When CEOs are haunted by memories of past recessions

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David Koo

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The economy, we're often reminded, is cyclical. But we all hope our careers won't be. That means those of us who make it to the very top-CEOs, for instance-may be unduly influenced by memories of prior economic go-rounds. David Koo, assistant professor of accounting in the Donald G. Costello College of Business at George Mason University, has found that memories of past recessions, triggered by recent ones, can weigh on chief executives' decisions, literally for years.

Koo's paper, co-authored by Isabel Wang of Michigan State University and Shuting Wu of Cal State Fullerton, is forthcoming in Management Science.

David Koo

The paper was inspired by trends in research outside the accounting field. "In the economics area, they have started looking at how executives' memories of recessions can affect important decision-making right now," Koo says. "We are trying to connect these emerging trends to the accounting area by focusing on pessimistic bias in their outlook of the company's performance."

The researchers adopted the 2008 financial crisis as a key moment for triggering veteran CEOs' memories of prior financial downturns. They analyzed annual management earnings forecasts for U.S. public companies for the period 2002-2018, alongside the characteristics and career histories of the CEOs who issued them. "We used the first forecast of the year for each year, because on average these are more optimistic," Koo explains. "Usually, nobody wants to say anything negative at the beginning of a year." The final data-set comprised 3,678 earnings forecasts from 466 CEOs.

Koo and his co-authors discovered that CEOs who had previously led companies through at least one past recession issued significantly more pessimistic forecasts post-2008 than they had before the crisis. As a general rule, the more recessions a CEO had undergone in their tenure at the top, the more pessimistic their post-crisis forecasts tended to be.

The same pessimistic pattern was not evident for CEOs who had not experienced a recession before 2008. Translating their findings into economic terms, the researchers concluded that one standard deviation of the memory-triggered pessimism effect was equivalent to 0.23-0.29 percent of share price.

Further, the post-crisis pessimism did not make the forecasts more accurate. It's safe to say, then, that the memory-triggered CEOs were, knowingly or not, displaying excessive caution and conservatism in their earnings forecasts. To be sure, anyone's outlook can darken with age, independent of their real-world experience. So the researchers performed subsequent checks to determine whether the increased pessimism was more closely related to growing older, or to specific memories of past recessions.

"Our takeaway is, if we have two same-age CEOs, one who has experience navigating recessions as a CEO and one who does not, the first one will become more pessimistic after the crisis," Koo says.

The more highly skilled CEOs (as measured by a widely accepted scale for managerial ability) exhibited less memory-induced pessimism, while CEOs who led more complex firms with a lot of moving parts were more prone to pessimism. "We expected that the manager-specific effect would be more significant when managers were under more demanding pressure or had more discretion," Koo explains.

As the 2008 financial crisis itself faded into memory, seasoned CEOs gradually let go of their pessimistic bias. But it took three years, on average, for their forecasts to fully recover. We normally think of past experience as an aid to learning, but here it seems that the opposite was the case: Memories of past experiences with recessions slowed down CEOs' post-crisis learning process.

"Prior research has found that past experiences can help people more rationally and then more wisely handle an ongoing crisis," Koo says. "But at the same time, executives are also human beings. They may be scarred by their experiences and that can induce them to be excessively negative or pessimistic when they go through a financial crisis."

Of course, that doesn't mean that the veteran CEOs were less effective at guiding their firms through post-crisis recovery. Koo emphasizes that his findings do not capture whether, and how quickly, companies bounced back from the 2008 recession.

"Memory may not be the most dominant factor in our decision-making, but it still can influence executives even in their managerial decision-making," Koo advises.

The lesson, then, is one for investors and other market players to store in their own memories for the next economic downturn: Take CEOs' post-crisis predictions with at least a grain of salt.