The authors examine the impact of managers’ past professional experience on their financial and investment decision making as CEOs. Previous studies have analyzed the impact of personal traits or early-life experiences on managers’ corporate decision making. This novel research examines the impact of managers’ more recent professional experience. The results indicate that the frequency, timing, and saliency of past professional experiences influence a CEO’s style.

Motivated by psychological evidence showing that past experience affects individual decision making, the authors argue that managers may behave conservatively because they have experienced past employers’ financial difficulties during their professional careers. The authors’ results indicate the importance of professional experience in shaping the decision-making behavior of CEOs. The authors find that the 23.8% of CEOs in their sample who experienced employer financial difficulties in their previous jobs tend to hold 7%–13% less debt and 5%–12% more cash and to have a 5%–10% reduction in capital expenditure relative to those who did not. The impact is greater when the frequency of employer financial difficulties is higher and when the timing is more recent. The results are similar for well-governed and poorly governed firms. The authors also find that although a negative experience has an impact on future decisions, a positive experience has hardly any impact on corporate policy.

Although they find similar effects for chief financial officers (CFOs), they find that previous professional experiences of CFOs have no impact on corporate investment policy. A CEO’s recent professional experience has a greater impact on a firm’s financial and investment policies than a CEO’s personal experiences or traits. The authors find that CEOs who have experienced professional financial difficulties do not necessarily appoint CFOs who have experienced distress.

The authors selected US firms that are doing well but some of whose managers have experienced financial difficulties in their previous jobs and some who have not. Using a dataset comprising about 5,200 CEOs and 4,000 CFOs over 1980–2011, the authors analyze the managers’ detailed employment histories to construct four measures of professional experience at firms that have faced financial difficulties. These measures are bankruptcy, bond ratings, adverse shocks to cash flows, and stock returns.

The authors build a composite index for all the CEOs and CFOs. To separate firm effects from manager effects, they base the measures on prior employment at other firms. Their identification strategy evaluates exogenous CEO turnover and non-CEO professional roles. They then create a regression panel to test the null hypothesis that a CEO’s professional experience has no impact on policy and that firm characteristics are the only determinant of debt level, cash holdings, and investments. To check the robustness of their model, the authors include firm effect, year effect, exogenous CEO turnover, and CEO characteristics (e.g., MBA degree, gender, and equity-based compensation) in their analysis.

Prior studies have found unexplained heterogeneities in corporate decision making that stem from the effects of managers. This study supports the view that managers’ financial difficulties in their professional experience make them relatively conservative; thus, they tend to hold more cash than necessary, keep less debt, and invest conservatively. The authors suggest that these CEOs’ conservative policies lower firm value by not investing in profitable opportunities and by not optimally using debt tax shields.