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Growth vs recession: The surprising way the economy affects CEO and auditor success

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By Luo Zuo, Associate Professor of Accounting

Have you ever watched a nature documentary in which a newborn animal latches onto and follows an animal that is not their biological parent? In many cases, the animal, recently hatched or born, has simply associated the first animal it sees as its parent, even when that’s not the case.

These moments make for heart-warming, or in some cases, heart-breaking television. But beyond these emotions lies a psychological theory called “imprinting,” which is broadly considered to be a critical period of learning.

Early studies in imprinting were largely performed on birds. The psychologist Konrad Lorenz, for example, found that Geese would imprint onto the first suitable stimulus they came across within the first 13–16 hours of hatching, even if that object was an inanimate one, or in one case, Lorenz himself.

Imprinting typically occurs very early on in life for animals. For human beings, however, imprinting can occur in different ways at various stages of life. Some moments in life are simply more formative than other periods. One formative period, for example, is when we graduate college and join the labor market.

We know through psychological research that upon graduating college and entering the workforce, individuals open their minds. In this time period, students transition from the world of education to a very real type of work environment. In this moment, humans are particularly open to environmental stimuli, including, but not limited to, the health of the labor market.

Introducing the CEO study

Recently, I conducted a joint study with Antoinette Schoar to examine the imprinting effect that economic conditions have on CEOs. Historically, CEOs weren’t heavily emphasized when considering a firm’s corporate behavior and performance. Rather, traditional finance theory focused on firm-, industry- and market-level factors. More recently, finance professionals have come to understand the importance of a CEO when considering an organization’s corporate policy and performance, but how CEOs matter is still somewhat unclear.

In my study, I examined the economic condition that existed when a CEO originally entered the labor market. Specifically, I wanted to understand if the economic conditions when an individual joined the labor market impacted their career path and leadership style when they ultimately became CEO.

Indeed, what I found is that environmental factors matter.

From a career perspective, CEOs who join the labor market during a recession become CEOs in less time than their counterparts who join the labor market in times of economic growth. However, those CEOs are more likely to be a CEO at a smaller firm or organization and more likely to earn a lower salary.

Environmental factors influenced CEOs beyond their career path, however. Upon becoming CEO, individuals who join the labor market in times of recession exhibit a more conservative leadership approach. They borrow less, have less capital investment, and their stock return volatility is much lower than CEOs who join the labor market in times of growth.

For those graduating in 2018, this is largely good news. The economy continues to grow at an impressive rate, meaning that the path to CEO, while longer, looks like a more lucrative one.

However, there is also good news for professionals who entered the labor market in times of recession. In a follow-up study, also with Antoinette Schoar, I examined the market reaction to the announcement of an appointment of a recession-era CEO. What I found is that investors like recession-era CEOs. That’s because recession CEOs, as previously mentioned, have a more conservative financial approach to leadership and a better skillset with which to manage firms in economic downturns.

Auditor study and implications for the macro economy

Intrigued by my findings on CEOs, I also examined the economic condition environmental effects on auditors with Xianjie He, SP Kothari, and Tusheng Xiao. Auditors play an important role in finance, reviewing annual reports, searching for fraud or other discrepancies, and verifying the findings and financial outlook for a client organization.

Like with CEOs, I found that environmental factors matter. Specifically, I found that auditors who joined the labor market during an economic recession, when there is more fraud discovery, became a more skeptical auditor later in their career upon becoming an engagement partner.

This finding has strong implications for the macro economy, because after a sustained period of economic growth, the financial industry may not have enough auditors that exhibit strong enough skepticism towards a company’s financial reports. When there isn’t enough skepticism exhibited by auditors, it’s more likely that potential financial issues are overlooked, which can negatively impact our ability to prevent or minimize future economic recessions.

Takeaways for educational improvements

These findings, while useful, do not allow us to retroactively make improvements to the way that we train students and new entrants into the labor force. However, they should provide us with the impetus we need to actively teach and train young professionals the lessons and skills needed to excel in their careers under inevitably different economic conditions.

I was recently invited to the Public Company Accounting Oversight Board, the regulator in the United States of auditors. One policy implication of these findings to them is that it is important to train junior auditors to be skeptical, regardless of economic conditions, rather than relying on more senior auditors to share their audit process, even though it makes the audit process more difficult. The hope is that by the time auditors advance into engagement partner roles, the skepticism learned early in their careers will feel routine.

Even within our MBA curriculum, these findings highlight the importance of teaching students about concepts like ethics. MBA students may not be leaders at this moment, but it will be too late to teach them ethics when they become CEOs. But if we make it a focus now, during a formative period in their lives, we can imprint important virtues in them that will set them up for success later in their careers.


About Luo Zuo, Associate Professor of Accounting

Photo of Luo Zuo, associate professor of accounting at JohnsonLuo has a broad range of interests in research at the intersection of accounting and finance. His current research can be divided into two strands. The first explores the individual effects of managers, investors, and auditors. A unifying theme in this strand of research is that an individual’s judgment and decision making are affected by her incentives, information, and behavioral traits. The second strand of his research focuses on corporate taxes. His papers have been published in leading journals and he is the recipient of numerous awards. Luo’s research has been featured in the Economist, the NBER Digest, the Wall Street Journal, and many other media sources. Learn more about Luo and his research here.


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