774
n
Gods and villains
responded to the CEO receiving an award. Initially, the stock
market (and, importantly, its share price graph) made a little
jump of joy (of about a quarter of a percent). However, for the
average rm, after a few days, the share price started decreasing,
and it kept decreasing for months. After about eight months,
the stock market rated the rms of award winners more than
8 percent lower than the unlauded CEOs’ shops. Eight percent!
For a billion-dollar company, this basically means that your CEO
getting a medal knocks 80 million bucks off your rm’s value!
That’s one mighty expensive medal.
How come the effects of receiving an accolade can be so
negative? I guess it is all about expectations. Recall that the initial
effects – both in terms of the CEO’s remuneration and in terms
of the stock-market response – were positive. But after a while
they turned nasty; if the CEO couldn’t meet the heightened
expectations, the stock market especially responded with disap-
pointment, and shareholders voted with their feet. And Jim’s
research shows that the average CEO could not live up to the
expectations.
Awards may heighten a CEO’s pay check and make the stock
market buzz with anticipation, but they also heighten expecta-
tions; if these expectations are not met, the award will come back
to haunt you. And I am sure that is not what they had in mind
when the cameras ashed while they proudly accepted the prized
medal at their black-tie Manhattan dinner.
Successful managers – incompetent for sure
One could doubt whether our celebrity CEOs really outperform
their more anonymous counterparts; certainly there is no
evidence to suggest that they do any better. Some would even go
a step further, and boldly argue where no-one has argued before,
namely that the highest-performing CEOs are also the dumbest
of all . . . Let me explain:
The world of business is risky. That’s inevitable. We can analyze all
we want, plan, debate, gather information and think it through
Business Exposed78
till it gives us a migraine, but sometimes
things just don’t work out and nobody could
have foreseen it.
So what makes for a good risk manager?
Well, it is someone who carefully chooses
the best odds. He will sometimes win, and
sometimes lose. But, he will always make deliberate and careful
trade-offs between his assessment of risk and return: the most
expected return for the least risk. Sometimes good managers
accept a low return when it is safe (like buying government
bonds); sometimes they accept a lot more risk in return for a
higher expected return (like investing in the stock market).
Bad managers are those people who just don’t get it. They accept
worse average returns for higher risks. Clearly that’s dumb. But
it is also where it gets tricky. Because if they accept very high
risks, in spite of lower average returns, every once in a while one
of these morons will actually hit the jackpot . . .* That is, if we
take the top one percent of top performers, they’re likely to be
those people who didn’t get it at all . . . but just got incredibly
lucky!
The same is true – as Stanford’s Professor Jim March asserted –
for CEOs. The ones that are the eye-catching top performers are
likely the ones who just don’t get it. The dangerous thing is that
they are also the ones with the absolute highest return in their
business. Therefore we naïvely believe that they “do get it” and,
in fact, are quite brilliant. Moreover, that’s what they start to
believe as well (“I win again; I must be brilliant!”). Yes, they got
lucky once, they might get lucky twice, or three times (at which
point we start to notice them) but eventually their luck will turn
(Bernard Tapie, Jeff Skilling, Cees van der Hoeven, and Conrad
Black come to mind).
* In statistical terms, good managers have a normal distribution around
a relatively high average; bad managers have a lower average return but a
distribution with “fat tails”. Consequently, because of the long right-hand tail, the
top performers stem from the “bad managers” distribution/pool.
‘‘
The world
of business is
risky. That’s
inevitable.
’’
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