Trophy Houses and Poor Corporate Performance
Earlier I wrote about Oswald’s finding that home ownership seems to be a major determinant of unemployment. Crocker Liu and David Yermack look home ownership by CEOs — the type of trophy homes that defy description.
Yermack is the economics I cited in The Confiscation of American Prosperity who showed how CEOs private use of corporate jets was a predictor of poor economic performance of their companies.
Here, Yermack & his co-author show that the ownership of these trophy homes is also a good predictor of poor performance. The idea is that these executive are signaling that they are confident that their job is secure regardless of performance. Anyway, here are my notes from this fascinating paper.
Liu, Crocker and David Yermack. 2007. “Where Are The Shareholders’ Mansions? Ceos’ Home Purchases, Stock Sales, and Subsequent Company Performance.”
“Microsoft Chairman Bill Gates received notoriety for constructing a 66,000 square foot home in Washington State, part of an estate valued at $140 million, while Mittal Steel (India) founder Lakshmi Mittal paid $128 million in 2004 for a London townhouse with a 20 car garage near Kensington Palace, the largest amount ever paid worldwide for an existing single family home. Conversely, Berkshire Hathaway CEO Warren Buffett is famous for having lived since 1958 in a house he bought for $31,500 in an ordinary neighborhood of Omaha, Nebraska.” see “Homes of the billionaires,” Forbes, March 10, 2005.
“CEO home purchases may indicate entrenchment, meaning that the CEO feels secure in his position and is not concerned with the possibility of removal by the board.”
“We find a strong temporal pattern of CEOs exercising options and selling shares in the period leading up to their home acquisition dates. These stock sales are often small relative to the CEO’s total investment in the firm, with a mean of about $450,000 and a median of zero. However, they appear to give significant signals about future company performance, a pattern that is all the more surprising due to the apparent personal liquidity rationale for the sales.”
“… we observe an inverse association between the value and size of a CEO’s residence and the returns on his company’s stock.”
“An entrenched CEO perceives himself as immune from discipline by his board and is uninterested in maintaining or improving his performance to attract outside offers.”
Ait-Sahalia, Parker, and Yogo study the macro associations between Manhattan luxury co-op price indices and movements in the stock and bond markets. Ait-Sahalia, Yacine, Jonathan A. Parker, and Motohiro Yogo, 2004, Luxury goods and the equity premium, Journal of Finance 59, 2959-3004.
They study 432 CEOs of S&P 500 companies at the end of 2004 and found that 12% of them lived in homes of at least 10,000 square feet or on at least 10 acres. In the subsequent year, the share prices of companies with mega-mansion CEOs lagged behind S&P 500 chief executives with smaller homes by 7%, on average.
“The median home includes 11 rooms plus 4.5 bathrooms, with a floor area of more than 5,600 square feet. It sits on land with a median area of one and quarter acres. Twelve percent of CEOs’ homes are situated on waterfronts, and 8.5% are adjacent to or on the grounds of golf courses.”
16 CEOs in our sample live more than 1,000 miles from headquarters (some live considerably farther), and another 16 who live between 250 and 1,000 miles from work.
“We calculate mean cumulative net-of-market returns on a monthly basis for a portfolio of 23 CEOs’ homes that exceed either 10,000 square feet in floor area or 10 acres in land area …. We similarly calculate the cumulative mean returns for a separate portfolio of 141 CEOs’ homes that either do not meet the size criteria or have missing values for these variables. The cumulative difference between these two mean values equals 4.1% after three months, 15.0% after six months, 29.2% after one year, and 46.2% after three years. The cumulative difference in means has a t-statistic of 1.70 after six months, 2.20 after one year, and 2.30 after three years.”