Narcissistic CEOs of public companies are shown empirically to be more likely to make adjustments to their firm's GAAP earnings. These adjustments are larger in scale, and lower in quality than adjustments made by non-narcisstic CEOs. That is, narcissistic CEOs manipulate earnings in order to look good in the short term.
This article is a review and exploration of the white paper:
also available at SSRN
All public companies are required to file financial disclosures in a specific format, which includes using Generally Accepted Accounting Principals (GAAP). Among other benefits, this standardization is more easily auditable, and provides clear comparisons of identical metrics across other firms. If a company announces that they made a quarterly profit, GAAP is what allows investors to know exactly what that "profit" means.
However, companies are free to disclose additional information as well, usually in annual reports or letters to shareholders. Sometimes, companies use the opportunity in order to provide additional visibility into the underlying financial performance of the firm, especially in cases where the GAAP financials were impacted by a one-time event. For example, if the company spent a lot of resources the prior quarter on a one-time corporate restructuring, management might reasonably expect that cost to never recur. In that case the firm would publish regular GAAP earnings, as usual, and then issue an additional press release announcing a "restructure-adjusted net earnings" number, intended to give investors a better idea of what earnings would have been without the restructure cost (and therefore a better idea of what to expect in the future).
In theory, this should be fine, and additional information should only benefit investors. In practice, non-GAAP earnings are absolutely rife with misinformation, and in the extreme have bordered on outright fraud. There is enormous literature on the topic, part of which we touch on here. High level, the key pieces to keep in mind are:
- Non-GAAP disclosures are not audited.
- Any non-GAAP earnings adjustments should be temporary, since they essentially attempt to explain what GAAP earnings ought to look like, if not for x, y, z reasons.
- Non-GAAP earnings adjustments can be both positive and negative.
On to the paper...
Hypothesis & Data
This paper attempts to determine if specific CEO personality traits have an affect on quantity and quality of a firm's non-GAAP disclosures. A narcissistic CEO may be more likely to value their own reputation/compensation above their fiduciary duty to shareholders, and so may be more aggressive than other firm managers in publishing misleadingly positive non-GAAP earnings. Specifically, the authors seek to confirm three hypothesis:
- Firms with narcissistic CEOs are more likely than other firms to publish non-GAAP earnings adjustments that increase earnings, rather than decrease them.
- The more narcissistic the CEO, the larger those non-GAAP adjustments become.
- The non-GAAP adjustments made by narcissistic CEO firms are more persistent (i.e., they are not actually one-time exclusions), and so of poorer quality, than that of other CEO firms.
Note that for the remainder of the article, short hand of "narcissistic CEOs" is used rather than "firms with narcissistic CEOs". Additionally, stating "narcissistic CEOs are more (less) likely to...", it is implied that they are more (less) likely than non-narcissistic CEOs.
Here's the fun part. While it would be incredible (though super creepy) to get access to actual psychological datasets for CEOs of public companies, that obviously doesn't exist and would likely be ethically ambiguous to use anyway. So the researchers used a proxy to assess the narcissism of the CEO by combining:
- Total CEO compensation (cash and non-cash), compared to the next-highest-paid executive at the firm - and -
- A 1-5 narcissism score determined by the size of the CEO's picture in the firm's annual report, where:
- The annual report does not contain a photograph of the CEO;
- The CEO was photographed with other executives;
- The CEO was photographed alone and the photograph occupies less than half of a page;
- The CEO was photographed alone and the photograph occupies at least half of a page, and the photograph shares the page with text;
- The CEO was photographed alone and the photograph occupies the entire page.
This is absolutely hilarious.
The study only included CEOs with at least 4 years of tenure at the company, in order to exclude data where new CEOs. Compensation data was taken from Execucomp, and the CEO photo data was hand collected. The data collected was from 1996-2014, and yielded 923 CEOs at 716 firms, with about 19,000 firm-quarter observations.
Researchers found the data to be statistically significant in validating all three hypothesis.
- Narcissistic CEOs are more likely to make non-GAAP adjustments that increase (rather than decrease) earnings, relative to other CEOs.
- The more narcissistic the CEO, the larger the non-GAAP adjustments are.
- Non-GAAP adjustments made by narcissistic CEOs are more likely to persist in earnings, and so were less appropriate to exclude in the first place.
There is a trove of preliminary findings and notes in the paper beyond just the core hypothesees above. A few highlights:
- 92% of the firm-quarters in the study had positive GAAP earnings.
- 44% of the firm-quarters in the study had non-GAAP adjustments. This is consistent with other literature. Non-GAAP adjustments used to be quite rare, but more recently have become ubiquitous.
- Narcissistic CEOs are more likely to run larger firms.
- Narcissistic CEOs are more likely to run more profitable (GAAP profit) firms, however, the data showed some evidence that GAAP earnings of narcissistic CEOs were themselves less persistent than the profits of non-narcissistic CEO firms, implying that narcissistic CEOs may be manipulating their GAAP earnings as well.
- There is some evidence provided that narcissistic CEOs make the non-GAAP exclusions specifically to meet or beat consensus analyst earnings expectations.
From the white paper: (emphasis added)
Our results show that narcissistic CEOs, in particular, are more prone to exclude income decreasing items from non-GAAP earnings to shape how their company is viewed. Narcissistic CEOs have an unremitting need for self-enhancement and the non-GAAP earnings settings affords them such an opportunity. Our results also suggest that more narcissistic CEOs are more likely to exclude a higher magnitude of income decreasing items from non-GAAP earnings. Furthermore, our results suggest that the exclusions from non-GAAP earnings made by more narcissistic CEOs are more persistent, which suggests that they are lower quality. Regulators and investors are concerned with managers using non-GAAP exclusions opportunistically. Our findings aid investors and regulators in identifying which firms have a higher likelihood of using non-GAAP exclusions to improve the appearance of their firms’ performance. Our findings demonstrate the meaningful effect that individual executives can have on firms’ strategic and accounting-related outcomes and choices.
Look out for narcissistic CEOs. There can be some benefit to having charismatic, confident leaders, of course - but view their financial disclosures with extreme skepticism.
The below table cites all data and sources used in constructing the charts, or otherwise referred to, on this page.
|Featured White Paper - The Impact of the CEO’s Personal Narcissism on Non-GAAP Earnings||The Accounting Review - Vol. 96, No. 3 May 2021
Also available for direct download at SSRN