Recent research by Texas A&M researcher Markus Fitza debunks the glib conventional notion of the CEO as the prime mover of a company’s fortunes. In a paper, The use of variance decomposition in the investigation of CEO effects: How large must the CEO effect be to rule out chance?, he investigated the impact of two factors: the CEOs’ abilities versus the occurrence of chance events. Put another way, the difference between pluck and luck.
Fitza said, in an interview with Science News,
“I wanted to know how big the effect of chance on CEO performance might be.” Chance can have negative or positive effects on a firm’s performance, he notes. “For example, a scandal at a major competitor can help a firm, while an accident at an important supplier can have negative consequences. Over a long enough time period such effects tend to cancel out (a phenomenon called ‘regression to the mean’), thus it is unlikely that a firm is consistently high performing just because of chance events.”
You’d think that would be a strong argument in favor of CEOs’ abilities rather than chance, but Fitza offers a coda: since CEOs’ tenure has dropped to four years, chance might not regress to the mean in such a short period. And in that case, a major hiccup in the market or a company scandal could obliterate the impact of a CEO on operational results.
Fitza’s research suggests that as much as 70% of the ‘CEO Effect’ touted in other, more CEO-favorable studies could be attributed to outright chance, not connections, skill, charisma, or mojo.Fitza applied statistical techniques, in particular variance decomposition, to determine the influence of difference factors on a central variable, such as company performance. Fitza’s research suggests that as much as 70% of the ‘CEO Effect’ touted in other, more CEO-favorable studies could be attributed to outright chance, not connections, skill, charisma, or mojo.
This belies the short-term obsession with performance — like firing a CEO after a single bad year — and it makes me wonder if companies would be better run if CEOs were appointed for longer terms — like 7 year contracts — during which they could only be fired for cause or willful negligence.
Winterkorn was not undone by luck, but by his misdeeds.Consider a CEO that is headline news these days. Martin Winterkorn was rapidly pushed out at Volkswagen immediately following the ‘Dieselgate’ scandal, which might have been considered just a bit of bad luck. He, in fact, asserted that he knew nothing of the company’s efforts to circumvent emissions testing on certain of the company’s various lines of diesel automobiles and trucks using so-called ‘defeat devices’. However, since the cheating on nitrogen oxide emissions appears to have been going on since at least 2009, this is not on par with a quarter or two of bad financial results, and it is so far-ranging and so integral to VW’s efforts to grow the adoption of diesel vehicles in the US that is is difficult to imagine how Winterkorn could not have known. Winterkorn was not undone by luck, but by his misdeeds.
There is no doubt that at least that the truly top performers — Steve Jobs, Bill Gates, Elon Musk — are worth the astronomical value that their boards, shareholders and the markets are willing to pay. But once you slide down the exponential peak of ability Fitza’s research says that we are overpaying CEOs. And more importantly, we may be allowing CEOs to try to rig the game to cover up for their inadequacies, and to create power cliques that support them in this.
Recent revelations about Winterkorn seem to show him concealing information about Dieselgate from his board of directors even as they were approving a new contract for him. As reported by Jack Ewing and Jad Mouawad,
[…] Several members expressed displeasure with Mr. Winterkorn’s failure to keep them in the loop. Mr. Weil, the prime minister of Lower Saxony, complained about it in a speech last week to the state Parliament.
Volkswagen is the largest company by far in the state and employs about 110,000 people there. The state government [Lower Saxony] owns a 20 percent stake in Volkswagen, and by law has veto power over major decisions.
Under German law, at least half of the seats on a company supervisory board are held by labor representatives. A spokesman for members of Volkswagen’s workers’ council, which is separate from the union and also has seats on the board, said he did not know how they learned of the emissions scandal and could not comment.
At Volkswagen, four of the 20 board seats are held by descendants of Ferdinand Porsche, designer of the original Beetle. The family owns a majority of Volkswagen shares through a holding company. A spokesman for the holding company declined to comment.
Volkswagen executives had a duty to inform the supervisory board of the emissions problem, said Ulrich Hocker, a Düsseldorf lawyer who is president of a shareholder advocacy group known by its German initials, D.S.W. But he said only the supervisory board would have legal standing to seek damages from Mr. Winterkorn, who has kept a low profile since leaving.
Some shareholders have complained that Volkswagen did not follow German laws requiring it to publicize information that could affect the stock price.
Mr. Hocker said shareholders are angry and want changes. “The whole company was run from Wolfsburg,” he said. “They have to get away from this centralized management.”
The reality is that truly great CEOs can have an exponential upside impact, but even an average CEO can damage a company exponentially.That last statement is telling, and suggests we have to look beyond CEOs’ generalized abilities, and specifically dig into the many factors in strategic management that CEOs get credited for, like inheriting or engendering the right kind of culture. And in Winterkorn’s case, it looks like he had created a closed, centralized, and debased work culture, and the workers, investors, and customers of Volkswagen have been immensely harmed by that.
The reality is that truly great CEOs can have an exponential upside impact, but even an average CEO can damage a company exponentially. That shouldn’t be translated into huge salaries for CEOs across the board, however, as if this will translate into making all CEOs great. Winterkorn’s case — like so many others — makes that abundantly clear.