Sunday, November 30, 2014

On the impact of CEOs

There is a popular idea of the CEO as the lone mastermind directing the fortunes of a company, playing a game of chess against the CEOs of other companies. In some cases, more often the exception rather than the rule, this appears to be the case. But I want to talk about the rule not the exception.

To begin with, we need to tackle this idea of the lone CEO. I've often faced situations when discussing gameplay where the CEO would respond "I'd love to do this but my management won't let me."

The first time you'll hear this it is often a shock. Surely the CEO has absolute power in an organisation? Alas, no. In many cases the power within an organisation is shared with the board and with lower levels of management. It is difficult to estimate how widespread this phenomena is or how much impact it has. Techniques vary from examining the role of the CEO, the titles of the CEO and whether the CEO was a founder or an insider / outsider. The answers usually vary from around 30% to 50% of companies having a 'strong CEO' i.e. one that can directly exert their will on the organisation and even then, this question is often hotly debated.

What is interesting, is there "no evidence that firms with powerful CEOs have on average worse performances than other firms" (see Powerful CEOs and Their Impact on Corporate Performance - Renee Adams). Instead these firms tend to be a mixture of the best and worst performers in the market. But how much is this difference?

Again, answers on these vary depending upon the examination, the definitions used etc. I've seen distributions of 15% to 25% of strong CEOs being top performers, the same amount being underachievers and everyone else roughly where the market is.

Of course, there are other ways of examining the impact of CEOs. For example, there has been considerable work on the impact of CEO death (compared to other executives) on the performance of a company. Whilst there has been shown to be a correlation between death and subsequent poor performance of the firm, an intellectual leap is often made that this correlates to the CEO having a positive performance. The problem is one of 'infantilism'. If a strong CEO exists, an organisation may well be ill prepared to cope with decision making for a short period of time due to the previous dependency. You cannot therefore simply assume that a negative performance is due to some beneficial impact of the CEO as opposed to a dependency on the role.

Another issue is that of situational awareness and competition. In previous work (looking at the levels of situational awareness vs action in 160 high tech companies) then, it has been noted that situational awareness and strategic play are not uniform and high levels of situational awareness and strategic play are associated with positive market cap growth (see figure 1).

Figure 1 - Awareness vs Action

Unfortunately, in the wider market it is estimated that less than 30% of large companies undertake any form of scenario planning and less than 4% have any means of visualising the landscape they compete in. Without this, strategic play appears to be more about copying others, gut feel, story telling and astrology than it is to chess. However, this is also an issue of competition because poor strategic play and situational awareness only matters when competing against others with better strategic play and situational awareness.

So, what's the impact of the CEO?

Currently that's an impossible question to answer. However, if we assume that between 30% to 50% of CEOs are 'strong CEOs' (i.e. power resides within them rather than elsewhere) and that between 15% to 25% have a positive impact, you can (as a rule of thumb) say that 4.5% to 12.5% have a positive impact. The remaining 87.5% to 95.5% have little or no effect at all, if not negative.

On the question of executive death, we cannot assume these figures demonstrate a positive influence (as opposed to a negative impact due to loss) due to the potential for 'infantilism' within an organisation. The issue regarding low situational awareness would also imply that the number of CEOs having a positive strategic benefit is low, however even in a game between blind chess players there will be winners and losers. Hence, for many markets the lack of situational awareness won't have a significant impact on outcome because all competitors lack situational awareness. Even astrology gets it right, sometimes.

Overall the data (which is far from conclusive) suggests to me that the impact will be at the lower end of the scale based upon the level of strong CEOs, performance differences and poor situational awareness. I'd put the figure at around 5% of CEOs having a significant, repeatable impact. This issue of situational awareness is also not confined to the CEOs but impacts other C-levels and can be exhibited by the tendency of strategy to simply emulate others.

So, whilst in some corners of industry the image of the "lone mastermind directing the fortunes of a company, playing a game of chess against others" seems reasonable and can appear to have a significant impact, this is not the rule. In most cases it would appear that replacing the CEO might have a short term detrimental impact (though this may well be due to infantilism of the organisation and the need for the role not the person) but the overall longer term impact appears negligible. You could just replace them with a random person from the street on the understanding that the power structures in the organisation would cope admirably. 

Now, I'm not suggesting you do this on an individual basis - particularly because you might unfortunately remove a person who is the exception and does create a significant impact. However, the argument that we cannot enforce a greater gender balance at the board level (as has happened in Norway) due to the importance and experience of these people is highly questionable in my opinion. I've not seen data that supports the idea that the commercial world would suffer due to such a change. In fact, it suggests there will be little negative impact on the performance of those companies. If anything the impact (due to diversity) may well be positive.

Until such time as someone can conclusively demonstrate that the existing cadre of CEOs have an overwhelmingly positive impact on performance, I'll hold the view that a short sharp shock (e.g. regulation requiring immediate gender balance in the board, at senior levels and employment of women as CEOs) is not only beneficial from a societal viewpoint but will not adversely effect the performance of industry in the long run. The argument that there aren't enough women with the calibre and experience to be chess playing CEOs is bogus in my opinion. 

Most CEOs don't play chess.