Research by three prominent finance schools across China has found that a local chief executive officer (CEO) is more likely to maximize the long term value of a company than a non-local CEO. While this theory had previously been hypothesized, it has now been shown mathematically to be the case.

Southern University of Science and Technology (SUSTech) Assistant Professor Shufang Lai (Finance) was the lead author of a paper published in The Accounting Review (IF = X.XX), a high-impact academic journal from the American Accounting Association. The paper was titled, “East, West, Home’s Best: Do Local CEOs Behave Less Myopically?”

The existing literature on managerial myopia examines when managers fail to maximize the value of a firm by focusing on short-term cash flows instead of long-term, value increasing investments. The majority of these studies tend to focus on underinvestment on research and development (R&D), as accounting rules in the United States require this expenditure to be accounted for immediately. On the other hand, long-term capital expenditure is expensed gradually through depreciation rules. It means that R&D spending has a larger impact on accounting profits, and studies have shown that a significant majority of executives would cut spending on R&D, among other intangible expenses, to meet their earnings targets.

While several studies have looked at contractual solutions to solve this dilemma, the three researchers in this paper looked at a non-contractual solution. Inspired by existing literature on the matter, the theory suggests that a local CEO would be known by the board of directors and face less pressure to boost short and near-term performance. A local CEO is also more likely to be known by local investors and stakeholders, which improves monitoring while making it less intrusive. It would also improve the information gap (known as information asymmetry) between all parties.

Through their analysis, they were able to determine that firms with local CEOs are significantly less likely to cut R&D expenditure to beat performance benchmarks compared to firms with nonlocal CEOs. The presence of a local CEO in a firm was shown to be more effective than any contractual solution to curb short-termism on the part of an executive.

The researchers also showed that local CEOs do not face the same short-term approaches as nonlocal CEOs on approaching retirement age. The effect of CEO myopia was found to be greater when local investors tend to invest locally and the firm is strongly local. They also found that a local CEO with strong roots in their location is more likely to focus on long-term sustainability.

This paper adds to a small but growing set of literature that suggests that there is a range of non-financial methods for firms to adopt in finding, managing and working with CEOs. It provides a working mechanism for using social capital to influence business outcomes and the behavior of a firm’s CEO.

SUSTech Assistant Professor Shufang Lai was the first author of the paper. She worked with Shanghai University of Finance and Economics (SUFE) Professor Zengquan Li and the Chinese University of Hong Kong (CUHK) Associate Professor George Yang Yong.

The research received support from the Program for Innovative Research Team of Shanghai University of Finance and Economics, the National Natural Science Foundation of China, the Project of Key Research Institute of Humanities and Social Science in Universities by the Ministry of Education of China (MOE) and the 111 Project.

Article link: https://aaajournals.org/doi/10.2308/accr-52555