The last two bubbles—the dot-com bubble of the 1990s and the real-estate bubble of this decade—have combined to create a new culture of real-estate voyeurism. Thanks to Internet-based services and the digitization of public records, real-estate obsessives can check out how much friends and neighbors paid for their homes (domania.com), how much said homes might be worth (Zillow), and what those homes look like from above (Google Earth).
These developments have been a boon to real-estate agents, would-be flippers, celebrity trackers, and all-around busybodies. Now, thanks to two finance professors who have examined the extreme home-buying habits of some of America’s wealthiest individuals, they could be a boon to stock pickers, too. Robin Leach, meet Peter Lynch.
In a working paper titled “Where are the Shareholders’ Mansions?” David Yermack of New York University and Crocker Liu of Arizona State wonder whether there is a relationship between CEO home-buying behavior and stock performance. (The title is a riff on the classic 1940 investment book Where Are the Customers’ Yachts?.) In doing so, the two academics are invading one of the last preserves of executive privacy, and we should all be very grateful! Thanks to Securities and Exchange Commission filings, the public can learn a great detail about the salaries, benefits, and perks that CEOs receive. But up until now, homes have generally been off-limits. For security reasons and to ward off jealousy from bitter shareholders, angry underlings, and discarded first wives, CEOs like to keep their homes well-hidden behind security gates and tall hedges. (About 18 months ago, I interviewed a famous private-equity magnate. There were two ironclad ground rules. First, the conversation would be on background. Second, I could not describe the grounds, the furnishings, or the mind-boggling size of his house.)
Yermack and Liu insist there’s a solid academic reason to look through the keyholes. They want to figure out if a mansion purchase signals commitment or cashing out. A CEO who buys a 12,000-square-foot mansion could be showing his intent to stay for the long haul and to bust his butt so that he’ll have the cash to pay off the huge mortgage. In which case, you’d expect stocks of the companies where the CEO just bought an obscenely large house to thrive. Buy!
Or the purchase of an absurdly large house could signal entrenchment: The CEO is too comfortable with his position and his personal finances. He has made so much money that he can’t really be bothered with running the company. And the willingness to spend gazillions on a house—not to mention the furnishings, artwork, and baubles to fill it—betokens a general inattentiveness to costs. In which case, you’d expect stocks of the companies where the CEO just bought an obscenely large house to fare poorly. Sell!
Intuitively, the entrenchment argument makes sense. Just look at this very long-term chart of Microsoft. You’ll see that since the late 1990s, when Bill Gates moved into his gargantuan home, the stock has essentially moved sideways, significantly underperforming the market.
Using property records, public databases, and search engines, Yermack and Liu were able to identify the primary residences of 488 of the 500 CEOs of the S&P 500. These guys—and they’re almost all guys—are living large. The mean residence of a CEO was anything but mean: 6,145 square feet, 12 rooms, 5.37 acres of land, and a market value of $3.1 million. For the 164 in the sample who bought new houses after being named CEO, the mean house was even less mean: 6,635 square feet, 13.1 rooms, 6.13 acres, and a market value of $3.9 million. “Aerial photographs indicate that outdoor swimming pools, tennis courts, boathouses, formal gardens, and detached guest houses or servants’ quarters are common features of CEOs’ homesteads,” Yermak and Liu write. CEOs are also engaging in the same sort of financing that the home-buying masses do.
Then the professors examined the returns of the CEOs’ stocks, and discovered that the bigger the home, the worse the stock performed. In 2005, the stocks of companies whose CEOs lived in larger homes (i.e., above the average for all CEOs) returned, on average, 3.35 percent less than companies whose CEOs lived in below-average homes. And the CEOs who lived in the biggest homes (at least 10,000 square feet or over 10 acres) underperformed their peers who inhabited more modest homes by 6.9 percent, on average.
Next, they looked at stock returns for 164 companies whose CEOs bought new homes after becoming CEO. Here, again, they found trouble, especially for CEOs who bought mega-homes on mega-plots. They found “a significantly negative stock performance following the acquisition of very large homes by company CEOs,” on the order of 1.25 percent performance lag per month. The conclusion: “We interpret the stock return evidence as consistent with large CEO home purchase indicating entrenchment and foreshadowing poor future stock performance.” What’s more, when CEOs sold stock to finance the purchase of a home—as was the case in 32 percent of the instances—those stocks performed worse than companies where CEOs held on to their stocks. Yermack says this is the most interesting finding. The data seem to indicate that a good number of CEOs are selling shares—ostensibly to raise cash to buy a house—just before their stock goes south. “I think it could be that these guys know something and want to get out of the stock,” he said. “Ordinarily, you can’t do that as an insider unless you have an alibi, and buying a house is about the best alibi you can come up with.”
A few caveats. CEOs can’t be judged by square footage alone. A 4,000-square-foot co-op in New York can be just as self-indulgent as a 20,000-square-foot estate complex in Wichita, Kan. And they shouldn’t be judged on cost alone. In San Francisco, spending $5 million on a home is par for the course among highly paid professionals. In Wichita, it’s almost unheard of.
And there’s another possible explanation that could explain the link between over-the-top home purchases and disappointing near-term stock returns. Big-ticket home purchases rarely take place when the market is about to boom. CEOs weren’t exactly rushing to buy estates in 2001 and 2002. But when the market has been on a nice long-run bull run, when people feel really good about the present and even better about the future, they’re far more likely to buy or build an extravagant home. In other words, they may be buying at the top, so it’s no surprise that share prices drop soon after.
Still, the overall argument is compelling. If you want to judge the prospects of a stock by crunching some numbers, perhaps your first stop shouldn’t be the SEC’s Edgar database. Perhaps it should be Zillow.