factors that’s important,” he adds.
The CEO does not have to be the most knowledgeable person in the firm as long as other executives have the requisite knowledge—and the CEO is paying them commensurately.
If the CEO has a financial background, the chief financial officer is heard less often on investor calls.
“The way a firm approaches external communications can reveal something about how the firm internally operates,” Minnis says. This may be most illuminating for outsiders with less access than board members and employees to what’s going on within the firm.
This article first appeared in The Chicago Booth Review.