There's plenty we know about psychopathy in the business world. We know that psychopaths congregate in business schools. We know the empathy-challenged among us are drawn to the corporate realm and tend to end up in senior management roles. Last year an Australian study concluded that one in five CEOs could reasonably be considered psychopathic.
But until now, no one has answered the all-important question of how all this corporate psychopathy stuff affects one's portfolio. But thanks to a new study out of the U.K. that used five different proxies for detecting psychopathy in the C-suite, we can confidently assert that entrusting your assets to someone on the Patrick Bateman end of the basic human decency scale is a bad idea:
All gauges of psychopathy correlate negatively with future returns. For 4 out of the 5 proxies considered the relationship with returns is statistically significant. Such results imply that managerial psychopathic behavior is an ominous sign of shareholder wealth destruction.
In other words, companies run by psychos – or, more responsibly speaking, companies run by those who exhibit "psychopathic-like tendencies" – tend to punish shareholders.
This conclusion might go against the grain of certain preconceptions of business success, that an effective manager must dispense with niceties, pursue a course of ruthless domination and generally take on the mindset of a flinty-eyed predator – say, a lion, or a tiger, or a bear. And there's some truth to it. As the study pithily notes: "Overall, the literature reveals that the concentration of psychopaths tends to be particularly high in prisons and boardrooms."
But it turns out that a psychopath lying and cheating his way to the top doesn't necessarily benefit the broader organization. As the theory goes, psychopaths tend to break rules and take risks – bullshitting regulators, binging on leverage, etc – that end up harming companies in the long run and making shareholders less rich.
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At this point, the reader might be curious how the researchers know who is and isn't a psychopath. Unfortunately, they didn't have a list of psycho CEOs at their disposal, nor did they consider mailing out a survey to every publicly traded company in Britain marked CEO PSYCHOPATH STUDY – PLEASE COMPLETE AND RETURN (though it would be interesting data point in itself to see who complied).
Instead, the authors used a few proxy measures intended to correlate the odds that someone in senior management had psychopathic characteristics. These traits include "parasitic and irresponsible behavior, pathological lying, emotional insensitivity, impairment of behavioral controls, elevated sense of self-worth."
The study's psycho proxies:
- Linguistic analysis: Do annual reports contain language that denotes aggression (demolish, conquer), blame (stupid, terrible) and self-regard (I, me, mine)?
- Audit analysis: Were the companies targeted for investigations or disciplinary actions by Britain's Financial Reporting Council?
- Risk-taking: Did companies exhibit idiosyncratic risk in terms of the Capital Asset Pricing Model?
- Empathy or lack thereof: Did the companies make charitable contributions?
As it turns out, all but one of these proxies – audit-related interventions – correlated in a statistically significant way with lower stock returns. (Note that the authors are Brits, and their sample comprised 209 of the companies in the FTSE 350.) Does this mean psychopaths are always bad for business? Probably not. Nor does it mean bad returns are necessarily the result of having a differently-virtued individual sitting atop the company. But it does suggest that the traits commonly ascribed to psychopaths don't become a profit-seeking public corporation.
There's actually an unexpected element of moral uplift in all this for the corporate world. While the results might belie the common notion that you want to have a "killer" on your side, they confirm that the general social norm "psychopaths are bad" does hold for the capitalist class. Psychopaths may be built for the business world, but the business world isn't built for psychopaths.
Of course, this wouldn't be a good investing study if it didn't end with a hint as to how to make money from it, and the authors dutifully oblige:
We are able to predict significant falls in stock prices of companies which are deemed likely to have psychopaths in their echelons of power. If diligent market participants conduct the necessary research to identify these companies, they will be able to enjoy superior investment performance, by simply eliminating these inferior stocks from their portfolios.
We look forward to iShares' upcoming Psychopath-Free ETF.