On Leadership
Are “kings the slaves of history,” as the Russian novelist Leo Tolstoy put it, or is “the history of the world but the biography of great men,” as the English historian Thomas Carlyle argued?
Americans side with Carlyle on the question of determinism. A recent Pew poll found that 57% of Americans disagree with the idea that success in life is pretty much determined by forces outside of our control, a higher percentage than any other country surveyed.
And Americans apply this philosophy in business, placing a greater emphasis on the role of CEOs in shaping the fate of the companies they run. American public company CEOs are the highest paid in the world, with annual compensation nearly 3x that of CEOs in the rest of the world.
This pay comes largely in the form of incentives, like options that are tied to share price performance. This equity-focused compensation structure is the brainchild of Harvard Business School professor Michael Jensen, who co-wrote an influential article in 1990 arguing that CEO compensation should be tied to stock price performance in order to better align manager incentives and ensure that corporations are able to attract “the best and brightest individuals to careers in corporate management.”
But what role does a CEO actually play in driving stock price performance? And if we define the “best and brightest” as those with the best resumes, do conventional markers of early career success predict which CEOs perform better than others?
Over the past year, Verdad intern Haonan Li and I set out to answer these questions. Haonan created a database of ~8,500 CEOs and their characteristics, each individually mapped to their respective companies for the duration of their tenure, and pulled company fundamentals from Compustat, stock returns from CRSP, CEO tenure and education from Boardex, and long-form CEO biographies from CapitalIQ.
Haonan then ran a battery of tests on the new dataset, looking for correlation, persistence, and predictive power. We wanted to answer two sets of questions:
Do CEO characteristics predict stock price performance? Do CEOs with MBAs perform better than CEOs without MBAs? Do CEOs with MBAs from the best MBA programs outperform other CEOs? Do CEOs who worked at top consulting firms and investment banks outperform other CEOs? More broadly, are the “best and brightest” better at running companies?
Is CEO performance persistent? If someone was a successful CEO of one company and took over as CEO of a different company, does his or her performance at the first company predict performance at the second company? If a CEO does a good job for three years, does that predict stock price performance over the subsequent three years? More broadly, are some CEOs better than others at driving share price performance?
We believe this research has important implications for investors. There is broad consensus among investors that one should seek out “well-managed” companies. And what better way to assess the quality of management than to examine the chief executive’s resume and record?
This approach makes intuitive sense. Surely it is better to invest in the star CEO who has a record of stunning returns than a schmuck who has underperformed the S&P? Better still if the star was forged in the crucibles of Harvard and McKinsey. There is a big market for books about these genius CEOs and how they achieved their success—and what lessons corporate executives and investors should take away from the histories of “great men.”
The siren songs of credentialism and tales of corporate "great men" are seductive. It is the pedagogy by which most college students learn and explain history. But if the data shows that CEO performance isn’t persistent, or if the resume characteristics we commonly associate with “quality” don’t, in fact, predict performance, are investors making a mistake in spending so much time on management quality? We will seek to answer these questions over the next two weeks.