CEOs' Homes Sign Of Company (Mis)Fortune?
Investors looking for stock-picking tips might find the answer right at home — not their own, but where CEOs live.
A new study makes the case that there is a strong correlation between executives' home-buying behavior and stock performance. The bigger the CEO's home, the worse the company's stock fares, according to two academic researchers. They also found that companies with CEOs living in more modest abodes often see their shares outperform.
Arizona State University's Crocker Liu and New York University's David Yermack, who teach finance at their respective schools, contend that a super-sized home purchase shows entrenchment. A CEO might feel secure in his position — and therefore isn't concerned that he is going to have to leave any time soon.
Of course, entrenched CEOs can win in the corporate world, and the time and money involved in buying lavish properties could be a sign they are making a long-term commitment to their companies and communities.
But the professors concluded that the purchase of a mega-mansion could also symbolize that CEOs view their homes as being more important than their companies, and that many sell company stock just before it peaks to buy and furnish their expensive new digs.
Liu and Crocker culled data on 488 principal residences from CEOs of companies in the Standard & Poor's 500 stock index at the end of 2004 for their study, entitled "Where Are the Shareholders' Mansions? CEOs' Home Purchases, Stock Sales, and Subsequent Company Performance." [The 12 CEOs not included may be renters who own no property or live outside the United States.] The researchers' sources of information included property deeds, tax records, online databases such as Zillow.com and Reply.com, Google searches, employment contracts and voter registration data.
Their findings certainly show a privileged class:
CEOs often buy new homes the year they get the "big" job, with a total of 164 S&P 500 executives doing so in this survey. To finance their purchases, the authors found that 44 percent used mortgages, almost evenly split between adjustable-rate and fixed-rate loans.
More interesting is that about one-third of CEOs appear to have exercised stock options and sold shares in the 12 months before they made a home purchase. The shares peaked right before the home was bought.
That doesn't mean that they necessarily sold those shares and then used the proceeds to buy their homes. The authors felt the timing of those equity moves was more than just coincidence, however, because the companies' share prices began to fall after that peak.
The study's authors found that a CEO who acquires an extremely large property generally exhibits inferior stock performance, as does a CEO who sold his or her firm's shares and options within 12 months prior to the purchase. A CEO who does not sell any shares to finance their house shows better stock performance.
"The stock charts show that some CEOs might be very motivated sellers who are rolling money into a home," Yermack said. "Home purchases could be a ruse. If you are going to dump stock, you can buy a house to cover your tracks."
Those living really large are the 12 percent of S&P 500 CEOs with homes topping 10,000 square feet, or on a minimum of 10 acres. But occupying the biggest house on the block doesn't make you a winner on Wall Street. Their companies' stocks lagged the S&P 500 by about 25 percent over the three years after the CEOs' home purchases. In contrast, those buying more modestly saw their companies' stocks beat the market benchmark by about the same amount.
Former Home Depot Inc. CEO Robert Nardelli's nearly 30,000 square-foot mansion was among the largest in the study. It was purchased after Nardelli took over the home improvement chain, and it underwent big renovations, according to Yermack.
But that kind of space didn't give him enough room to come up with a strategy for Home Depot that investors necessarily liked. The company's shares fell more than 3 percent on a split-adjusted basis from Nardelli's arrival in December 2000 to when he resigned at the start of this year under a cloud over his outsized pay.
Power-One Inc.'s former CEO and now chairman Steven Goldman was among the worst-performing big homeowners in the study. He bought a 12,000 square-foot home in Malibu, Calif., in 2000 for $15 million, according to Zillow.com. He sold more than 3 million shares in the 12 months before that purchase for a total market value of more than $100 million, according to Thomson Financial.
The year the house was bought also happens to be the year that the power products manufacturer's stock hit its all-time peak of nearly of $90 a share on a closing basis. But its shares have faced a steep slide since and now trade around $5.50 each.
Of course, not everyone who owns a big home is destined to disappoint investors. Yermack notes there are plenty with trophy properties that have done right by their shareholders, including Oracle Corp.'s leader Larry Ellison and Sun Microsystems Inc. former CEO and current chairman Scott McNealy.
Still, it's worth keeping tabs on CEOs' home-buying tactics. Bigger certainly isn't always better for investors.