CEOs near hometowns less likely to commit misdeeds

Published in 1976, the book ‘Place and Placelessness’ by Canadian geographer Edward Relph is considered a classic in examining geographic origin and the emotional significance of where a person is born and raised. One’s hometown, he wrote, is “the central point of human experience”. 

This is widely reflected in popular culture, particularly music, including songs such as Small Town by John Mellencamp (reflecting on his Indiana birthplace), Home Town by Joe Jackson (recalling the “distant sound of waves and seagulls” in the coastal UK city of Portsmouth), and My Hometown by Bruce Springsteen (on the declining fortunes of Freehold, New Jersey), the closing track on his 1984 album Born in the U.S.A. 

And while Springsteen famously sang that he was Born to Run from his stifling hometown (“Oh, baby this town rips the bones from your back, it’s a death trap, it’s a suicide rap”), Professor Raghu Rau of Cambridge Judge Business School finds that for a chief executive officer (CEO) their hometown has a more beneficial effect. In a study entitled ‘Born to Behave’, Raghu finds that CEOs who head companies near their hometowns are less likely to commit financial misconduct compared to other CEOs.

CEOs who work close to home less likely to engage in misconduct 

“The CEOs we term home CEOs – who manage companies whose headquarters are within 100 miles of their birthplaces – exhibit significantly lower misconduct levels,” says Raghu, Sir Evelyn de Rothschild Professor of Finance at Cambridge Judge. “We found significantly lower levels of misconduct for home CEOs based on 4 types of misconduct – accrual-based earnings management, accounting fraud, opportunistic insider trading, and financial offenses. This effect is amplified in regions with strong local investor presence and higher religiosity (religious belief or attachments), and for CEOs with longer tenures in their home state. 

“We also found the same patterns apply to CFOs (chief financial officers), who may in fact be more involved than CEOs in reporting decisions because they directly oversee financial statements,” he says. 

The study, published in the Review of Accounting Studies journal, is co-authored by Zicheng Lei of King’s Business School, King’s College London, Dimitris Petmezas of Durham University Business School, Raghavendra Rau of Cambridge Judge Business School, and Chen Yang of Adam Smith Business School, University of Glasgow. 

“These findings about home CEOs suggest that geographic and cultural factors could be a fruitful avenue for future work on preventing misconduct,” says Raghu. “As we highlight in our research, there are significant knowledge gaps when it comes to corporate misconduct, and hopefully some of these other gaps will be addressed in future research.” 

Misconduct has long been shown to be a major factor affecting investor confidence and decision-making, including their general willingness to invest in financial markets and their likelihood to invest in specific firms. Yet while there have been many studies on how misconduct affects investor behaviour, the issue of how personal traits influence a company’s likelihood of committing financial misconduct have largely been unexplored. 

How a hometown influences a CEOs norms and values 

The authors focus on a CEO’s hometown because the research of Edward Relph and others show how people make strong connections with their local communities, and this is a key factor in social legitimacy because such legitimacy is based on shared norms and values.  

As defined in a 1995 study cited by Raghu, legitimacy “is a generalised perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and definitions”. That earlier study says legitimacy is generalised in that it reflects an ‘umbrella evaluation’ that, while it can be resilient to particular events, is dependent on a broader history of events. 

As the new study’s authors say: “Local communities often scrutinise homegrown CEOs closely, having more information about them and a stronger interest in their companies due to personal connections”. Such heightened attention “motivates CEOs to behave in ways that meet their hometown’s expectations, including avoiding financial misconduct”.  

In addition, increased local monitoring of homegrown CEOs may raise the detection rate of misconduct. The basic rules of criminology dictate that the behaviour of executives should adjust positively as the expected cost of misconduct increases

Local CEOs’ ethical conduct unaffected by firm size or board 

The research also examines whether the findings may be affected by stronger corporate governance at firms with home CEOs. But after looking at 3 different potential factors – board size, percentage of independent directors and E-index (which measures board entrenchment provisions such as staggered boards, poison pills and supermajority requirements for bylaw changes) – the authors find that local CEOs are still associated with lower rates of misconduct.  

The research finds, further, that the lower financial misconduct for local CEOs is not related to CEO compensation structures. The results are also unaffected when adjusting for CEOs’ political leanings, a tendency toward overconfidence, religious influences, adjustment to lobbying, and other county data such as population, income and education. 

To explore how social connections of local CEOs affect misconduct levels, the research identifies counties with a stronger local investor base and greater religiosity, and CEOs with longer work histories in their hometowns – and all these factors resulted in a lower incidence of financial misconduct. 

The study is based on firms covered by database ExecuComp from 1992-2018, excluding financial firms and utilities because they are heavily regulated. The measure of home CEOs is based on manual collection of birthplaces from various sources, including Marquis Who’s Who and Standard and Poor’s Register of Directors and Executives. The study’s final sample includes 1,595 CEOs in 1,268 firms. 

A longstanding interest in CEO origins and personal experiences 

Raghu has long been interested in how a CEO’s birthplace and other life experiences influence their later business decisions.  

In 2016, he co-authored a study that found a relation between a CEO’s experience of fatal disasters in childhood with risk-taking later in life. “CEOs who experience fatal disasters without extremely negative consequences lead firms that behave more aggressively, whereas CEOs who witness the extreme downside of disasters behave more conservatively,” the study says. “These patterns manifest across various corporate policies including leverage, cash holdings, and acquisition activity. 

“Ultimately, the link between CEOs’ disaster experience and corporate policies has real economic consequences on firm riskiness and cost of capital,” that research concludes. 

That study won the tongue-in-cheek Ig Nobel Prize awarded by the magazine Annals of Improbable Research, which honours achievements that “first make people laugh then make them think”. 

In 2020, Raghu examined the connection between executive compensation and CEOs employed at firms located near terrorist attacks, finding that such CEOs can earn an average pay increase of 12% after the attack relative to CEOs at firms located far from attacks. There has been relatively little research on how non-monetary factors affect executive compensation, with mixed results, so the research by Raghu focused on “a specific nonmonetary factor, a terrorist attack, on compensation” in order to clearly isolate such a factor. 

“A terrorist attack is a clean, sharp, and specific event that forms an unexpected unambiguous deterioration in the quality of the CEO’s living environment. Hence, if CEOs do indeed react to non-monetary factors in total compensation, we should see an increase in their pay following terrorist attacks,” the study said. 

And in 2023, Raghu even went back before birth. In a study entitled ‘Tainted Beginnings, Risky Endings’, he found that CEOs exposed before birth to the most hazardous waste sites in the US take more risks and that such risks lead to firm underperformance and a higher likelihood of CEO turnover.  

“Previous literature has explored how CEOs’ early-life experiences shape corporate policies, but these studies typically face selection bias issues,” the research says. “Our study addresses this gap by examining an exogenous factor – pollution – that likely affects CEO risk preferences without being influenced by parental or CEO choices.” 

Says Raghu: “My interest in the early influencers of CEOs relates to my belief that the actions of executives do reflect their ‘previous lives’, so to speak, before they even entered the business world,” says Raghu. “It’s the old discussion about nature versus nurture, and it’s clear to me that both apply when it comes to how CEOs approach issues like risk, which are essential to manage if a company is to be successful.”