Yahoo Finance When Superstar Executives Become a Company Liability
Superstar executives may generate buzz for their companies, but not all press is good press when it comes to boosting share prices. Recent reports of a falling-out between Bill Gross, co-founder of Pacific Investment Management Co, and Mohamed El-Erian, the firm's former CEO, underscore the pitfalls of a having a superstar like Gross at the helm. In February, just before El-Erian's exit from Pimco, The Wall Street Journal reported on the difficult working relationship between Gross and El-Erian. Making matters worse, Gross told Reuters that El-Erian was trying to undermine him by talking to the Journal. Following El-Erian's March departure from the $2 trillion asset manager, fund tracker Morningstar penned an in-depth analysis of Pimco's culture and brought its stewardship grade down from a B to a C. Morningstar also lowered its "Parent Pillar" score, an indicator used to analyze mutual fund firms, from positive to neutral.
Stewardship affects performance, according to a March 2014 survey by Morningstar, which found that firms with the highest manager retention, manager tenure and ownership of mutual fund shares had higher success ratios and Morningstar ratings, on average.
It turns out that the same traits that lead entrepreneurs and innovators like Gross to brainstorm great ideas often undermine them as managers, according to "The Dark Side of Entrepreneurship," a 1985 research paper by Manfred F.R. Kets de Vries. "Many entrepreneurs have a need for control and are suspicious about authority," he wrote. "Hence, they find it very difficult to work with others in a structured situation where they are not in control ... Offering the deference needed of a subordinate is difficult."
Other possible problem traits, according to Kets de Vries, include obsessive attention to detail, anticipation of the worst and losing sight of the reality of situations.
[See: 10 Risky Investments Billionaires Can't Resist.]
The problem with brilliance. Nicholas Bloom, an economist at Stanford University, says firms with founders as CEOs and presidents tend to be badly managed, which is why companies long managed by founders often experience stock appreciation once the founder steps down.
"In the case of Pimco, Apple or Berkshire Hathaway, these are firms created by brilliant geniuses, but often these characters are not great managers. They are inspired at business decisions and planning, but on average are moderate at best at broader day-to-day management," Bloom says. "... So it is no surprise these creative geniuses fall out with their heir apparents on a regular basis."
A paper Bloom co-authored asserted that while founder-owned firms and government-owned firms are usually poorly managed, multinational, dispersed shareholder and private-equity owned firms are typically well managed.
Jason Schloetzer, an assistant professor at Georgetown University who teaches courses on management accounting and performance measurement, says some superstar executives bring mixed attention to the companies they represent, including real estate mogul Donald Trump.
Power plays. Whether they are positive influences on their companies or not, many founder executives' grip on power is difficult to break, Schloetzer says. He cites the example of Howard Schultz, who founded Starbucks Corporation in 1985 and served as CEO from 1987 to 2000. In 2007, while serving as board chairman, Schultz sent internal memos disapproving of then-CEO Jim Donald's actions. Schultz became CEO once again in 2008, replacing Donald.
In cases where other top executives and shareholders want to push a celebrity executive out of power, Schloetzer says many companies will simply move the CEO to the board, a change he calls more symbolic than structural. "There are some instances in which founders know when to step aside when the news turns from positive to negative, and others just continue to hang on. From a public company perspective, the board of directors needs to be strong," Schloetzer says. "A celebrity CEO [or founder] has a lot of bargaining power over the board."
[Read: 10 Tips For Retiring Entrepreneurs.]
Activist investors including Carl Icahn, David Einhorn and Bill Ackman have become ardent foes of celebrity executives in recent years and may be one of the few effective catalysts for change in executive leadership, Schloetzer says. In 2011, for example, Ackman, who was then JC Penney's largest shareholder, pushed out CEO Myron Ullman in favor of a chief executive who could offer a bold new approach, Ron Johnson. Johnson failed to understand the company's core customers, however, and after revenue fell, he left and Ullman returned. And in May 2013, Occidental Petroleum Corp. Chairman and Chief Executive Ray Irani left the company after more than two decades at the helm when investors voted en masse to remove him.
Activist investors may be the only route to oust a CEO or president, as the board may be reluctant to vote against the executive. The goals of the investor and the board may not align. Investors may be looking for short-term returns, which may lead them to flee when events occur that could negatively affect stock prices, such as a CEO acting irresponsibly. The board, on the other hand, may be looking at the long-term rewards of keeping the executive if he or she has historically provided good results for the company.
Performance perspective. New research shows that CEOs have a greater effect on a company's success (or failure) than previously thought. According to a 2013 study by Donald Hambrick and Timothy Quigley published in Strategic Management Journal, 38 percent of variance in a firm's return on assets can be attributed to its CEO. The researchers considered the 1,500 largest U.S. corporations and excluded CEOs who served one year or less as well as those who served for more than 20 years.
Also, the direct impact of CEOs on profits seems to be increasing over time. In a separate paper, Hambrick and Quigley examined three periods: 1950 to 1969, 1970 to 1989 and 1990 to 2009. The effect CEOs had on return on sales increased 4.1 percent in the first period, 10.9 percent in the second period and 16.2 percent in the third period.
From an investor's point of view, the power of a well-known founding executive depends on the role of that CEO and how he or she engages with the press. Charley Polachi, managing partner of Polachi Access Executive Search, has recruited C-suite talent for more than 30 years and says that although Steve Jobs was a major force of innovation at Apple, Tim Cook is clearly the better executive.
"Tim Cook is a better CEO, and he knows how to run a company," Polachi says, adding that Cook's early career at large companies like IBM and Compaq as well as his educational background prepared him for this role. "He had great training and an MBA from Duke, whereas Jobs never had that. Jobs was a leader who used the power of persuasion, and Cook was a manager who could orchestrate things. He's a deliberate, process-oriented person."
Pimco fallout. Turmoil in the upper ranks of the staid bond world may be troubling for investors. Shares of Allianz, the German insurer that owns Pimco, have fallen 6.73 percent in the past month.
Eric Jacobson, senior fund analyst at Morningstar, discussed Pimco's future in a March 19 conference call. Although Morningstar lowered Pimco's stewardship rating, the company reaffirmed its gold rating for the flagship Pimco Total Return Fund. Regarding leadership at Pimco post-El-Erian, Jacobson said he expects the succession plan for Gross will begin once management starts grooming deputy chief investment officers.
[Read: Should Managers Invest in Their Own Mutual Funds?]
When asked how Gross' management style might change after the controversies following El-Erian's departure, Jacobsen said that although Gross does not see the recent shake-up as a crisis, "There is a recognition on his part that culturally things were not what he wishes they were ... The bottom line is that's he's becoming more introspective than in the past. It's difficult to tell if it will be sustained. He may decide at some point that he's done x, y and z, and he doesn't want to do any more of that."
Gross will likely delegate more responsibilities to the deputy CIOs, Jacobson said, since he relied on El-Erian to handle communication with lieutenants and address concerns from subordinates as well as other duties. The deputy CIOs will oversee portfolio managers and head committee meetings in a rotation, spreading out many of the duties that once belonged to El-Erian. Jacobson said it is unlikely Pimco will announce a succession plan until Gross leaves the company.
"[Gross] likes to sit at his desk and do research, do email and not interact with people so much," Jacobson said in the conference call. "The flip side of the negative stuff that's been said is that he has a very keen focus, and that is one reason that I think he has never wanted to be CEO. He thinks of himself as an investor first."
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