Research shows highly connected CEOs get larger stock profits

CEOs with more connections earned greater stock returns following purchases or sales of their companies’ shares, a new study shows.

Researchers Tomas and Dobrina Jandik, both finance professors at the University of Arkansas, and Rwan El-Khatib, finance professor at Zayed University in the United Arab Emirates, found that between 2001 and 2014, well-connected CEOs of Standard & Poor’s 1500 companies earned about 10% higher returns for 180 days after purchases of their companies’ shares.

“The well-connected CEOs outperformed the unconnected CEOs by about 10%,” Tomas Jandik said. Research for the study started in 2017, and he noted it regarded legal stock trades. The researchers analyzed stock gains associated with insider trades initiated by CEOs of large U.S. companies as a result of their connectedness.

In the study, the researchers relied on BoardEx, a database that tracks network connections of more than 1.4 million corporate executives and board members of public and private companies. Network connections included interpersonal ties, such as shared past employment history, educational overlaps or common position on boards of charities or social clubs.

Well-connected CEOs’ stock returns were especially strong for companies with greater investment risk, weak governance or managed by CEOs without a finance background, according to the study. And, the returns were better if the CEO had past connections to the company’s chief financial officer.

Also, CEOs with more connections avoided losses by selling their shares before a “bad news” event, or a day in which a company has a large stock price decline, the study shows.

“Our research demonstrates that well-connected CEOs are better informed and are not hesitant to personally profit from this knowledge,” Dobrina Jandik said. “However, in well-run companies, this information advantage could and should improve CEO decision making and ultimately positively influence firm value.”

Amid the pandemic, Tomas Jandik noted the value of existing connections is even greater because of the difficulty to meet in person. He also said COVID restrictions make it more difficult to establish new contacts and could lead to communication challenges in the future.

The study, which is expected to be published later this year in “The Financial Review,” was supported by the UA High Performance Computing Center.