Dealing with CEO misconduct
How should the board react if news got out that the chief executive officer (CEO) was abusive to an employee? Or that he had a relationship with a client? Or that he made insensitive remarks about a particular race or ethnicity? Or hiked prices of a product indiscriminately?
News like that spreads like wildfire, especially in the era of social media, turning the spotlight on the company, especially the board, which is seen as the corporate conscience-keeper.
When it comes to questionable behaviour on the part of a CEO, the way a board reacts speaks about a company’s culture. While the law calls out what is illegal, there are other transgressions that demand a board’s attention.
Researchers David F. Larcker, director of the Corporate Governance Research Initiative at Stanford Business School, and Brian Tayan, a researcher at the same institute, look at incidents of CEO misbehaviour in the US between 2000 and 2015 and evaluate the response of boards.
They identified 38 incidents where a CEO’s “bad behaviour” attracted a significant amount of media attention. And they found that:
l 34% involve reports of a CEO lying to the board or shareholders over personal matters—such as a drunken driving offence, prior undisclosed criminal record, falsification of credentials, or other behaviour or actions.
l 21% involve a sexual affair or relations with a subordinate, contractor, or consultant.
l 16% involve CEOs making use of corporate funds in a manner that is questionable but not strictly illegal.
l 16% involve CEOs engaging in objectionable personal behaviour or using abusive language.
l 13% involve CEOs making controversial statements to the public that were offensive to customers or social groups.
And, in these instances, shareholders mostly reacted negatively. Stock price reaction to initial reports showed that companies saw an arithmetic mean fall of 3.1%, the authors found.
For instance, Hewlett Packard Co. stock fell almost 9% over a three-day period following reports that former CEO Mark Hurd had a personal relationship with a female contractor, according to the study.
In over half the cases (55%), the board of directors initiated an independent review or investigation, the study said, and added that boards are most likely to announce an independent review in cases of potential financial misconduct.
“It is a great deal of pressure on a board to act when news of a CEO’s conduct gets picked up by the media. Valid or not, allegations can spread virally, and references to prior occurrences can resonate in news stories years after they initially occurred—with a lingering effect on corporate reputation,” the researchers wrote.
What followed in most cases was also a CEO’s termination, especially when there was financial misconduct.
“Questionable financial practices was the only category of behaviour that almost uniformly resulted in termination; all other behaviour—including allegations of lying to the board or shareholders, expressing controversial views, personal relations with employees, and exhibiting objectionable language or behaviour—resulted in both outcomes (termination and retention) across our sample,” said the researchers.
In 32% of the cases, the board also took actions other than termination in response to CEO misconduct.
These included stripping the CEO of the chairman’s title, removing the CEO from the board, amending the corporate code of conduct, reducing or eliminating the CEO’s bonus, resignation of other directors, and changes to board structure and composition.
But the ramifications to the company usually do not end with the CEO’s departure.
About one-third (34%) of companies faced additional fallout, including loss of a major client, federal investigation, shareholder or federal lawsuit, and other shareholder action, found the study.
“It is unclear whether CEO misbehaviour is symptomatic of broader cultural or organizational deficiencies, although it is worth noting that 45% of companies in the sample experienced a significant unrelated governance issue following the event, such as an accounting restatement, unrelated lawsuit, shareholder action, or bankruptcy,” said the authors.
While some kinds of misconduct are clearly unacceptable, there are many grey areas—should a board investigate allegations of a CEO being “abrasive” or engaging in “tirades”? What about allegations of “arrogance” or “hubris”, ask the researchers.
“Companies need to define clear parameters to identify questionable behaviour that should be of concern to board members,” they said.