Company leaders who commit illegal or immoral indiscretions not only hurt their own image but also their employer's bottom line, new research finds.
A study set to be published in an upcoming issue of the Journal of Financial Economics found that CEOs and other company executives caught doing drugs, having sexual affairs, or being violent or dishonest can have a multimillion dollar impact on a company's value.
For the study, researchers analyzed 325 instances of executive indiscretions. Indiscretions were divided into four categories: substance abuse, violence, sexual indiscretions and dishonesty.
The study's authors found that leaders who make one of these public blunders cost their employer an immediate 1.6 percent loss in shareholder value. That translates into an average loss of $110 million in market capitalization.
The research shows that the higher up the corporate ladder the indiscretions come from, the larger the impact. Transgressions from the CEO cost businesses a 4.1 percent loss in shareholder value, or $226 million, according to the study. [See Related Story: Choosing the Right CEO Matters More Than Ever]
"Collectively, our results imply that the personal integrity of the top management team plays an important role in the valuation and business operations of the firm," the study's authors wrote.
Besides a loss in shareholder value, employers also see a decline in the number of new major customers and joint venture partnerships following CEO indiscretions.
"Customer losses are particularly severe for those indiscretions that damage the firm’s reputation the most," the study's authors wrote.
Out of the four types of transgressions studied, dishonesty was found to have the biggest negative impact.
"Our research certainly suggests shareholders and potential business partners perceive that someone who is duplicitous in his or her private life could be more willing to mislead professionally," Adam Yore, one of the study's authors and an assistant professor at the University of Missouri, said in a statement. "Personal integrity at the top matters and can have major impacts on these companies."
The researchers found that some companies are not impacted as much by their leaders' public missteps. Specifically, businesses that the study's authors termed as "shady," because they regularly failed to comply with federal rules, saw smaller market reactions when managerial indiscretions were made public.
After looking at company leaders who committed one misstep and those who committed multiple transgressions, the researchers found that the likelihood of being fired for disciplinary reasons was similar for both groups.
The study found that indiscretions were made by those in charge more often at poorly run organizations where getting fired for mistakes was less likely.
Overall, the research found that CEO turnover or a cut in pay does increase dramatically following managerial misdeeds.
"The collateral damage goes further: At least some shareholders seem to hold board members responsible for indiscretions associated with the firm’s executives," the study's authors wrote. "Board members receive significantly lower votes in the director election immediately following announcement of an indiscretion."
The study was coauthored by Brandon Cline, an associate professor at Mississippi State University, and Ralph Walkling, founder of Drexel University's Center of Corporate Governance.