With Apple's (Nasdaq:AAPL) near-legendary CEO Steve Jobs heading back to semi-retirement and Hewlett-Packard (NYSE:HPQ) recently changing the name on the door of the executive suite once again, the quality of executive management is a hot topic. Time and time again, the markets have proven that even companies in low-growth or commodity industries can offer winning stocks on the basis of exceptional management. Likewise, the markets have shown that few stocks can thrive for the long term with suboptimal leadership. (For some ways a CEO can help improve a company, check out Management Strategies From A Top CEO.)
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What, then, goes into making a CEO and how does he or she build value for shareholders?
The Traits of Highly Effective CEOs
Unfortunately, there are no objective quantifiable markers of a good CEO. Great CEOs have come from the Ivy League and from Nowhere State. Likewise, good CEOs have had deep backgrounds in a single industry or wide-ranging careers across many functions and sectors. Nevertheless, a few key traits seem to come up over and over again.
Arguably nothing is more important to a company than a CEO who understands both the market today and where it will be tomorrow. There is a famous quote from Walter Gretzky, father of hockey legend Wayne Gretzky, that goes "skate where the puck is going, not where it's been," and CEOs would do well to take this to heart. Bill Gates understood the potential of the PC before many others, just as Steve Jobs understood the potential of mobile computing, and those visions helped build their respective companies. Consequently, this is a key CEO trait and a key component of long-term success. For companies to stay strong, it is vital to understand what the customer is going to want in future, maybe even before the customer knows it.
Execution and Organization
CEOs do almost nothing on their own. Warren Buffett does not quote rates for Berkshire Hathaway's (NYSE:BRK.A) insurance businesses and McDonald's' (NYSE:MCD) CEO isn't slaving away over a grill. What makes for a successful company is the ability to identify quality managers at all levels of the organization. CEOs have to find quality vice presidents, those vice presidents have to find quality managers and those managers have to find good workers.
A corporate organization has to be functional and efficient. Multiple layers of bureaucracy can slow things to a crawl, demotivate employees and quash new ideas. Likewise, there has to be accountability and execution at all levels. Good CEOs build good organizations, populate them with good people and then make sure the right incentive structures are in place to keep it all moving forward. (To help spot poor moves from a CEO, read Pages From The Bad CEO Playbook.)
Candor, with Compassion and Pragmatism
Arguably the most important attribute of a CEO, beyond his or her own integrity, is a sensitive "BS meter" regarding everyone else's integrity. CEOs need to know when they're dealing with suppliers, customers or co-workers who cannot (or will not) deliver what is expected of them. Along the same lines, while a CEO needs to be demanding and expect high standards to be achieved, he or she cannot be so harsh or volatile that underlings prefer to lie than deliver bad news.
Likewise, successful CEOs do not rely upon mass-firings to cover up their own mistakes. Sometimes there is no choice but to close an under-performing business and fire the workers, but all too many CEOs curry favor with Wall Street (and their board of directors) by large-scale firings aimed at momentarily boosting margins - all without a hint of irony that it is often the same CEO who boldly pushed the company to hire those workers to fulfill his or her "growth strategy."
How CEOs Build Value
Right Markets, Right Times
A good CEO should be able to build value in any industry, but long-term value creation is preconditioned on a healthy underlying market. IBM (NYSE:IBM) saw the future of mainframe computing (and then PC computing) and made sure that it was ready to enter more promising markets like storage and IT services. Likewise, DuPont (NYSE:DFT) has a long tradition of developing new markets and then leaving them behind (or deprioritizing them) as they transition from growth to cyclical growth.
Driving Hard Bargains, but Not Too Hard
Here again there is a delicate balance - a balance that the best CEOs seem to intuitively understand. It is important to be efficient and to be a hard negotiator. At the same time, long-term corporate success is predicated upon hiring good people and keeping them motivated to continue working hard. Fear motivates for a while, but eventually quality workers tire of the stick and leave the company in search of an employer that will give them carrots instead.
Along similar lines, good CEOs understand that their companies are part of a food-chain and it is difficult to succeed by beggaring partners. Companies like Apple, McDonald's and Wal-Mart (NYSE:WMT) demand a lot from their suppliers, but they don't look to put them out of business. Put differently, a good CEO understands that a cow can be milked for years, but can only offer up steaks once. (For more on CEO that made a difference, see CEOs Who Blazed The Trail (Kroc, Hock And Welch).)
Managing for the Future, Not the Mirror
Quality CEOs generate above-average returns on capital, something that comes about largely from strong margins (an efficient operating structure and strong brands) and efficient use of capital. Often this means running a lean, efficient structure that is no bigger than it has to be and having a CEO who is willing to jettison businesses that do not (and cannot) earn a satisfactory return on capital.
That seems obvious, but it is difficult in practice. Most CEOs have big egos, but you have to have a healthy ego to want the responsibility of that job and withstand the challenges. In lesser CEOs, that ego can manifest as a drive to run as big of a company as possible - with bigger taking the place of "better." Many CEOs regard their employer as "their company" and run it like a medieval lord would run a fief, and not as an employee running a business on behalf of shareholders. Likewise, a CEO who cares more about being named to industry "roundtables" or showing up regularly on CNBC is likely managing for the mirror and not for the shareholders.
The Bottom Line
Unfortunately, there are few inarguable quantifiable ways to evaluate CEOs, and what few ways exist are almost always backwards-looking statistics like return on capital. Still, shareholders can listen carefully to how CEOs communicate with them, monitor the types of decisions the CEO has made in the past and evaluate whether the company operates a sustainable model - not wasting money or capital on vanity projects or unsalvageable businesses, but not stinting on research or fair compensation. As few things are more important in the long-term success of a company than quality management, it is very much worth an investor's time to do thorough due diligence on a CEO and the vision he or she has for their enterprise. (To learn more about the relationship a CEO has with the stock price of the company, check out CEO Savvy And Stock's Success Go Hand In Hand.)
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