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It's a story investors love. A larger-than-life CEO hustles into a
troubled company just in time to rescue it from disaster. With visions
of Lee Iacocca and Lou Gerstner, even (dare they dream) Jack Welch, in
their heads, investors dip into their wallets and bet that one
charismatic leader can fire up the share price and bring them untold
riches.
Just how powerful is the perception of the CEO as savior? Look back to
1996, when in a single day investors drove up shares of Sunbeam by half
when it was announced that Al Dunlap had been hired as CEO. The
following year investors added $3.8 billion to AT&T's market cap on the
day that C. Michael Armstrong was named the new CEO. And just this
summer shares of Tyco International jumped 46% the day after it was
announced that respected Motorola executive Ed Breen was the new leader
of the troubled conglomerate.
As the first two examples suggest, the story can have a very unhappy
ending. Yet for years the media, Wall Street, executive recruiters, and
CEOs themselves have portrayed chief executives as all-powerful titans
essential to the long-term health of the companies they run and wealth
of the shareholders they serve. And the post-bubble atmosphere of
corporate malfeasance has, if anything, heightened the importance of
CEOs in the eyes of stock pickers. More than 90% of Wall Street analysts
and institutional investors said they were more likely to buy or
recommend a stock based on a good CEO reputation, up from 70% five years
before, according to a study conducted in 2001 by consulting firm
Burson-Marsteller. "There is still this sense that CEOs are
superhumans," says Leslie Gaines-Ross, the firm's chief research officer.
Faced with the myriad factors that determine the fate of businesses,
investors tend to gravitate toward something they can put a face on.
"It's a common psychological process," says Rakesh Khurana, an assistant
professor at Harvard Business School who studies CEOs. "It's so much
easier to take complex events and reduce them to an individual." But
does this impulse to put our trust (backed by our money) in a single
person make sense? Is betting on the CEO any way to invest?
To answer that question it's necessary to consider another: How much
effect does the CEO really have on a company's stock price or
profitability? As Warren Buffett once observed, when good management is
brought into a fundamentally bad business, it's often the reputation of
the business that remains intact. Such skepticism (or as we like to call
it, common sense) hasn't stopped a gaggle of academics from trying
desperately to measure, to an exact number, the "CEO effect." One
decades-old study went so far as to conclude that a chief executive
alone accounts, on average, for 44% of the company's return on assets
during his tenure. (Oh sure, they scoffed at the science of phrenology
too!)
No, it is not yet possible to put the influence of a good leader into a
neat mathematical formula. While we know in our hearts that CEOs
matter--all that squishy stuff like managing, strategizing, and
inspiring that we read in Peter Drucker books--the consensus among those
who have studied the subject seriously is that they don't influence a
company's share price more than, say, overall industry conditions or the
economic climate. "The fundamentals of the company are far more
important than the CEO," says Bob Olstein, manager of the Olstein
Financial Alert fund.
Consider a recent study by University of California at Irvine management
professor Margarethe Wiersema. Wiersema tracked the performance of 83
new CEOs given the reins during 1996 and 1997--about 40% of whom were
brought in from the outside to rescue or revitalize companies. Two years
after their start dates, Wiersema found that the presence of the new
CEOs had brought no significant improvement in financial performance. In
fact, even as the bull market was roaring, most of the group's stocks
declined.
For a more specific cautionary tale, look at the experience of AT&T
shareholders under the aforementioned C. Michael Armstrong, who took
over the reins of Ma Bell in 1997. A 31-year veteran at IBM, Armstrong
had earned a reputation as a turnaround specialist during his stint as
head of the Hughes Electronics division of General Motors. His arrival
was cheered by Wall Street: By early 1999, AT&T's stock price had almost
doubled.
But just a year later the picture turned ugly after it became clear that
Armstrong's gung-ho acquisitions strategy, which included the purchase
of two cable companies for more than $100 billion, was yielding
disastrous results. Today, with the company awash in red ink and
operating under a crushing debt load, AT&T's stock (even factoring in
the AWE spinoff) is trading well below its 1999 peak. "They brought in
their gun-toting, motorcycle-riding sheriff, and five years later it has
one of the worst balance sheets in corporate America," notes Khurana.
And then there's the research of Constance Helfat at Dartmouth's Tuck
School. In studying CEO succession, Helfat has found that companies with
executives promoted from the inside perform about as well as those that
have recruited from elsewhere. The white-knight theory simply doesn't
pan out.
So what, if anything, should you look for in a CEO when considering
whether to invest in the company? These days, of course, Wall Street is
searching more for straight-arrow law enforcers than for gunslinging
cowboys. "The market wants antiheroes," says Neil Scarth, manager of
hedge fund Symmetry Management. Many experts say that's a good policy
for all environments. "I'm always looking for people who aren't too
promotional," says Olstein.
The best CEOs, in fact, are probably the ones who put systems in place
to develop future generations of strong leaders. Khurana points out that
leaders like Jack Welch at General Electric, Sam Walton at Wal-Mart, and
Herb Kelleher at Southwest Airlines spent years institutionalizing their
management processes deep into the ranks of their companies. "The
difference between a cult and a religion is that one outlasts a
charismatic personality," notes Khurana. "Herb Kelleher was building a
cathedral."
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