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What a CEO’s sport says about their risk tolerance

Over the years there have been many attempts to explain why CEOs run their companies in situations that many outside observers would question. While officially important decisions are the responsibility of the entire board, there is little doubt that CEOs tend to call the shots – with the result that the corporate landscape is littered with ill-conceived mergers and acquisitions, over-ambitious strategies, and aggressive sales and marketing campaigns is and the like.

Commentators often distinguish two main types of CEOs – the expansive, visionary kind that often comes from a marketing background, and the more steady, numbers-oriented person usually associated with a finance background. They alternate frequently as investors alternate between a desire for vision and a preference for caution. But what if risk-taking has less to do with education and background and more to do with character and general behavior? Back in 2019, Robert Davidson, Aiyesha Day and Abbie Smith published research suggesting a link between CEO behavior outside of work and attitudes towards risk and other cultural aspects in the companies they run. Now another team of researchers has uncovered a link that could help those who hire executives have a better idea of ​​the likely future behavior of successful candidates. In an article published in a recent issue of the Journal of the American Taxation Association, Shuqing Luo, Terry Shevlin, Luring She, and Aimee Shih point out that CEOs are more likely to engage in aggressive tax planning when they play high-risk sports. This appears to be a very specific problem, but the researchers point to academic work in psychology showing that individuals’ exercise activities reflect their tolerance, or appetite for risk, and suggest that while they focused on control, because they are accounting scholars, but the results do have wider implications.

Terry Shevlin, a professor at the Paul Menage School of Business at the University of California, Irvine, said in a recent interview that while he wasn’t sure a candidate’s athletic preferences would necessarily be a “red flag” for recruiters, he feel it was helpful to get a picture of the person. He added that it’s “a pretty easy thing” for boards of directors or even auditors to ask the question to gauge an executive’s tolerance for risk.

Shevlin acknowledges that some might say that high-risk sports like skiing or rock climbing are played by certain groups of people because they can afford it or have access to the right places. However, he insists that the methodology allows for it and that the research is based on information about sporting interests that has been disclosed by the individuals themselves. Overall, the team identified about 20 sports and ranked them by level of participation (golf was unsurprisingly the most popular) and injury risk data for each sport. The researchers also took into account that in some cases the interest is in watching rather than actually participating.

In the paper, Shevlin and his colleagues say they “expect that individuals will develop specific sporting interests based on their personal risk preferences after weighing the benefits of participating in the sport against potential risks of injury.” Tax planning is a useful measure because “a company’s tax aggressiveness is a unique and strategic decision of top management when such a decision is the result of cost-benefit considerations”. They add: “On the one hand, companies can achieve significant tax savings by taking aggressive tax positions, by structuring business transactions in tax gray areas, or by operating in low-rate systems that can test the limits of tax compliance; On the other hand, aggressive tax positions can expose companies to regulatory compliance uncertainties and tax risks, including regulatory fines, penalties and reputational risk. Ultimately, executive risk preferences are likely to play an important role in tradeoffs.”

The researchers say the study highlights the differences between decisions driven by individuals’ “innate preferences” and those driven by incentives, where companies want CEOs to behave in riskier ways. As such, the findings could ultimately lead to more informed business decisions. For example, executives looking to fill top management positions can ask respondents about their sporting hobbies, as this can help gauge their level of risk aversion. Banks and lenders could ask the company’s top executives directly about their sporting hobbies to better assess the risk involved in lending to client companies. Financial analysts and institutional investors could also ask top management about their sporting activities to assess management’s risk preferences and assess the impact of such risk preferences on management’s tax planning decisions.

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