CEOs Matter Less Than You Think

Today’s Wall Street Journal contains an entertaining story about the recent financial setbacks suffered by hedge fund manager Robert Chapman. It makes for good reading, as Mr. Chapman is quoted as saying that “We serve eviction notices to incompetent executives” The Journal reports how Mr. Chapman once described the 78 year-old Chairman of a company as a “helpless Mr. Magoo-like character" and its CEO as “The Dummy.” And they tell us that “Mr. Chapman’s office features a toy guillotine, a shark skull and other symbols of gruesome destruction.”

Whether Mr. Chapman is an effective intimidator and turn around artist is unclear at the moment, but what struck me about the story was that it was yet another indication that CEOs, or perhaps CEOs and their top teams, are treated as the most powerful factor that drives organizational performance. The message in the business press – and from headhunting firms too – is that if things are going good, than it is because a company has great leadership. And if things are going badly, then it is largely because of bad leadership – so if you replace the CEO or perhaps the senior team (serving them with “eviction notices”) then everything will be fixed. As we show in our leadership chapter in Hard Facts, a related conclusion is accepted by economists like Michael Jensen, who argue that if you get the CEO’s incentives “properly aligned” with organizational goals, then, boom, performance will improve because they will be properly motivated to act in the firm’s best interest.  Indeed, many experts who draw on economic perspectives like agency theory complain that the problem with CEO pay is that they are paid well when things go wrong or right, and if companies would just provide CEOs with the right incentives, then the CEO pay controversy would – or at least should -- go away.

The problem with these arguments is that they all are based on the assumption that CEOs have a lot of influence over performance. After all, if CEOs didn’t have much influence, tying their rewards to performance or getting rid of bad leaders wouldn’t matter much. It is instructive to compare this unwavering faith in the power of CEOs with the best evidence. Yes, leaders do have some impact, but far less than most people think. My colleague Jeff Pfeffer published a paper in 1977 in the Academy of Management Review showing that leader's actions rarely account for more than 10% of the variation in organizational performance, and often, account for much less. Subsequent studies have confirmed this general pattern. Leaders do have a somewhat stronger effect on performance when companies are small and young. But a host of experiments and field studies show that the business press and other observers consistently give leaders far more credit and far more blame than they deserve. Apparently this happens because people are brainwashed by cultural myths about the power of leaders and because it is requires less mental effort – and is more comforting – to view, say, Procter & Gamble as AG Lafley or Oracle as Larry Ellison, then to think about the long list of factors that actually cause performance.

Jeff Pfeffer emphasized that leaders have, at best, modest control because there are so many factors that are simply impossible for them to control – economic conditions, industry structure, fixed costs, what competitors do, what happened before the CEO took over, and what a nuances of what the other hundreds and thousands of people in the company do. A few years ago, I was talking with Spencer Clark, a former GE executive who had led a large business during Jack Welch’s reign about the limits of CEO power. Clark  remarked “Jack did a good job, but everyone seems to forget that the company had been around for over a hundred years before he ever took the job, and he had 70,000 other people to help him.” Indeed, although CEOs can certainly make a difference, especially founders, many of the greatest companies – take Toyota or Procter & Gamble – have succeeded because they have such great systems that it makes it easy for competent people to succeed, not because of the work of leaders with magical powers.

Another reason that leaders don’t have as much effect as most people think is what statisticians call “the restriction of range” problem. Although, as Mr. Chapman says, evicting incompetent leaders is no doubt important, some researchers – notably Stanford’s James March – have argued that nearly all people that are seriously considered for senior management positions are competent (as they are heavily screened, trained, and all have shown that they can do the work) so it doesn’t make much difference which finalist you choose. March, the master of challenging conventional wisdom with logic and evidence – and his charm – once wrote:

Management may be extremely difficult and important even though managers are indistinguishable. It is hard to tell the difference between two different light bulbs also; but if you take all the light bulbs away, it is difficult to read in the dark. What is hard to demonstrate is the extent to which high performing managers (or light bulbs that endure for an exceptionally long time) are something more than one extreme end of a probability distribution generated by essentially equivalent individuals

March’s perspective is bolstered by evidence that corporate boards place irrational faith in magical superstar CEOs, as a savior who will ride in on a white horse and transform a struggling company into an industry leader. See Rakesh Khurana’s lovely book Searching for a Corporate Savior for some of this work.

What does this all mean in practice? There are a lot of nuances, but the most important implication is that bringing in a new CEO is rarely a magical quick fix. Executive search firms love CEO changes –especially external hires – because they make money on each search and hire. But the weight of the evidence suggests that bringing in a new CEO doesn’t help that much, often makes no difference at all, and can even do moderate damage.

Venture capitalist Steve Dow is one of the few people in industry I’ve talked to who actually seems to get and act on this evidence. As we wrote in Hard Facts:

Start-ups have notoriously high failure rates, no matter how well they are managed. Dow has been a general partner at VC firm Sevin Rosen since 1983 and served on dozens of boards over the years. He tells us that many board members, especially young venture capitalists who lack operational experience, are quick to talk about replacing the CEO at the first hint of trouble. Dow asks them, “Now, suppose you were CEO, what would you do differently than the one we have right now?” Dow says that most of the time they can’t think of much, if anything, they would change. Like everyone else, until they think about it carefully, these venture capitalists can’t separate the CEO’s performance from the firm’s performance.

Comments

[Robert Hruzek]

Interesting thoughts, Bob. I wonder - is the most important role for a CEO regarding influence really "good PR"? Look at the few CEOs who are actual household names, like Lee Iococca and (more recently) Dr. Z. If they are likable fellows (in their advertising), then generally people will "feel good" about the company. Just a half-baked theory.

I also wonder if "group decision-making" (a.k.a. James Suroweiki's "The Wisdom of Crowds") holds more promise? If you can meet the conditions for "wise" crowds, they seem to far outperform any one "smart" guy. Also a half-baked thought.

But on the other hand, two halves can make a whole pie!

[Anna Farmery]

Great thoughts....where Presidents and CEO's are influential is setting the tone for the organisation. I once saw a survey that said the CEO sets high expectations but accepts mediocrity...now that is influence on the future!