Focus on businesses, not the people who run them
Rather than on the people and personalities at the top of a company, investors would do better to concentrate their attention on its balance sheet, debt and, above all, valuation
To what degree do chief executives drive the share-price performance of the companies they run?
It is a key question for investors to consider and one that divides opinion. Here on The Value Perspective, for example, we prefer to focus on a business’s balance sheet than the people at the top – for one thing, as we recently discussed in relation to Carlos Ghosn, you can never be sure how long a chief executive will remain in place.
For others, however, “the cult of the CEO” – to borrow a phrase from this excellent piece by Dan Rasmussen and Haonan Li in Institutional Investor – is hard to resist.
The article describes how academics made a link between how CEOs are compensated and stock prices in a 1990 paper and, since then, the remuneration packages of company bosses have rocketed upwards – mostly in the form of options and stock grants.
Rasmussen and Li highlight data from the Stanford Graduate School of Business showing how, adjusted for inflation, average compensation for CEOs at the largest companies in the US broadly held steady at around $1m (£770,000) from the mid-1930s to the end of the 1970s.
By the 1990s, however, it had quadrupled to $4.1m and, by the mid-2000s, it had more than doubled again to $9.2m.
“What if CEOs don’t play much of a role in driving stock price performance, and the ‘aligned incentives’ of equity incentive pay don’t change behaviour in any way that benefits shareholders?” Rasmussen and Li go on to ask.
What if this modern take on executive pay has “produced better outcomes for CEOs and business school graduates,” it adds, “but not better outcomes for investors or society at large?”
Are highly paid CEOs value for investors?
The piece then sets out to answer two sets of questions – the first lot focusing on whether CEO characteristics predict stock price performance and if CEOs with MBAs perform better than CEOs without MBAs; and the second lot analysing whether CEO performance is persistent – in other words, does a successful stint by a CEO at one company predict more of the same when they move on to another business?
As Rasmussen and Li note, “the siren songs of credentialism and tales of corporate ‘great men’ are seductive” while “a central premise of business education is that leadership and management can be taught in the classroom”.
And yet, briefly put, the pair found no statistically significant evidence that MBA programmes produce CEOs who are better at running companies, if performance is measured by stock-price return.
Does a CEO's track record predict success?
Turning to the question of whether CEOs’ track records might predict success, even if their educational credentials do not, Rasmussen and Li find “little to no persistence in CEO performance from one company to the next”.
“The proportion of CEOs who continue to perform well is,” they add, “in line with what we would expect under random conditions.”
While Rasmussen and Li then move on to some pretty robust conclusions about the effectiveness of tying executive pay to stock price, here on The Value Perspective, we will just restate our original point.
Most company bosses (MBA or not) are neither geniuses nor fools – merely human – and so, instead of on them, we prefer to focus all our attention on their businesses’ balance sheets, debt and, above all, valuation.
The Value Perspective team
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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