A rather interesting tidbit of information came to light this past week when the records of the Financial Crisis Inquiry Commission were released by the National Archives. Reporting to the Commission in May 2010, it emerged from this release that investor Warren Buffett believes CEOs and corporate leaders have little to do with a successful company. He summarized his position by declaring that, “if you have a monopoly newspaper, if you have a network television station […] you know, your idiot nephew could run it.” By this “idiot nephew” diatribe he meant that, given a natural monopoly or an opportunely placed business model, executive management is to a large extent irrelevant to a company’s fortunes, since it’s the basic product of this company and its advantaged position within its market that does most of the work.
But is this true? Is Buffett’s glib dismissal of executives well-founded and justifiable? Well, as will be outlined below, much has happened in recent years to substantiate his views. From the rising turnover of CEOs to the vagueness and imprecision in measuring CEO performance, there are increasing signs that chief executives are sometimes glorified — and very well-paid — company mascots more than primary architects and drivers of corporate operations. Even when they lord over successful corporations, it can often be demonstrated that these corporations benefit from monopoly-like conditions or favorable positions within their markets. Conversely, new CEO appointments and changes to strategy don’t do that much to alter the fate of a company locked in unfavorable circumstances with an unviable product.
But when it comes to the fate of the humble CEO, it seems that an increasing number of them are destined to be replaced within a very short span of time. In 2014, it was found that the rate of their stepping down or dismissal was accelerating, with the “churn” among FTSE 100 chief executive officers rising to 23% from the 14% of the year before. Similarly, CEO turnover in the United States attained its highest level in 2014 since the financial crisis of 2008, with the total number of exits growing by 7.6% over 2013.
What this ascending pace of executive recycling indicated is that a growing number of companies are discovering how the appointment of a new chief often does little to change their levels of success and profitability. They and their boards hire a new CEO with the expectation that it will make a difference to their balance sheets or flagging performance, only to find that it doesn’t, so they consequently single out yet another replacement in the hope that he or she will do better. Unfortunately for them, all their constant recycling often achieves is an affirmation of how CEOs often don’t have the power to reform the fundamental nature and profitability of a business, as could be witnessed with the 2011 discharge by HP of Leo Apotheker after 11 months on the job, or the ousting by Mattel of Bryan Stockton in 2015. In other words, their heightened turnover rate corroborates Buffett’s analysis, in that a struggling business often remains a struggling business, regardless of how many seemingly well-qualified CEOs pass through its doors.
That the turnover rate was at its highest around the time of the financial crisis in 2008 also adds further support to his claim. In 2008, there were a total of 1,484 CEO departures, some 10% higher than the total for 2014. Likewise, the average CEO tenure in the US was at its shortest in the aftermath of the financial crisis, with the mean having reached a low of 8.1 years by 2012. Together, these two troughs exhibit quite clearly how the average CEO’s job stability was at its worst just when external, structural forces — i.e. the Global Recession — were a stronger determinant of how her company performed than her own input. It generally wasn’t she who reduced her firm’s profits or got herself dismissed, but rather the overall robustness of the firm’s business model and its position relative to the turbulent environment in which it found itself.
Despite this comparative impotence, the CEO is still blamed more often than not for the trials and tribulations of their respective companies, implying that one of their main tasks is not so much to oversee every aspect of their firm’s activities, but to act as a figurehead/scapegoat, someone whose arrival and departure can reassure everyone else inside and outside the firm that something fundamental is changing. In fact, even though there’s no available data to directly prove that CEOs are less important than is commonly believed, there is some evidence to suggest that when they actually do make an effort to be proactive in the running of their corporations they sometimes cause more harm than good.
For example, a 2014 study conducted by the University of Utah revealed that increased executive pay is correlated with decreased financial performance of firms, since inflated pay often encourages “overconfidence in [CEO] decision making.” With their overconfidence, executives engage in “increased risk-taking behaviors, such as aggressive mergers and acquisitions, investments in bad projects, and wasteful spending.” Put differently, they depart from what is arguably their standard role, which is to entrust everyday operations to the people around them and intervene only when the machine is veering off course. This was to some degree evident in the exit of Jack Griffin from Time in 2011 after a paltry five-month tenure, which was apparently brought about because of sweeping management changes that had “alienated some long-time staffers.”
Moving away from these surficial adjustments to management and work culture, there are numerous indicators that the biggest differences CEOs make to their firms’ valuation and performance often comes not over the longterm, but rather when they’re initially appointed. An article published this year by researchers from Oxford University showed that the stock prices of companies rise on average by 5.3% when a new CEO holds a public presentation within 100 days of their hiring. What’s interesting about this finding is that the positive effect wears off after the 100-day period, regardless of whether changes in strategy or investment are similarly announced. This would attest to the ‘talismanic’ role and effect of CEOs, to their importance in presenting the comforting semblance or suggestion of forward movement to investors and employees, quite irrespective of what, if anything, they’re actually doing.
Measuring the Unmeasurable
As for what they’re actually doing, and as for the effects they’re reputed to have on a company’s health over the longterm, the Harvard Business Review compiles its list of the 100 best-performing executives in the world predominantly in terms of “total shareholder return, as well as the change in each company’s market capitalization.” It therefore judges Lars Rebien Sørensen of Danish pharmaceutical corp Novo Nordisk as the best CEO in the world as of 2015, since he’s presided over sufficiently large increases in his company’s shareholder returns and market capitalization since 2000 (when he became chief executive).
That said, there’s no attempt at all to distinguish between how much of Novo Nordisk’s 1,554% increase in industry-adjusted shareholder returns are a result of his continual input, and how much of it is the product of the structures and operations that had already been established between the company’s founding in 1923 and his promotion. Given that the study doesn’t incorporate any data on the strategy changes, decisions, boardroom shakeups, takeovers or investments he and his peers may have spearheaded, it becomes clear that it entirely conflates the performance of CEOs with the overall performance of the firms they head. As such, it lends credence to the idea that CEOs are often simply totems, symbols, figures, expressions and spokespeople for their corporations, and that it’s uncritically taken for granted that they’re responsible for everything that goes on within corporate headquarters, even if this is true only in a legal, formal sense.
What’s more, given that Novo Nordisk has numerous patents in the US relating to diabetes and other conditions, and given that it “controls nearly half the market for insulin products,” it’s tempting to conclude that the company enjoys something of a natural monopoly in its primary market and that, as Warren Buffett’s pronouncement before the Financial Crisis Inquiry Commission would predict, its success has come more from this monopoly than from Sørensen’s aptitude.
However, to be fair to Sørensen, he does seem to acknowledge in his interview with the HBR that his apparent success is largely the upshot of Novo Nordisk’s cornering of the diabetes market, affirming that, “Outsiders sometimes come in and say, “You’re dependent on diabetes for 80% of your revenue—you should diversify.” But I’ve always believed that you should do things that you know something about, that you’re good at.” Not only that, but he even admits that when he and his boardroom had tried to steer Novo Nordisk’s ship differently, it didn’t really work: “We’ve tried a lot of diversification strategies in the past, but we’ve failed because of the inherent scientific and commercial uncertainty and our own naïveté. So our expansion has been completely organic.”
As for other CEOs and their performances, it’s being increasingly remarked that, aside from simply gauging company performance à la the Harvard Business Review, it’s very difficult to establish an objective measure for them. Writing in Forbes, CEO consultant Joel Trammell noted that this difficulty has arisen because, often, “there is not clear agreement on what the CEO should actually be doing.” That there isn’t clear agreement indicates that board members “may not have even given much thought to the question of what the CEO’s job really is,” and in turn, this indicates that there isn’t really a clear job description for chief executives, since these executives don’t have any particular, specific role, aside from stepping in and rearranging the furniture when things go badly.
This view was, unsurprisingly enough, affirmed by Warren Buffett himself in 1988, when in his capacity as the CEO of Berkshire Hathaway he declared that standards for CEOs “seldom exist. When they do, they are often fuzzy or they may be waived or explained away […] At too many companies, the boss shoots the arrow of managerial performance and then hastily paints the bull’s-eye around the spot where it lands.”
CEOs Who Aren’t CEOs
Of course, for every CEO dismissed within a year for having no discernible effect on their firm’s prognosis (e.g. Leo Apotheker or Jack Griffin), there’s always a Mark Zuckerberg, Bill Gates or Steve Jobs, a model CEO who doesn’t merely serve as the human face of their company, but who actively shapes it from the ground up. There’s no doubt that these three innovators aren’t the kind of unproductive “idiot nephew” executive who exists mainly to take the credit or the flack for their company’s undulations, but it should nevertheless be highlighted that all three were the founders (or co-founders) of their respective firms, responsible for conceiving the groundbreaking new products that made their firms the household names they are today.
That is, their renown and success comes almost entirely from their status as founders, inventors, programmers, engineers or designers, rather than from their status as CEOs responsible for moving resources around. They invented novel products or new ways of doing business, and the same holds for nearly every other big-name executive in the popular consciousness today, such as Larry Page of Google, Jeff Bezos of Amazon, Elon Musk of PayPal/Tesla/SpaceX, and Larry Ellison of Oracle.
That these CEOs are so well-known and celebrated because they’ve pioneered new, innovative businesses is testament to Buffett’s thesis: namely, that it’s the soundness of a business model and its position within the industry that’s key to determining its success, and not the existence of someone at the top making adjustments to ‘corporate culture‘ here and there. This is further supported by the fact that, even with the likes of Zuckerberg and Gates, the prosperity of their respective companies doesn’t rest only with the novelty of their products, but with how this novelty enabled them to command a monopoly in the market for these products. Facebook, for instance, has often been described as boasting a natural monopoly in the world of social media, just as Microsoft has/had a monopoly when it came to operating systems (and internet browsers). Therefore, even if there’s no question that both companies were innovators in their fields, they grew from strength to strength because they held monopolies, not because their CEOs were management geniuses.
Actually, it’s probably because of the dual roles of such executives as Zuckerberg and Gates that there’s a popular tendency to overestimate just what a CEO does qua CEO. Neither is this overestimation helped by the ever-skyrocketing pay executives enjoy, with the average pay ratio of a CEO to the median worker being 204-to-1. Translated into sums of money, this works out as $13.8 million versus $77, 800, while in one of its more shocking examples it translates into the $25.6 million of Walmart CEO Doug McMillon versus the $22,591 taken home by the company’s median worker (1,133-to-1). In view of how we inhabit an ostensible meritocracy in which we’re often told that those who work the hardest earn the most money, these kinds of wide disparity must surely create the impression that CEOs exert a correspondingly massive influence on the affluence of their firms.
Yet even if most CEOs do work very hard, the incidence of high CEO turnover rates, the cardinal importance of monopolies and market position, the 1-to-1 conflation of CEO performance with company performance, the uncertainty over what a CEO should even be doing, the suggestion that overpaid and overconfident CEOs screw up the natural equilibrium of their firms, all of these pieces of evidence combine to insinuate that executives are often not that decisive an influence on the performance of their respective outfits, or at least not as important as their pay packets would have us believe. However, because of their position at the top of their organizations, they can often set their salary to whatever level they like, thereby taking a share of their company’s profits that engenders the illusion they’re simply taking an amount ordinate with their impact and influence.
Far more frequently than most CEOs would like to admit, this share isn’t at all proportionate. However, even if executives are merely figureheads more often than we care to realize, this role of figurehead is still very important, at least to a company’s market valuation. As we saw earlier, share price often rises with the announcement of a new CEO, despite initial excitement failing to be converted by the new executive into sustained growth in around 50% of cases.
This just goes to show how the CEO is more often a symbol or embodiment of his corporation than a key mover, a personification used by his corporation as a whole to express and crystallize its often diffuse intentions to change, to grow, to invest and to outcompete its rivals. He serves as a conduit between his firm and the outside world, a mouthpiece whose lone voice functions to convince the market and customers that his organization is of one voice and one mind, even when, behind the scenes, it perhaps isn’t. Ultimately, his job is to reassure shareholders and fellow employees with the simplification that, because someone stands at the top of their business’s hierarchy, that business is entirely under control, and that altering its trajectory when times are tough is simply a matter of appointing someone new to his position.
This isn’t to say that his role is purely for show, since examples of CEOs announcing changes to management hierarchies and company operations are easy to find via quick internet searches. But it is to say that, even with the real power of CEOs to hire, fire and strategize, much of their input has a shallower effect than might be imagined. They’re often powerless to alter the basic, fundamental product or service for which their companies are renowned (e.g. no Twitter CEO is likely to demand that it heal its woes by switching to real estate), and they’re often powerless to alter the position of this product or service in relation to the market and the company’s competitors (e.g. there’s little Twitter can do about the existence of Facebook).
Added to this, CEOs often find themselves sitting atop gargantuan corporate structures that have been in motion for years and decades, operating according to an autonomous logic that’s difficult to modify, reform or oversee, especially when there are a hundred different departments within these structures to keep track of at the same time. This is why Warren Buffett’s claim before the Financial Crisis Inquiry Commission in 2010 was entirely credible, if somewhat overstated. Sure, most CEOs are probably more capable than he gave them credit for, but they have to be someone’s cousin, right?