Aug. 24, 2010
When companies go out of business, their leaders often blame something other than their own performance for the failure. Lehman Bros.’s CEO Richard Fuld said his immense compensation package had nothing to do with his firm’s death in 2008.
Ken Lay and Jeffrey Skilling blamed an angry short seller in Florida for bringing down Enron.
And a parade of CEOs has for decades claimed the economy and outside pressures were responsible for General Motors’ difficulties, not poor leadership or a broken culture.
But a new study by a University of Iowa business professor suggests that when a company goes under, it’s more often than not the result of bad business decisions by its leadership. CEOs, he said, are more than just scapegoats.
"We found that managers of failed firms are less skilled than their peers and the consequences of their incompetence are economically significant," said Tyler Leverty, assistant professor of finance in the Tippie College of Business. "We conclude that yes, managers do matter when companies fail."
In his paper, "Dupes or Incompetents: An Examination of Management’s Impact on Firm Distress," Leverty and his co-author Martin Grace of Georgia State University, look to find in what ways bad leadership hurts a company. The conventional wisdom is that CEOs largely think alike, and given a set of circumstances, will act in mostly similar ways.
But Leverty’s research suggests otherwise and found that some CEOs significantly improve a firm’s performance, while others hurt it.
The researchers looked at property-casualty liability insurance companies to see how CEO decisions affected firm performance. The industry was particularly useful, Leverty said, in part because it is a risk-intense business even in good times, so a firm’s performance is less tied to the whims of the economy. Insurance is also heavily regulated, so one measure of a CEO’s effectiveness was how often he managed to keep his firm off the regulatory radar, and if there, how quickly they removed it from scrutiny.
It also provided a good laboratory because CEOs within the industry move around a lot, so researchers can in many instances directly compare a leader’s performance with one company to another.
In all, they looked at the performance of 12,000 insurance companies’ between 1989 and 2000, with about 2,000 observations having CEO overlap. The study measured how quickly CEOs were able to remove their firms from regulatory scrutiny, whether management quality reduces the likelihood a firm becomes insolvent, and whether ability influences the cost of insolvency in a firm that does go out of business.
Leverty used what he considered a very basic and conservative definition of management quality—does a CEO use capital and labor in the right proportion? Does the CEO minimize firm costs, maximize revenues, operate efficiently and use technology effectively? For instance, if a company spends more than a similarly sized competitor but shows poorer performance, the researchers chalked that up to a lack of management skill.
"An inefficiency is a manager’s fault," he said. "They should identify it and fix it."
He found plenty of evidence that good managers matter. For instance, good CEOs can remove their firms from regulatory scrutiny 8 to 16 percent faster than a poor manager. And in insurance companies that are going out of business, a more talented CEO can get a better return on the firm’s assets by up to 10 cents on the dollar.
STORY SOURCE: University of Iowa News Services, 300 Plaza Centre One, Suite 371, Iowa City, Iowa 52242-2500
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