Is Your C.E.O. Trading Up?
Then You Should Trade Out

Now there's one more reason to seethe over the size of a C.E.O.'s mansion. According to a recent study, the bigger the boss's crash pad, the worse the company's future performance.

Fresh off the presses from professors Crocker Liu of Arizona State University and David Yermack of NYU's Stern School of Business comes a paper self-explanatorily titled, "Where are the shareholders' mansions? CEOs' home purchases, stock sales, and subsequent company performance."

Liu and Yermack spell out their meticulous analysis over 39 pages replete with scatter plots and bar charts. Their research is based upon a sample of the principal residences of all C.E.O.s of companies in the S&P 500 index in office at the end of 2004, a total sample of 488.

Fast forwarding through all the t-stats and coefficients, their main conclusion goes something like this: When a company's C.E.O. exercises stock options to pay for an especially extravagant new home, that company fairs worse than other companies whose C.E.O.s stick to more modest digs.

During 2005, the mansion handicap averaged out to an 8.7 percent poorer stock performance for the affected companies.

What's the root of the problem? Productive time lost during intra-house travel? The mental focus wasted on scrutinizing tile samples? Or maybe that firm outing Chez Boss dented moral for all the peons sans palaces of their own?

According to Liu and Yermack, increased real estate investment signals "C.E.O. entrenchment." Most C.E.O.s are wealthy enough to buy a new home without liquefying shares, so the pre-purchase divestiture is a sign that he or she feels immune from board discipline.

In most cases, C.E.O.s with the most "trophy assets" like jets and lavish estates perform the poorest. They could be resting on their laurels, getting sidetracked by the new toys, or suffering from performance insecurity that compels the nervous C.E.O. to acquire very public trappings of success.

Or, maybe it's because everyone is a little less inclined to work 14 hours a day to pay for the chief exec's infinity pool and grass tennis courts.

C.E.O.s generally sell company stock within the year prior to buying a new home, but Liu and Yermack also separated out those who financed the purchases without divesting share. In those cases, company stock tends to perform well after the real estate transaction.

The researchers concluded that retaining company shares despite new financial pressure signals exceptional commitment by a C.E.O. to his company.

Liu and Yermack also wonder--but fall short of investigating--whether C.E.O.s might be using home purchases as screens for trading on inside information. That would mean that they sell company shares under the pretext of raising cash for a real estate acquisition, while the true motive is knowledge of an oncoming stock plunge.

Conspiracy theory aside, what's the bottom line for shareholders? When you see the C.E.O. trade up, trade out.

by Liz Gunnison