Think differently

Hungry for risk-taking? How a CEO’s personal risk appetite affects his/her firm’s internationalization efforts

Hamid Boustanifar , Associate Professor

Hamid Boustanifar, Associate Professor at EDHEC Business School, explains in an article published on The Conversation, how the personal appetite for risk of CEOs of large companies is reflected in the decisions of their companies.

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9 Feb 2022

In 2008, Tesla was at the brink of bankruptcy and Elon Musk had to invest in the company the last of his remaining cash from Paypal to keep it solvent. Today, Tesla is a trillion-dollar company known for
disruptive innovation and an aggressive expansion strategy in foreign markets. Musk’s belief as to the value of greater corporate risk-taking (seen as an important factor behind Tesla’s success), is clear: “There’s a tremendous bias against taking risks.

His proclivity towards greater risk-taking can be seen in his ambitious level of international expansion, as well as his tendency to make riskier internationalization choices, such as building brand new factories (e.g. Gigafactories of Shanghai and Berlin), as opposed to simply buying an existing factory.

Musk’s appetite for risk and Tesla’s success is definitely an outlier among CEO and companies, but is there a more general phenomenon occurring, whereby some CEOs have a much greater or lesser personal appetite for risk that then spills over to their firms’ decisions? In our recent research, published in the Journal of International Business Studies, we ask and answer this question, finding that across a large sample of CEOs and their firms, differences in one person’s risk appetite (if that person is the CEO) will predictably and significant affect the riskiness of his/her firm’s internationalization choices.

Risk/reward ratio

In general, we know that internationalization is characterized by clear benefits but also clear risks. In terms of benefits, by entering new markets firms increase their customer-base, gain access to natural resources, human capital and expertise, know-how, or take advantage of more efficient and low-cost business environments.

For example, oil and gas companies have long known to locate themselves where the oil and gas reserves are. Another example is the Chinese state-owned oil giant CNOOC that has sought to buy western energy firms such as Nexen and Unocal to gain access to valuable expertise. Another familiar example is California-designed iPhone that is made in China. Such examples are abundant around us. Indeed, firms have increasingly internationalized by directly investing in foreign markets, with the amount of foreign investments by multinational firms currently five times larger than what it was in 1990s, reaching to almost $1tn in 2020.

However, the risks of expansion into foreign markets include animosity from customers towards foreign products, unfamiliarity with rules and regulations with respect to doing business, potential restrictions imposed by foreign governments, and lack of knowledge about the local culture.

So what might tip the balance of the risk/reward relationships for firms pursuing internationalization? While the answer is surely multi-faceted, we suggest that one understudied factor is the personal risk appetite of the CEO. While this idea sounds intuitive, there is surprisingly little systematic evidence for or against this idea, with most prior studies focusing on characteristics of the firm (e.g. financial resources) or managerial histories (e.g. prior experience in working or living abroad). We speculate that one reason for this situation is the difficulty in getting a good reliable measure of differences in the personal risk appetites of CEOs that can then be used to predict differences in firms’ internationalization decisions.

A reflection of personal choices

We overcome the empirical challenge of measuring CEO’s risk propensity (in the context of international business studies) by using some novel data capturing the personal wealth and personal investment choices of every CEO in Norway. Such data are collected due to the personal wealth tax in Norway, in which tax authorities gather detailed information about assets and liabilities of all tax-payers. We use these data to capture a CEO’s personal risk appetite through his/her personal investment decisions; namely, we measure the proportion of their financial assets a CEO has invested in more risky investments (e.g., stock market) versus less risky (e.g., depositing money in the bank or investing it in bonds). A particular advantage of using such a measure for CEO risk appetite is that it captures their “revealed preferences,” which is generally superior to relying on hypothetical survey questions about risk-taking. We use this measure to then examine the extent to which it can predict firms’ internationalization choices, in terms of how much (degree), where (location) and how (choice of entry mode).

Our results are quite clear, showing that CEOs with a greater risk appetite will tend to steer their firms towards greater degrees of foreign investments. These CEOs are also more likely to have their firms expand to more risky locations, i.e., countries at a greater cultural distance, and also choose riskier modes of entry when doing so, i.e., acquiring companies rather than establishing an alliance with them.

Despite these clear results, we also wondered whether we could find additional evidence that these relationships really reflected a CEO pushing his/her risk appetite onto his/her firms. So, we added a variable capturing differences in a CEO’s power in the firm (vis-à-vis the board of directors). Here, we find that the relationships mentioned above are indeed particularly strong when the CEO is more powerful, which is consistent with our intuition that it is indeed the CEO who is seeking extend his/her risk appetite beyond his/her personal investment choices to the firm’s international investment choices. 

To recap, our study shows that not only are there identifiably different CEOs risk appetites, but also that these differences are consequential, as CEOs seek consistency between their personal choices and those of the firms they lead.

In terms of future research that could build upon our foundation, one could consider the next level of consequences (financial), given the strategic consequences in differences in CEO risk appetites. In other words, when CEO risk appetite is the major predictor of a variety of foreign expansion decisions, are such internationalization choices likely to result in better or worse performance? Relatedly, while our study focused on internationalization entry decisions and choices, what about exits? Would we expect a CEO with a relatively high-risk appetite to stay longer or exit more quickly from a poorly performing internationalization location (country) or entry mode (alliance)? Lastly, future research could consider the relevance of differences in CEO risk appetite for other important strategic decisions, such as the often-debated question of how much leverage a firm should take. We hope our study can serve as a platform to address these and other important research questions that explore the connection between the personal preferences of key leaders and those of the firms that they lead.

Article written by Hamid Boustanifar - Associate professor at EDHEC Business School, Edward J. Zajac - Professor at Northwestern University / Kellogg School of Management, et Flladina Zilja - Assistant Professor at Copenhagen Business School. This article is republished from The Conversation under a Creative Commons license. Read the original article.

Photo by Scott Graham via Unsplash.