CEOs ain’t misbehavin’? A new study from the Stanford Graduate School of Business, “Scoundrels in the C-Suite,” discusses the fallout from and responses to “bad behavior” by CEOs.  While “bad behavior” clearly includes illegal conduct, it may also include other types of questionable but not illegal behavior.  Both of those types of misconduct can make the news.  How have corporations handled these allegations of misconduct?  The study reviewed the news media between 2000 and 2015, identifying “38 incidents where a CEO’s ‘bad behavior’ garnered a meaningful level of media coverage (defined as more than 10 unique news references).” The study then examined the publicly available corporate responses and other consequences of those incidents.

When credible allegations of serious CEO misconduct are made – conduct that is not in the interest of the company or its shareholders – the study observes, the board of directors, in furtherance of its duty to monitor, has an obligation to investigate. If the allegations are verified, “the board should (and normally will) take corrective action, including termination, required leave of absence, reduction in pay, and changes to policies or procedures for executive conduct.” If the CEO engages in illegal activity, the response, in most cases, is fairly predictable. What that corrective action should be in the case of acts that are questionable but not illegal is not always clear. Compounding that uncertainty, media attention will subject corporate responses to increased scrutiny and intensify pressure on boards: “In this case, the board must decide whether and how to investigate, and whether or not to address the matter publicly or privately. Equally important is the board’s assessment of whether CEO misbehavior will impact the broader organization and shareholder value. This includes determining the scope of the CEO’s actions, and whether the actions are indicative of systemic or potentially widespread cultural problems that adversely impact shareholders…. Research also finds that the behavior of individuals within an organization is influenced by the ‘tone at the top’ and that, when left uncorrected, misbehavior can spread.”

The authors acknowledge that the incidence of CEO misbehavior and the nature and extent of board responses are difficult to gauge accurately because some misbehavior and some board responses may never be publicly reported.  Moreover, the divide between which questionable behavior should be or need not be of concern to board members is not always clearly delineated: for example, “should the board investigate allegations that a CEO is ‘abrasive’ or engages in ‘tirades’?” In any case, once the media step in, “[v]alid 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 study identified the following categories of conduct and their incidence:

• “34 percent involve reports of a CEO lying to the board or shareholders over personal matters—such as a drunken driving offense, prior undisclosed criminal record, falsification of credentials, or other behavior or actions.
• 21 percent involve a sexual affair or relations with a subordinate, contractor, or consultant.
• 16 percent involve CEOs making use of corporate funds in a manner that is questionable but not strictly illegal.
• 16 percent involve CEOs engaging in objectionable personal behavior or using abusive language.
• 13 percent involve CEOs making controversial statements to the public that were offensive to customers or social groups.”

The extent of media coverage was just short of stunning. The study indicates that “reports of these actions were included in over 250 news stories each, on average. Furthermore, reports were persistent, with references made to the CEO’s actions 4.9 years on average after initial occurrence.” [Emphasis added.] As one example, the authors cite news stories referring to a CEO’s “odd behavior” that persisted even though it was first reported over 10 years previously. In addition, the study reports that share prices declined “by a market-adjusted 3.1 percent (1.1 percent median) over the 3-day trading period before, including, and after the initial news story.” Interestingly, though, the study found that, for 11 of the 38 companies, stock prices “exhibited positive abnormal stock price returns when CEO misbehavior made the news. Perhaps unexpectedly, there is no discernable relationship between the type of behavior and stock price reaction.”

According to the study, the most common corporate responses to (and other fallout from) allegations of CEO misconduct were as follows:

• In 84 percent of the cases, the company issued a press release or formal statement addressing the issue.
• In 71 percent of the cases, a spokesperson provided comments to the press.
• In only 37 percent of the instances did a director provide comments to the press, but a director’s willingness to discuss the matter directly with the press did not appear to vary with the type of or “severity” of the CEO’s conduct.
• In 55 percent of the incidents, the board initiated an independent investigation, with the board most likely to announce an independent review in cases of potential financial misconduct.
• In 32 percent of the cases, there was another type of board action or response, such as removing the CEO from the board or from the chair position, amending the corporate code of conduct, changing the board structure or composition, or reducing or eliminating the CEO bonus.
• In 34 percent of the cases, there was other fallout from the incident, such as a change in marketing, loss of a major client, federal investigation, shareholder or federal lawsuit or shareholder action such as a proxy contest.
• In almost half the cases (45 percent), the company experienced unrelated significant governance issues following the event, such as an accounting restatement, unrelated lawsuit, shareholder action, or bankruptcy, raising the question of “whether CEO misbehavior was symptomatic of broader cultural or organizational deficiencies.”
• In 21 percent of the instances, the CEO had engaged in previous, or engaged in subsequent, questionable behavior, including allegations of sexual harassment, insider trading, and other infractions, felonies or misdemeanors.
• In 8 percent of the cases, the CEO resigned from another board.
• In 58 percent of the instances, the CEO was terminated because of the issue.
  • The mean number of days to termination was 375 days, with a high of almost nine years. Eleven instances resulted in termination on the same day as the story hit the media.
  • Terminations occurred across all categories of alleged behavior, but questionable financial practices almost always resulted in termination.
  • Two terminated CEOs were subsequently rehired by the same company.

The study authors conclude with more questions for further consideration:

• Misbehaving CEOs are an attractive media target: “What is the duty of the board of directors to pursue reports of misconduct, particularly in cases where behavior is not explicitly illegal and shareholders have suffered no apparent loss? When are allegations serious or credible enough to merit boardroom attention? What steps should boards take in response?”
• Because establishing an appropriate “tone at the top” is an important aspect of corporate leadership, how “can the board assess the impact of CEO misconduct on the organization broadly? How can they tell whether misconduct is confined to the individual or is widespread?”
• Often, the board becomes aware of the CEO misconduct after the news becomes widespread. “Should the board be more proactive in employing [tools to detect] early signs of CEO and employee misconduct” such as confidential workplace surveys, third-party websites and independent social media listening tools?

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