As much as people may praise great CEOs like Steve Jobs, it’s not at all clear that having a strong CEO is a good thing for most companies. Many studies find that strong CEOs result in lower firm value, and others show that strong CEOs take their companies to the top or bottom of the pile, with weaker CEOs turning in moderate performance. It’s not a purely academic matter either, knowing when strong CEOs are most effective could impact the way directors and shareholders behave.
“Unconditional measures of CEO power show a negative relation with firm value,” write Minwen Li and Yao Lu at Tsinghua University and Gordon Phillips at University of Southern California and the NBER, write on the Harvard Law School blog. “However, the interaction terms between CEO power variables and our measures of product market conditions are significantly positive, suggesting that the product markets with high fluidity, demand shocks and competition make CEO power more beneficial.”
Fluid situations favor strong CEOs
In their paper, CEOs and the Product Market: When are Powerful CEOs Beneficial, the researchers look for markets where there is a lot of fluidity (product offerings turnover quickly), where demand is changing quickly, or where the amount of competition that a company must face is increasing. They then compared that to explicit and ‘soft’ measures of CEO power (particularly whether the CEO had a hand in appointing many of his fellow C-level execs or directors).
They find, as in previous studies, that most of the time it doesn’t pay to have a strong CEO, but they also found that companies with strong CEOs outperform in highly fluid situations. They interpret this to mean that when market conditions are changing quickly, a company needs strong leadership that can adapt without missing a beat.
Companies may just need better capital allocation skills at the board level
They also found that strong CEOs spend a lot more on capex and advertising when faced with changing conditions and a competitive market, which suggests another possible interpretation for their results. It could simply be that the companies who spend more to take advantage of the opportunities do better than those who focus on controlling costs. If strong CEOs are biased in their capital allocation strategies, and those strategies work well under certain market conditions, that seems like an argument in favor of finding board members with experience in capital allocation.
See full study here.