Over $80 Billion in Market Value Gone: Why Do CEOs' Personal Scandals Cost Companies So Much Now?

Scandals come in all kinds, but what finally forces a CEO out is that investors lost money.

Since the start of 2017 — less than two years — $83.19 billion of corporate market value has vanished because of CEOs' personal scandals.

The two most recent cases of a stock diving over a CEO scandal are both tech companies.

First, Elon Musk flippantly announced a plan to take Tesla private on social media, then changed his mind and dropped it two weeks later, and before that had blown over he smoked marijuana on a livestream. On the day the buyout was announced, Tesla stock rose 12.6%, but over the next month it slid as the scandal spread and several core executives left. By September 7, the company was worth $22.9 billion less.

The other is Richard Liu, who became the subject of a criminal rape investigation by U.S. police. JD.com's repeated public statements about what the investigation covered and why it was opened were flatly contradicted by the police, and the stock fell 16% in two days, erasing nearly $5.8 billion. Several law firms are already preparing class-action suits accusing JD.com of misleading investors.

The Tesla and JD.com scandals are still unfolding. Many other CEOs who got themselves into serious trouble have already lost their jobs.

Since 2017, at least 20 companies have watched their market value collapse, their valuations cut, or even their day-to-day operations disrupted because of misconduct by their CEOs. Of those 20 CEOs, 18 have resigned or been fired.

By QDaily's incomplete count, they cost their companies more than $83.19 billion, all of it lost after the scandal came to light or after the CEO quit or was fired.

Over the past decade, the number of CEOs brought down by scandal has risen fast.

PwC's 2016 study of 2,500 companies found that more than twice as many CEOs resigned or were fired for misconduct between 2012 and 2016 as in 2007-2011, and that the fastest growth came at companies in the BRIC countries — Brazil, Russia, India and China.

Most Are Moral Scandals, But What Really Forces CEOs Out Is That Investors Lost Money

The triggers for these short-term collapses fall into two groups: sex scandals like Richard Liu's, and displays of severe emotional instability like Musk's.

The livestream Musk appeared on was filmed in California, where smoking marijuana is legal. A few years ago the stunt might have helped him build the image he wanted — the maverick taking on the old car and energy companies. Coming after a run of bad news at Tesla and around him personally, it landed differently.

The Musk episodes that raised doubts

May 2

On Tesla's first-quarter earnings call, an analyst asked a question about the finances: what would come of the company's plan to cut capital spending below $3 billion this year, and what were the details? Musk cut off the audio: “Excuse me. Next. Next.” Then he added, “Boring, bonehead questions are not cool. Next?” When another analyst asked about Model 3 reservations, he said, “We're going to go to YouTube. Sorry, these questions are so dry. They're killing me.” Musk apologized for this on the next quarter's call.

July 13

British diver Vernon Unsworth, who advised the Thai government and helped rescuers find the 12 trapped students, said the mini-submarine Musk sent was no help at all and that taking part in the rescue was just a “PR stunt.”

Musk then called Unsworth a pedophile on social media, showed no proof, and quickly deleted the tweet. On September 5, Musk raised it again in an email to a reporter, calling him a pedophile once more, again with no evidence. A scandal the internet had largely forgotten was pulled back into public view.

August 7

Musk announced on Twitter that he would take Tesla private at $420 a share. Outsiders doubted the deal was possible. A week later Musk said Saudi Arabia's sovereign wealth fund had repeatedly said it would put up the money; on August 24, he said he would drop the buyout.

August 16

In an interview with The New York Times, Musk described working without rest and without a social life, and needing drugs to fall asleep; at one point he broke down in tears and said the strain on him was enormous.

September 6

On a livestream watched by 450,000 people, Musk took the host's joint and smoked it, musing about how hard it is to keep a car company alive.

After this run of spectacles, investors and analysts began to ask whether Musk was steady enough to lead the company out of its troubles.

To the capital markets, Tesla's most immediate crisis was operational: Model 3 production behind schedule, cash running short.

Tesla's second-quarter results this year showed total debt of about $22.64 billion and negative free cash flow of $1.05 billion. Eight years after going public, Tesla still has never turned an annual profit.

Yet the episodes that dragged Musk into public argument had nothing to do with Tesla. The Thai rescue, for one, came down to a few rescuers doubting and dismissing Tesla's proposal. None of it improved how the company ran; it only kept pushing the stock down.

The marijuana was worse. California law allows smoking it, but in practice many U.S. companies that sell marijuana still forbid employees from smoking it during work hours. And Musk is also the CEO of SpaceX, which has several contracts with the U.S. Air Force; under the rules, anyone holding a U.S. government security clearance is barred from using marijuana. The Air Force opened an investigation into Musk over it.

Asked about Musk's behavior, Warren Buffett said that a CEO discussing deal intentions in public on a popular social platform could indeed raise legal problems: “I don't think tweeting did him [Musk] a bit of good.”

Around the time of the marijuana livestream, three of Tesla's core executives left one after another: chief accounting officer Dave Morton, vice president of global finance and operations Justin McAnear, and chief people officer Gaby Toledano.

Before those three left, James Chanos, president and founder of the U.S. investment advisory firm Kynikos Associates, counted 41 executive departures at Tesla in 2018, among them president of global sales and service Jon McNeill, Autopilot vice president Jim Keller, and vice president of finance Susan Repo.

The kind of sex scandal Richard Liu is caught in is the more common cause. Of the 20 CEOs in our count whose companies suffered short-term collapses, 11 were tied to sexual harassment.

Harvey Weinstein leads the list. The films his studio released each year ranked below those of the six traditional major distributors at the box office, but still took about 2% of the North American market that year, making it a mid-size studio that mattered. It produced or distributed Carol, Paddington, Silver Linings Playbook and The King's Speech, among others. Many of its films or their leads won Oscars, and The Weinstein Company made director Quentin Tarantino famous.

But after The New York Times and The New Yorker exposed Weinstein's sexual harassment in October 2017, he and his company were boycotted en masse by Hollywood performers and by politicians. Films it had planned to release, including The Current War and Paddington 2, were delayed or shelved. In under six months, a company once valued at $980 million filed for bankruptcy. That is before counting its share of a North American box office worth more than $10 billion.

“Public attention to CEO misconduct keeps growing, to the point of being excessive, and boards have to respond and act quickly and decisively,” said Davia Temin, CEO of the brand consultancy Temin and Company.

Information technology has changed the climate of public opinion: social media running around the clock amplifies both publicity and bad news, and a company's value falls apart in far less time.

The media's effect does not fade quickly either. Harvard Business Review tracked 38 news stories about CEO misconduct between 2000 and 2015 and found that coverage of them went on being widely cited for an average of 4.9 years.

In this climate almost no one, boards included, is willing to keep a CEO with a moral blemish. The faster a company gets its CEO to apologize or resign, the smaller its losses — and that is also the fastest way to quiet the public.

When the CEO who controls every final decision suddenly leaves over a scandal, the company's operations are bound to suffer. That is one big reason JD.com's stock swung the way it did: without Richard Liu, JD.com cannot run normally.

Under JD.com's charter, the board cannot hold a formal meeting unless Liu is present, unless he recuses himself. JD.com even states explicitly that “any restriction against his wishes” should not be an exception to the rule, unless he becomes permanently incapacitated in mind or body. The Wall Street Journal reported that when Liu was arrested on suspicion of rape, it technically left JD.com's board unable to move.

However celebrated a CEO is, he will still be challenged when he stops delivering returns to shareholders. Even Mark Zuckerberg, who alone controls more than half the board's voting power, has faced repeated proposals from activist investors over the past two years demanding he give up the chairmanship. It is just that hired hands are pushed out faster.

Set against the market value a CEO can destroy, after all, the cost of a severance check to get him to leave is small. In June, Intel CEO Brian Krzanich stepped down after a past office relationship came to light. Intel lost $26.65 billion in market value on the news. Reuters reported that after being asked to resign, Krzanich received $38 million in compensation — less than the rounding error on Intel's loss.

CEOs Have Been Made Into Stars, Which Magnifies Their Scandals

CEO scandals do so much damage to companies today because CEOs have been cast as stars, the leading men in stories about wealth. They are themselves a central piece of the modern Great Man Theory.

Thomas Carlyle, the Scottish historian who proposed it, wrote a famous line: “The history of the world is but the biography of great men.” For thousands of years this was how people summed up their own history, though in recent years the idea has met more and more doubt.

Successful CEOs are called “visionaries”; their work is summed up as “changing the world.” Their daily habits are offered as proof that they are not ordinary: Apple CEO Tim Cook and Disney CEO Bob Iger getting up around 4 a.m., or Mark Zuckerberg and Steve Jobs wearing the same outfit every day to save time (these inspirational stories always erase Zuckerberg's suits at government events and Jobs's taste for luxury brands before he turned 40).

For all the embellishment, the responsibility and influence of CEOs really have grown. The CEOs of big companies today manage ten times as much wealth as their counterparts did 60 years ago. Look at the shifting threshold of the Fortune 500: in 1955, each CEO of a top-ten company ran a business worth at least $15.918 billion. By 2018 the figure had been multiplied by ten, to $157.311 billion (adjusted for inflation into 2018 dollars).

The change began in the 1950s. After World War II no war again swept across a whole continent, and a climate for business growth appeared that had no precedent: companies were no longer confined to a few regions and began to spread across the globe.

At the same time, people joined a company and worked there for life as a “company man,” trading freedom for stable income and a future they could count on. The people running those companies grew steadily more important.

The firm that may have spotted the trend first, and helped it along, was McKinsey. Its partner Arch Patton published more than 60 reports beginning in 1951 arguing that management pay was growing far more slowly than worker pay. That argument won McKinsey one consulting contract after another to redesign pay systems and widen the gap between management and staff.

Patton said much later that he felt guilty about it. Still, over the past half-century and more, corporate pay has tilted further and further toward paying management well in exchange for driving growth and higher returns to shareholders.

Bloomberg data show that between 1950 and 2013 the ratio of CEO pay to worker pay grew by 1,000%. A Fortune 500 CEO now makes 204 times what an ordinary employee makes.

Figures from the U.S. Economic Policy Institute likewise show that what S&P 500 companies pay their CEOs rises in proportion to market value. The higher a CEO pushes the company's value, the more he is paid.

In the earnings reports of big listed companies we regularly see how the stock has moved over the period. It is one of the things Wall Street cares about most.

CEO pay is tied closely to the share price. Cook, for instance, collects bonuses far larger than his salary when he meets shareholders' expectations for the stock. In 2017 his total compensation was $102 million, of which $89 million came as stock awards. Those awards were granted because Apple's shareholder return during his tenure beat two-thirds of the companies in the S&P 500. Part of the 560,000 shares he received was restricted stock, a reward for staying on as CEO for another year.

Under this system of incentives and appraisal, a CEO's strategy is bound to bend toward lifting the share price now. Four earnings reports a year push CEOs to plan in three-month cycles instead of concentrating on where the company should be in the long run. At the same time, once a CEO's public image runs into serious trouble, or a bad business decision costs the company value, the board is more likely to fire him without ceremony.

But at companies where the founder is CEO, the board finds it hard to remove him even after he has damaged the interests of the company and its shareholders.

Asked by The Wall Street Journal in August who could replace him, Musk said no one is better suited to be Tesla's CEO than he is. “It's not that I want to be CEO,” Musk said. He worried that if he stepped down, Tesla would fall into crisis.

Uber's former CEO Travis Kalanick, after his second-in-command Jeff Jones left in March, kept dragging his feet on a successor, until investors finally confronted him.

Under the current incentive system, said Aswath Damodaran, a professor at New York University's business school, tech companies are run by people suffering from what he calls “Steve Jobs syndrome.” “Every CEO wants to be a star like Jobs — the person who grows a company into a giant.”

Founders especially. After Jobs's legendary reversal of fortune, stories of founders returning to their companies multiplied.

Howard Schultz came back to Starbucks in 2008 to rescue a stalled business; Morris Chang returned to TSMC during the financial crisis; so it went at Trip.com Group, Huazhu, Acer, Dell, Twitter. Even Bill Gates, long since a full-time philanthropist, served as an adviser again during Microsoft's 2014 leadership handover, giving 30% of his time to running the company.

But as Damodaran told The New York Times, “For every successful Apple, there are 100 companies trying to be the same thing and crashing and burning.”

Research also shows that CEOs are leaving sooner, and that founders are replaced just as often. Harvard Business School professor Noam Wasserman studied 212 U.S. startups from 1990 to the early 2000s and found that more than 50% of founders were no longer CEO by the third year after taking venture money; most gave up control as their companies grew.

New Safeguards Are Under Discussion

Whether by scholars' counts or an outsider's plain impression, boards firing scandal-tainted CEOs is now routine in most places. But it is emergency treatment after the fact, and by then the damage to the company's stock, business and reputation has usually already been done.

So how a board can limit a CEO's power, and reduce or wall off the damage his misconduct does to the company, has been one of the hottest questions in corporate governance for years. That most listed companies now split the roles of chairman and CEO (in China's company law, the “general manager” is in effect the CEO) is one product of that debate.

Frequent scandals have brought more debate about ways to check a CEO. Strategy& data show that CEOs holding concentrated power is becoming rarer, down from 48% in 2012 to 10% in 2016. That is one more reason CEOs are easy to fire.

As the scandals keep coming, more checks are still being argued over, and new ones keep appearing.

“Boards also need to set a higher standard,” said Constance Bagley, CEO of Bagley Strategic Advisors, on how to lower the risk a CEO's misconduct poses. She proposed appointing an ethics committee and building a broad-based board able to check the CEO.

Simon C.Y. Wong, a partner at the London investment firm Governance for Owners, wrote in a blog post that a board able to check a CEO requires non-executive directors whose standing equals or exceeds his.

He pointed to the U.K., where chairmen usually command management's respect because they tend to be about ten years older than the CEO and have successfully run large companies themselves, or made their name some other way. Wong quoted a British independent director: “You need someone who, when necessary, will dare to tell the CEO, ‘You're being an idiot.’”

Gene Munster, managing partner at Loup Ventures, a venture firm that had been bullish on Tesla, wrote in an open letter to Tesla's directors that the company should build a broad-based board. He offered Apple's as the example: its members include former Genentech CEO Arthur Levinson, Disney CEO Bob Iger and former Boeing CFO James Bell — executives with long experience running large international companies.

Checks on the power of executives and founders at private companies are advancing too. After Weinstein, Wall Street acquired the “Weinstein clause”: language written into merger agreements that not only requires the seller to represent and warrant that its executives' conduct meets accepted social standards, but also requires the seller to compensate the buyer for losses caused by the misconduct or scandals of those executives, sexual misconduct and sex scandals included.

These proposals and mechanisms can restrain a CEO's behavior in real ways and reduce the harm misconduct does to a company.

But there is another reality: no single system of corporate governance has ever worked everywhere. And when people weigh a CEO's record, one fact is often overlooked. Taking in everyone with a stake inside and outside the company, firing the CEO looks less like finding a solution than like offering up a scapegoat.

Charts by Zheng Shuya

Cover image: Visual China Group