The effect of misalignment of CEO risk tolerance and corporate governance structures on firm performance

Abstract

To explore the link between corporate governance and performance, we examine whether the misalignment of CEO risk tolerance (based on an index constructed from personal traits) and governance structures affects company performance. Utilizing the IBM Watson Personality Insights service to analyze verbal communication by the most senior executives of large US companies to obtain their fundamental Big Five personality traits, our study proposes two hypotheses: First, CEO risk tolerance and corporate governance structures are associated, and second, misalignment of these structures with risk tolerance negatively affects financial performance. We use a large sample of over 8,000 firm-year observations and a two-stage contingency approach suggested by Ittner and Larcker (2001) to test our hypotheses. Our findings are consistent with our misalignment–CEO risk tolerance predictions and support upper echelons theory in the corporate governance setting.