Sell Signal: When Boss
Buys a Trophy Home

When the boss buys a trophy home, investors would do well to sell shares in the company, according to a new study of stock performance of Standard & Poor's 500-stock index firms following home purchases by chief executives.

Call it the mansion effect: The bigger the CEO's home is, the worse the company's stock fares, the study by Arizona State University finance Professor Crocker Liu and New York University finance Professor David Yermack found.

Investors who short shares of companies after the CEO has moved into a palatial home would reap returns of 29% after one year, and 46% after two years, the study estimates. The authors calculated hypothetical gains based on short sales, a trading strategy in which shares are borrowed and sold in hopes of replacing borrowed shares later at a lower price.

Executives who pay for large homes by selling company stock or exercising stock options are another bearish sign. The study found shares in those companies underperformed market benchmarks for several years, while those funded without stock sales held up.

Since executives' stock sales to finance a home purchase are tiny relative to overall trading, the authors say the resulting stock-price slump may signal that top executives have become lazy, entrenched and entitled. Alternatively, the authors speculate that imperial CEOs may demoralize other executives and employees, dragging down overall corporate performance. Insider trading can't be ruled out, as the authors warned that some CEOs may use a home purchase as "pretext" when their real motive is to dump shares based on nonpublic information about the firm. Mr. Yermack said that researchers want to do further study of stock trades that looked "really suspicious."

When it comes to homes, the researchers discovered that CEOs typically live large. Berkshire Hathaway Inc. Chief Executive Warren Buffett still lives in the Omaha, Neb., home he bought for $31,000 in 1958, but it's far more common for top executives to trade up and spend millions of dollars on homes.

However, "the typical CEO is not acting like the pig at the trough," said Mr. Yermack. "Most of them live in houses that are smaller and less opulent than I would have thought."

The typical home in the study was a single-family residence with 11 rooms, 4.5 bathrooms and more than 5,600 square feet. With a $2.7 million market value, the median home price for CEOs in the study was 10 times as high as the $274,500 median sales price for all homes sold in the U.S. Outdoor swimming pools, tennis courts, boathouses, formal gardens, and detached guest houses or servants' quarters are common, and one CEO's spread featured a private polo field and equestrian ring. About 12% were waterfront properties and 8.5% were located on or next to a golf course.

About 44% of the homes in the study were funded through mortgages, and 27% were paid for by executives selling shares of company stock and exercising stock options. The average mortgage was $828,000, with about half of the executives using an adjustable-rate mortgage, compared with 23% of the overall population.

The study covers 488 homes of executives at S&P 500 firms in 2004 and those firms' stock-market performance in 2005. For CEOs with multiple homes, the authors focused on residences close to work.

Email your comments to rjeditor@dowjones.com.