Chief executives are being fired more frequently, and sooner into their reigns, than ever before. These dismissals are harsh short-term decisions.
The first half of the paradox is that managements are supposed to be thinking, planning and acting on the basis of long-term aims. The second half of the paradox lies in this heavy reliance on an individual, the CEO, in an age when power and responsibility are supposed to be devolved down the line, and when management is seen as a group activity to which team work is fundamental.
A bad CEO cannot be solely to blame for bad results. So why exactly did the boards of Mattel, Lucent, Newell Rubbermaid, Campbell Soup, Coca-Cola, Gillette, Procter & Gamble, Maytag and Xerox oust their CEOs after tenures ranging from a mere thirteen months to three years? Part of the answer is that all these companies were widely admired successes.
The Problem of an Encore
The responsibility for failure must be shared by the boards in all these examples. They all made the fatal mistake of leaving the Encore Problem ("What do we do for an encore?") completely to the new CEO.
Boards are eager to gratify the stock market with a soaring share price (which also brings welcome uplift to stock options). However, they take actions that undermine the only reliable foundation for share price growth. That is a strong and credible long-term strategy.
Embarking on a takeover binge, for instance, is an excellent way of undermining a share price. Yet boards are always voting in favour of deals that are all but guaranteed to weaken the shares for good.
In a very convincing manner, Warren Buffett, by far the most successful acquirer of the last hundred years, has explained the failures of other buyers. His own purchases have followed a basic formula. He has only looked for targets that are large enough to be worth the trouble (as should you). They must also fulfil six criteria:
- To demonstrate consistent earning power.
- To earn good returns on equity.
- To have little or no debt.
- To have good management in place.
- To are simple businesses.
- To be available at a known price.
Instead of studying past records, most CEOs look at projections of future earnings: "of little interest to us", says Buffett, who cares just as little for turning round companies in trouble.
Buffett is just as averse to over-paying for a whole business as for a block of shares. The failures are often so indifferent to the price that they (or rather the shareholders) will pay that they not only make the first approach, but are the ones who name a price. They may well raise that price, at times more than once, in order to secure the deal.
Buffett has observed a recurrent phenomenon in the 20 or so companies of which he has been a director down the years: "The conversation turns to acquisitions and mergers much more" when competitors are on the warpath - especially in buoyant stock market conditions. These encourage companies to pay for their purchases in shares, and Buffett is firmly opposed to this.
As he argues, the purchased company will probably change hands at the full intrinsic value of the business - at the very least. The purchaser's shares, however, will be valued at market, which may be a lot less than the intrinsic worth of the business.
Buffett's views are so renowned that Coca-Cola's recent attempt to buy Quaker Oats came as a great surprise. Buffett both sits on the board and speaks for a major slice of the equity. The new chief, David Daft, had good reason to want Quaker: its Gatorade sports drink has a Coke-like hold over the market, and Pepsico, the arch-rival, had already made an offer. However, Buffett snubbed Daft and vetoed the acquisition as neither of these arguments fitted Buffett's criteria.
There was a particularly curious pattern at Campbell, as at Xerox, P&G, Maytag, Lucent and Rubbermaid. The displaced CEOs were mostly outsiders, and were all replaced by the men who had retired in their favour.
This is an awful failure in succession policy - and that is surely one of the prime responsibilities of the CEO, acting in close collaboration with his board. So the return of the retired heroes is particularly grotesque. If they had performed very well during their tenure, the subsequent disasters would never have happened.
The task should be clearly defined, the performance criteria are agreed, and the appointee's plans for carrying out the mission are agreed and regularly assessed. The CEO should be named only after satisfying six criteria:
- Has the candidate shown consistent ability to raise earning?
- Do those earnings represent a worthwhile return on equity?
- Has the candidate demonstrated the ability to optimise the generation of cash?
- Has he or she put good management in place throughout the organisation?
- Does the candidate follow the KISS principle: "Keep It Simple, Stupid".
- Have the candidate's investments consistently generated an economic value higher than their cost?
It should always be simpler to make these judgments about an insider than an outsider. Yet according to Watson Wyatt, the percentage of American CEOs recruited from outside rose from 11 per cent to 20 per cent between 1990 and 1999. Is it a coincidence that over this decade, so says Drake Beam Morin, a third of CEOs taken on at 450 major corporations lasted no more than three years?
Indeed, a fourth of the companies used up three CEOs in the period. Those boards were not doing their job - and if that job is not being done properly, the would-be hero at the summit must also fail.