The Influence of Managerial Risk Taking and Corporate Leadership on Firm Sustainability

Abstract

Shareholders charge the Chief Executive Officer with the responsibility of ensuring that the firm follows sustainable practices and other value enhancing procedures. At the same time, upper echelons theory suggests that managerial traits and values ultimately influence executive decisions. As risk management is at the heart of corporate sustainability, the question of interest then becomes whether executive risk tolerance influences the sustainable practices of the firm. Without the ability to query CEOs directly, measuring their willingness to take on risk must be done indirectly. This analysis employed two possible proxies for executive risk taking, testosterone levels and option-laden compensation packages. Testosterone has been linked to aggressive, masculine behavior, and higher levels have been associated with greater risk taking. In turn, testosterone has been shown to be positively correlated with a person’s facial width height ratio (fWHR). In the case of executive pay, vega represents the change in CEO compensation due to variations in the firm's equity volatility and provides a direct link between equity incentives and risk-taking behavior. In assessing firm sustainability, a holistic approach considered long- term value-enhancing factors, including a collection of environmental, social, and governance (ESG) drivers. Thus, the first test examined whether an increase in CEO risk taking as measured by greater fWHR or vega is associated with a decrease in sustainability proxied by the firm’s ESG score. In a second set of tests, the analysis investigated the effect of CEO turnover on sustainability.

To test the first hypothesis, regressions used panel data covering a five year period from 2018-2022. I examined member firms in the S&P 500 at the end of 2022 that were publicly traded in the previous five years. For the dependent variable, the regressions used ESG scores from S&P Global, while public domain headshots generated fWHR measures for the CEOs. Controlling for other executive and firm characteristics, the main takeaway from testing the first hypothesis was that fWHR negatively affected ESG. While the effect was statistically significant, the effect was small. A one standard deviation increase in fWHR decreased ESG a half point on a 100 point scale. In part two, firms experiencing CEO turnover had a greater increase in ESG scores the following year than did firms with no change in chief executive, 2.43 vs 1.75. However, the difference was not significant. Looking at a subsample, firms where the new CEO had a lower fWHR measure than the old CEO, there was still no statistical difference between firms with CEO turnover and those firms where there was no change. On the other hand, if the CEO successor had a higher fWHR, ESG increased by 3.91 compared to 1.45 for the no CEO change set of firms, a significant difference. This last result is the opposite of what was expected and along with other confounding effects suggests that the relationship between risk taking and sustainability may not be as simple as first posited. For example, firms with higher R&D ratios, and thus led by CEOs that appear willing to take on risk, also had higher ESG scores. In “reading the tea leaves” a potentially richer theory evolves from the discussion. It appears that too much risk taking is not good, but too little is not ideal either. The analysis suggests that how CEO’s think of risk matters, and to promote sustainable practices, CEOs must be calculated, creative and strategic in taking on risk.