The (weak) link between CEO pedigree and performance
It doesn’t take an MBA to understand that the people who do the hard work, every day, of running our companies are by far the most important people on our team. Thus far, we have worked with three models in terms of finding leadership post close: 1) previous owner/operator stays on, 2) promote internally and 3) source an external operator.
One of the challenges of the third option is that it is incredibly difficult to have the perfect operator ready to step into a given CEO position at the snap of your fingers, since every situation is unique and timing is inherently unpredictable.
Furthermore, what exactly constitutes the “perfect operator”? On the surface, it would seem all else equal, we should favor candidates with elite credentials who, given their pedigreed background, we should consider ourselves lucky to hire. After all, if a well-heeled Harvard Business School grad can run a Fortune 500 Company, they should be able to run a small business… right?
Turns out, some people have started looking into this notion that fancy MBA = good CEO, and have found some surprising results. I know people, put down your Southsides and pay attention.
For instance, a recent article in Institutional Investor titled The MBA Myth and the Cult of the CEO, authored by Dan Rasmussen & Haonan Li, asked some fairly obvious questions, such as: 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?”
To answer these questions, using a database of approximately 8,500 large company CEOs to measure MBA credentials against stock returns, the authors found no statistically significant alpha against broader market returns, meaning there is no evidence that MBA graduates are better at running companies (if measuring performance by stock price).
“Well, of course that’s the result!” they cry from the mahogany paneled rooms of the Harvard Club – “they were including ALL schools in their analysis, not elite schools, which are obviously the breeding grounds for the best and brightest! Cream rises to the top, after all!”
Sorry old boy, turns out it doesn’t matter. From the authors:
“We ran similar regressions controlling for industry and found that — even after controlling for industry — elite MBAs did not produce positive statistically significant alpha….. The perceived quality of each institution appeared to have no correlation with stock price returns. Northwestern led with an alpha of 0.58 percent per month. Stanford eked out a barely positive alpha of 0.03 percent per month. Harvard and Wharton had negative alphas of -0.15 percent and -0.19 percent, respectively, per month. “
Of course, as the authors point out, there is a null hypothesis issue with this analysis, in that they cannot prove a negative, i.e., that credentials don’t have an effect on the share price, so this isn’t a perfect analysis. However, the point is that statistically speaking, resume pedigree is not a reliable predictor of superior performance in the CEO spot.
For us, the takeaways of this research are perhaps different than the typical Institutional Investor reader who is involved in public markets, since stock price performance is an irrelevant factor for a closely held private company. Rather, the research is a reminder that, as anybody involved in small business operations knows, business is messy and there are no shortcuts. A person with an amazing pedigree could be an amazing operator, just as could a person with no educational credentials. We can’t just look at a resume to filter candidates, we have to keep an open mind and remember that leadership decisions are much more nuanced.
More importantly, we cannot use resume pedigree to judge character or cultural fit. And since there are so many variables that impact operator performance, at the moment, the best we suppose we can do is to make hiring decisions based off of a well defined set of values. That way, at the very least, we can sleep well at night knowing everybody on our team is aligned on a deeper level.