Chief executive officer private firm experience and idiosyncratic risk

• Published date: 01 May 2024
• Author: Dev R. Mishra
• Date: 01 May 2024
• DOI: http://doi.org/10.1111/corg.12556

ORIGINAL ARTICLE

Chief executive officer private firm experience and

idiosyncratic risk

Dev R. Mishra

University of Saskatchewan Edwards School of

Business, Saskatoon, Saskatchewan, Canada

Correspondence

Dev R. Mishra, University of Saskatchewan

Edwards School of Business, Saskatoon S7N

5A7, Saskatchewan, Canada.

Email: mishra@edwards.usask.ca

Abstract

Research Question/Issue: We examine chief executive officers' (CEOs) lifetime work

experience in private firms and its potential influence in shaping managers' style in

public firms and their corporate policies and thus the market's perception of a

firm's risk.

Research Findings/Insights: We find that the idiosyncratic risk of public firms

increases with the extent of CEO work experience in privately owned firms

(CEO private experience). While there is no evidence of higher investment risk taking

by private CEOs, the proportion of private-firm work experience has a positive asso-

ciation with disclosure deficiency, decrease in manager-owner agency conflicts, and

an increase in political risk revelations at earnings conference calls, which, in turn, are

associated with the elevation of idiosyncratic risk.

Theoretical/Academic Implications: The findings of this study underscore arguments

in the upper echelons theory, imprinting theory, and behavioral agency theory. The

study also has implications for literature related to corporate disclosure, governance,

and political risk.

Practitioner/Policy Implications: Idiosyncratic risk is important for firms, as the litera-

ture suggests it hurts a firm's ability to finance future capital investments; therefore,

it is optimal for corporate boards to have strategies in place to monitor and offer

orientation packages targeted at alleviating CEO style heterogeneities presented by

their prior work experience in private firms.

KEYWORDS

corporate governance, CEO private experience, earnings conference calls, idiosyncratic risk,

political risk

1|INTRODUCTION

Apart from natural chief executive officer (CEO) characteristics such

as hubris/overconfidence, age, gender, and acquired CEO traits

such as education and marriage (Bertrand & Schoar, 2003;

Falato et al., 2015; Malmendier & Tate, 2005,2008; Roussanov &

Savor, 2014), formative life/work experiences affect the CEO's

management style and thus corporate policies. For example, CEOs

with early military experience adopt conservative corporate policies

and demonstrate ethical behavior (Benmelech & Frydman, 2015);

industry-expert CEOs negotiate better deals and pay a lower target

premium (Cust

odio & Metzger, 2013); financial-expert CEOs use

project-specific (vs. one-for-all) discount rates, manage financial poli-

cies more actively, and manage to raise funds during tight credit

conditions (Cust

odio & Metzger, 2014); managers whose careers

begin during recession adopt conservative investment styles and

focus on cost-cutting (Schoar & Zuo, 2017); and CEOs with prior

CEO work experience in other (similar) firms demonstrate poorer

post-succession performance (Hamori & Koyuncu, 2015;

Zhang, 2008).

Received: 14 April 2022 Revised: 7 July 2023 Accepted: 29 July 2023

DOI: 10.1111/corg.12556

Corp Govern Int Rev. 2024;32:567–589. wileyonlinelibrary.com/journal/corg © 2023 John Wiley & Sons Ltd. 567

We investigate another, albeit overlooked, formative life/work

experience based on their careers in private firms and its potential

influence in shaping managers' style and corporate policies and thus

the market's perception of a firm's risk. More specifically, we attempt

to elucidate this association and examine whether the extent of CEO

private-firm experience (henceforth, CEO private experience) affects

corporate policies that have implications for idiosyncratic risk. Idiosyn-

cratic risk as the key outcome variable is widely used in CEO attribute

studies such as the following: Idiosyncratic risk has corporate invest-

ment policy implications (Roussanov & Savor, 2014); the likelihood of

CEO turnover and turnover-performance sensitivity increase in idio-

syncratic volatility (Bushman et al., 2010); incentive plans that expose

managers to the firm's idiosyncratic risk likely “distort a manager's

choice of investment and financing policies”(Glover & Levine, 2017,

p. 337); idiosyncratic volatility anomalies associated with selective dis-

closure (Jiang et al., 2009); idiosyncratic risk represents the informa-

tiveness of stock prices (Ferreira & Laux, 2007) and drives the

forecastability of the equity market (Goyal & Santa-Clara, 2003).

It is known that unlike public firms, private firms are not moni-

tored by the public, investors, media, market regulators such as SEC,

and exchanges; have little or no requirements for dealing with the

complexities of public disclosures; require no regular public communi-

cations with investors such as earnings conference calls; and involve

less complicated, starkly different governance structures. Therefore,

the CEO style formed from their private firm experience is likely to

disadvantage them in handling some complexities of public firms,

which would likely adversely affect investors' risk perceptions. On the

other hand, it is likely that private CEOs carry a management style

that could be valuable in general or at minimum for public firms that

are financially constrained and controlled by dominant shareholders,

which may likely help alleviate investors' perceptions of risk. For

example, the private CEOs likely get opportunity to learn skills to deal

with financially constrained firms, because the literature suggests pri-

vate firms face higher borrowing costs (Mortal et al., 2020) and are

disadvantaged in syndicated debt markets (Saunders & Steffen, 2011).

Further, private firms likely carry lower agency problems due to direct

monitoring and management by owners; involve direct dealings with

single, family, or finger-countable owners with significant concentra-

tion of their wealth within the business; and thrive in a culture of no

takeover defenses. Given these competing possibilities, the direction

of the effect of CEO private experience on idiosyncratic risk is an empir-

ical question and likely exerts a heterogeneous effect across diverse

types of firms.

The study's sample utilizes information about CEOs of Execu-

Comp firms from 1993 to 2016 and their private experience estimated

using work experience from 1945 to 2016 as recorded in their Boar-

dEx Curriculum Vitae (CV). With this sample and by using an elaborate

set of observable firm, CEO and industry characteristics, and unobser-

vable year and firm-fixed effects as primary empirical strategies to

alleviate usual concerns about CEO–firm matching where possible,

this study adds to our knowledge in three ways. First, it shows that

CEOs' private experience contributes to elevating firms' idiosyncratic

risk. Second, it finds that (i) disclosure deficiency is increasing in CEO

private experience, and the former, in turn, contributes to the elevation

of idiosyncratic risk; (ii) the concentration of ownership within the top

5 institutional blockholders increases CEO private experience, and in

turn, it contributes to elevating idiosyncratic risk; and (iii) CEO private

experience is associated with poor management of or poor effective-

ness in alleviating firm-level political risk concerns during earnings

conference calls. The political risk concerns revealed in conference

calls positively relate to idiosyncratic risk. Third, private CEOs likely

enter executive search criteria not necessarily for their private firm

experience, but because at the time of appointment, private CEOs are

more likely (1.27:1 odds) to have served as CEOs at other firm(s) and

are more likely (1.14:1 odds) to carry a more diverse job experience.

Because CEO work experience is known to the corporate board

(and search consultants) at the time of hiring, such an association may

simply reflect riskier firms' tendency to hire Private CEOs such that it

likely captures firm-specific heterogeneity. It is understood that the

endogenous matching of firm (board) goals and CEO characteristics

cannot be ignored, making it difficult to claim a causal relationship

between the extent of CEOs' private experience, firm policies, and risk

without substantial due diligence. To this end, first, the sensitivity of

idiosyncratic risk to the extent of CEOs' private experience remains

positive and significant in accounting for time-invariant CEO, time-

invariant firm, and “year x industry”effects. Second, our results sur-

vive robustness tests using RecessionStart as an exogenous shock to

early career potential against highly paid corporate (public) jobs as an

instrument in the specifications that control for year and industry and

year and firm-fixed effects. Finally, to further alleviate identification

issues, we also exploit CEO turnover events, analyze idiosyncratic risk

changes across different types of CEO transitions at and around CEO

turnover in univariate and multivariate settings, and continue to

observe a strong positive association between CEO private experience

and idiosyncratic volatility. The survival of our predictions in these

extensive batteries of identification tests suggests that there is some-

thing unique about the CEO style embedded in CEO private experience

that affects firm policies that positively affect the firm's idiosyncratic

risk.

This study has important contributions to existing literature and

implications for firms' governance practices. First, the findings of this

study underscore arguments in upper echelons theory (Hambrick &

Mason, 1984) as it considers another formative life experience of

CEOs, which is their prior work experience in private firms, and that

such background characteristic of CEOs affects management style

and corporate outcomes; behavioral agency theory (e.g., Wiseman &

G

omez-Mejía, 1998); and imprinting theory (Marquis & Tilcsik, 2013)

that imprinting of private firms' culture and business environment into

private CEOs has implications for the corporate policies they adopt

and their outcomes at public firms. Second, it proposes and tests

several channels through which the style formed out of private firm

experience likely creates an environment for higher idiosyncratic risk.

The findings to that effect have implications for the literature on

disclosure, governance, and firm-level political risk (e.g., Brockman &

Yan, 2009; Dennis & Strickland, 2002; Ferreira & Laux, 2007;

Gao et al., 2017; Rubin & Smith, 2009). Third, the study provides

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