Thursday, September 09, 2004

Stock crashes when CEO flies

CEO plane usage linked to declining stock value.

Short version: David Yermack shows that when CEOs get personal use of corporate airplanes, the firm's stock underperforms "market benchmarks." This underperformance is consistent with a view that the plane usage is symptomatic if a greater agency cost problem.

Longer version:

Perquisite consumption (a fancy way of saying that managers have certain advantages) has long been seen as a prime example of the Shareholder-Manager conflict (see Jensen&Meckling 1976). However, we rarely can quantify the cost. David Yermack helps us to be able to do so.

He examines stock price behavior of firms that allow their CEOs personal use of corporate planes. He finds that :

"CEOs' personal use of company aircraft is associated with severe and significant
under-performance of their employers' stocks. Firms that permit personal
aircraft use by the CEO under-perform market benchmarks by about 4 percent or
400 basis points per year, after controlling for a standard range of risk, size
and other factors. This result proves robust to a wide range of alternative
performance measures and additional controls."

Why? One view is that the managers are wasting money by flying. While this is likely to be true, the magnitude of the underperformance and the expense of flying the plane do not correspond. (well maybe if the plane was used for repeated trips to Saturn.)

A much more likely cause is that the plane usage is symptomatic of more severe agency conflicts (if they will take the corporate jet, then they must not be looking out for shareholders too much!) This is like the evidence from merger and acquisition literature that shows some deals destroy much more value than the value of the deal itself as it signals managers willingness to spend on bad deals--see Kodak and Sterling drug).

Other interesting findings in the paper:

  1. The author finds "find a negative association between CEOs’ personal aircraft use and their level of abnormal compensation, measured as the residual from a separate compensation regression model. While this finding is consistent with Fama’s ex-post settling up perspective, its magnitude is quite small and it has only borderline statistical significance. A CEO who consumes an extra $1,000 in perks, according to the model’s estimates, will see his other compensation fall by about 10 cents."
  2. In what may be an endogeniety story, there is "little evidence...that variables associated with monitoring or governance have any association with perks."
  3. One way to avoid having to disclose this perk consumption is to increase consumption of other perks. Why? Only those perks that make up 25% or more of the total need be reported.
  4. "Aircraft use is by far the largest disclosed CEO perk, appearing more than twice as often as the next most popular item, financial counseling, which includes tax preparation, estate planning, and the cost of representation in contract negotiations." Moreover this is growing quickly: There has been a "sharp increase in the frequency of personal aircraft use over the ten-year sample period, with the annual rate having risen from 9 percent in 1993 to above 30 percent in 2002."
  5. The "the median cost to the company of CEO's personal aircraft use, when disclosed, is a little above $50,000. Costs of operating different aircraft vary greatly.
    Maynard (2001)...estimate[s] the hourly cost of leasing an eight-person Cessna Citation V aircraft as $10,000, or $2,500 per person if the CEO on average travels with three other passengers. A CEO with $50,000 in reportable aircraft use would therefore spend about 20 hours per year in the sky, enough for perhaps three round-trips between New York and Florida." (For comparison, I just checked and a round trip flight from NYC to Tampa Florida is selling for about $236.)
A very cool paper! Although I confess I might like it because it fits my prior beliefs on the subject. That said, if you are looking for a "fun" finance paper to read, this is it!

While I do not know how long the link will last, Yahoo also has an interesting write-up on this paper.

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