Many explanations have been made over the years about why chief executives are able to lead companies into situations that few outside observers would doubt. Although all boards are responsible for making key decisions, it is clear that chief executives tend to have a lot of influence. This has led to a corporate landscape littered by poorly-conceived mergers, acquisitions, ambitious sales and marketing campaigns, and other misguided actions.
Commentators frequently identify two types of CEO: the visionary, expansionary type that is often derived from marketing backgrounds and the steady, numbers-focused person usually associated with finance backgrounds. As investors shift between a desire to see the future and a preference for safety, they often alternate. What if your attitude to risk is less dependent on your background and training, and more about your character and general behavior? In 2019, Robert Davidson and Aiyesha Day published research pointing out a connection between CEOs’ behavior and attitudes to risk and other aspects at their businesses. Another team of researchers discovered a link that could help those who hire senior executives to have a better understanding of their future behavior. Shuqing Luo and Terry Shevlin, Luring She, and Aimee Shih wrote that CEOs are more inclined to engage in aggressive tax planning when they have been involved in high-risk activities. Although this seems like a very specific issue, the researchers point out that psychology research has shown that CEOs are more likely to engage in aggressive tax planning if they participate in high-risk sports.
Terry Shevlin is a professor at Paul Menage School of Business, University of California, Irvine. He said that while he wasn’t sure whether a candidate would have a sporting preference, it helped him build a picture of the person. It was “a very simple question” that boards and auditors could ask to determine the executive’s risk tolerance.
Shevlin admits that there are some who might argue that certain high-risk activities, like rock climbing or skiing, are only undertaken by those who can afford it or have the resources to do so. He insists that the methodology allows this. The research is also based on the information provided by individuals about their sporting interests. The team identified 20 sports, ranked them by their level of participation (golf was unsurprisingly the most popular), and the data on injury risk for each. Researchers also acknowledged that some people might be more interested in watching than taking part.
Shevlin and his coworkers state that they expect individuals to develop particular sports interests based upon their risk preferences. This is in addition to the tax savings that can be generated by structuring business transactions in grey areas of tax laws and operating in tax regimes that have low tax rates. However, firms that take aggressive tax positions could expose them both tax risks, including penalties and uncertainty, as well as tax fines and reputation risk. The trade-offs are likely to be influenced by executives’ risk preferences.
According to the researchers, the study highlights the difference between decisions driven by “innate preferences” of individuals and those that are “incentive-induced,” where companies want CEOs be more risky. According to the researchers, these findings could eventually lead to better corporate decisions. Boards of directors looking to fill high-ranking management positions might ask interviewees about their hobbies. This can help determine their level of risk aversion. To help clients with their risk assessment, banks and lenders might ask top managers of the firm about their hobbies. Institutional investors and financial analysts could also inquire about top management to assess their risk preferences and the impact of these risk preferences on tax planning decisions.