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.
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!
Posted by: Robert Hruzek | August 14, 2006 at 05:47 AM
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!
Posted by: Anna Farmery | August 12, 2006 at 02:51 PM