An international analysis of CEO social capital and corporate risk‐taking

Published date01 January 2019
AuthorStephen P. Ferris,Tijana Rajkovic,David Javakhadze
Date01 January 2019
DOI: 10.1111/eufm.12156
An international analysis of CEO social capital
and corporate risk-taking
Stephen P. Ferris
David Javakhadze
Tijana Rajkovic
Department of Finance, University of
Missouri, 404 F Cornell Hall, Columbia,
MO 65211-2600, USA
College of Business, Florida Atlantic
University, FL 33431-0991, USA
Lucas College of Business, San Jose State
University, San Jose, CA 95192-0066, USA
This study examines the effects of CEO social capital on
corporate risk-taking around the world. We document a
significant positive relation between CEO social capital and
aggregate corporate risk-taking. Further, we find that CEOs
with large social capital prefer riskier investment and
financial policies. We also determine that the effect of CEO
social capital on corporate risk-taking is moderated by the
extent of legal protections provided to shareholders, the
financial development, and the culture of the country in
which a firm is incorporated. Our results are robust to
alternative proxies of risk-taking, alternative model
specifications, and tests for endogeneity.
corporate risk-taking, social capital, social networks
G30, Z13
Contemporaneous corporate finance emphasizes the importance of the CEO's personal characteristics,
attitudes, and preferences for explaining corporate risk-taking. Graham, Harvey, and Puri (2013) find
that behavioral traits such as optimism and managerial risk-aversion are related to corporate risk-taking
practices. Cain and McKeon (2016) show that a CEO's personality trait known as sensation seeking has
The authors would like to thank the two anonymous referees and John Doukas (the editor) for helpful comments and
Eur Financ Manag. 2019;25:337. © 2017 John Wiley & Sons, Ltd.
important implications for the riskiness of firm policy choices. Hilary and Hui (2009) document that a
CEO's religion is related to corporate riskiness. Hutton, Jiang, and Kumar (2014) argue that the
personal political preferences of CEOs influence corporate behavior, and Hirshleifer, Low, and Teoh
(2012) find that overconfident CEOs increase their investments in risky projects. In this study, we
extend that line of inquiry by examining the effect of an important but previously unexamined factor,
the CEO's social capital, on corporate decisions about risk-taking.
Social capital, defined as the information, trust, and norms of reciprocity inherent in a social
network (Woolcock, 1998), has been widely examined in social science disciplines such as economics,
sociology, political science, and anthropology (e.g., Dasgupta, 2005; Fafchamps, 2002; Knack &
Keefer, 1997; Portes, 1998; Putnam, 1993; Schneider, 2006) but has received only limited attention in
academic finance.
Using a panel of firms from 45 countries, we ask whether the social capital of CEOs due to their
social networks influences firmsrisk-taking practices. Because our study uses an international sample,
we also examine how network effects are altered by investor protection standards, financial
development, and characteristics of national culture. Our empirical findings reinforce a growing
awareness among finance researchers that managerial social capital matters for corporate decision-
A number of studies document the ability of social networks to alter uncertainty and risk. Genicot
and Ray (2005) and Bloch, Genicot, and Ray (2008) show that social capital offers a mechanism of
informal insurance which can increase risk-taking.
Brass and Burkhardt (1993) contend that
with increased ties and access, an individual's power within a social network is strengthened. The
approach-inhibition theory of Keltner, Gruenfeld, and Anderson (2003) argues that the experience of
power drivespeople to take more risks. From agencytheory, studies such as Amihud and Lev(1981) and
Hirshleifer and Thakor (1992) find that one of the major reasons for low managerial risk-taking is the
career concerns of executives. Granovetter (1973), Schneider (2006), and Zhou (1992) determine that
social capital in social networks is instrumental for access to jobs. Nguyen (2012) shows that socially
connected CEOs are more likelyto find new employment after departure. The consistency acrossthese
studies leads us to hypothesize that social capital has a positive effect on corporate risk-taking.
The marginal effect of CEO social capital on increasing corporate risk-taking should be stronger
when investor protection standards are weak and financial markets are underdeveloped. We contend
that in countries with poor investor protection standards and low financial development, dominant
insiders and non-equity stakeholders have incentives to be conservative in directing corporate
investments (Morck, Wolfenzon, & Yeung, 2005; Roe, 2003; Stulz, 2005). Strong investor protection
(financial development), however, reduces these incentives, leading the firm to a more appropriate
level of risk-taking. John, Litov, and Yeung (2008) explicitly document a significant positive
relationship between corporate risk-taking and investor protection. Acemoglu and Zilibotti (1997)
argue that as financial markets develop, risk avoidance decreases because risk-sharing is more readily
In the absence of strong legal protections of investors and well-developed financial market
mechanisms, social capital matters more because investors in those countries cannot rely on the
legal system and market mechanisms alone to protect their interests. Thus, we argue that social capital
should have stronger effects on risk-taking when investor protection standards are weak and financial
Based on Arnott and Stiglitz's (1991) informal insurance model, Mobarak and Rosenzweig (2013) show that informal
insurance through a social network structure leads to more agricultural risk-taking in rural India. Miller and Paulson (2007)
find that household gambling increases with the quality of informal insurance.
markets are underdeveloped because in such an environment corporate risk-taking choices are less
optimal from the shareholdersperspective.
The nature of agency conflict and information asymmetry varies substantially across countries in
part because of the characteristics of national culture. A number of studies (e.g., Giannetti & Yafeh,
2012; Griffin, Guedhami, Kwok, Li, & Shao, 2014) document that national culture matters in corporate
decisions. From a corporate risk-taking perspective, Li, Griffin, Yue, and Zhao (2013) use cultural
values developed by Hofstede (1980, 2001) and Schwartz (1994, 2004) and document a positive
relation between national individualism and corporate risk-taking and negative relations between
national uncertainty avoidance and corporate risk-taking and national harmony and corporate risk-
If certain characteristics of national culture induce managers to take more risk, then shareholders
effectiveness in countering managerial incentives for a quiet life(Bertrand & Mullainathan, 2003)
will depend on the cultural attributes. Consequently, if CEO social capital matters for firm-level
efficiency manifested in increased risk-taking, then it should exert stronger influence in countries
where national cultural attributes do not enhance managerial risk-taking incentives.
To test the effect of social capital on risk-taking, we use the BoardEx databases provided by
Management Diagnostics Limited (London, UK). This dataset contains relational links between
executives based on prior overlap in employment, education, and membership in non-profit
organizations. Recent studies such as Fracassi (2016) and Engelberg, Gao, and Parsons (2012) employ
this database to estimate corporate social connections. We use the BoardEx database to develop our
CEO social capital measure estimated as the number of individuals with whom the CEO shares a
common educational, employment, or social history.
We obtain a number of important findings. We discover that social capital does influence corporate
risk-taking, where risk-taking is variously measured as the annualized standard deviation of monthly
stock returns or as the standard deviation of the return on assets. Disentangling the mechanism, we
determine that CEO social capital alters the riskiness of specific corporate investment and financial
policy choices. Specifically, we find a positive association between CEO social capital and R&D
expenditures (and financial leverage), and a negative association between CEO social capital and asset
liquidity. We also observe that the effect of CEO social capital in increasing corporate risk-taking is
stronger in markets characterized by financial underdevelopment and to a lesser extent by the weak
legal protection of investors. Further, we show that attributes of national culture also moderate CEO
social capital effects.
This study contributes to the modern finance literature in several ways. First, our study adds to the
emerging literature on the effect of social networks on corporate decision-making. El-Khatib, Fogel,
and Jandik (2015) show that CEOs with higher network centrality measures engage in more and value-
destroying acquisitions. Engelberg et al. (2012) document that social connections between banks and
borrowers through managerial interpersonal linkages reduce borrowing costs. Cai, Walkling, and Yang
(2016) report a positive relation between a firm's social connections and trading costs. Cohen, Frazzini,
and Malloy (2008) find that social networks are an important mechanism for information flows that
shape asset prices in the mutual fund industry. Cai and Sevilir (2012) show that social connections
improve information flow between a target and an acquirer. Fracassi and Tate (2012) document that
well-connected CEOs pursue acquisitions that destroy value. Different from these studies, our research
question directly focuses on the effects of CEO social capital on the broad issue of corporate
risk-taking, including specific corporate policies.
Second, our research also contributes to the literature examining the effects of CEO social capital
on corporate policy choices around the world. We complement the findings of Javakhadze, Ferris, and
French (2016) which examine the effects of managerial social capital on the investment sensitivity of

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