Past performance does not guarantee future results. Every serious investor knows that to be true. And yet, we all tend to get a little full of ourselves when we’ve had a good run. The better and more sustained our performance, the more overconfident we’re likely to become. It’s human nature. And it goes way beyond investing.
Success is its own worst enemy. Success is self-limiting. It applies to everyone to varying degrees, most notably CEOs and business leaders of companies big and small. And while that concept may fly in the face of common management doctrine, it explains why so many formerly-successful executives end up destroying enormous amounts of shareholder value and personal wealth.
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Of course it doesn’t have to be that way. Avoiding the most common pitfall in business is not rocket science, but it’s not a walk in the park, either. It takes maturity, self-discipline, self-awareness and humility. And there’s a mountain of evidence to suggest that most successful executives and business leaders are sadly lacking in those qualities.
Let’s start with the facts. In a 10-year study of 1,500 corporations with the biggest market caps, three noted business school professors determined that CEO compensation, incentive pay and tenure were all negatively related to shareholder returns. The reason? Overconfidence leading to bad strategic decisions.
Think about that for a minute. The universal metrics for business success are compensation and longevity. That’s how boards let CEOs know they’re good at what they do: by offering them lucrative pay packages, tying compensation to stock performance, and keeping them in their jobs.
According to the research, the more evidence executives have of their success, the more likely they are to become overconfident. That in turn causes them to make high-risk strategic decisions based on their own overinflated self-image, decisions that are not in their company’s or even their own best interest.
I don’t cite studies often, but this research was well done and its conclusions inescapable.
More importantly, the data jives with decades of my own experience with CEOs and boards of dozens of companies from startups to those in the S&P 500. I’ve seen it time and again: The bigger their egos become, the more likely executives and business leaders are to indulge their own uninformed gut decisions and make big mistakes.
One chief executive and co-founder of a successful public technology company was so dogmatic about charging customers more for his new flagship microprocessor than Intel – the largest chip company in the world with 90% market share – that he nearly bankrupted the company before the board finally ousted him.
Another CEO and co-founder of an award-winning software startup thought he could do no wrong after a successful IPO. Then Microsoft entered the market. The company might have survived if the CEO hadn’t surrounded himself with cronies, yes-men and rubber-stamping board directors.
Perhaps the most telling story is that of a long-time successful executive who finally hit the jackpot when he was hired to run a Fortune 500 company in Silicon Valley. On a grandiose vision and a prayer, he took the company on a wild ride that included a high-risk merger and billions in losses.
The company was eventually acquired, but not before the CEO retired a wealthy man. Shareholders didn’t fare so well. On a side note, that same former CEO now sits on the board of another once-high-flying Silicon Valley company that has been floundering for many years. Interesting how the phenomenon perpetuates itself.
I can go on and on with story after story, each one unique in its own way but all with the same phenomenon at their core: formerly successful executives writing checks that reality can’t cash. Unfortunately, they’re always drawn on investor’s bank accounts.
There are, however, several solutions to the problem. First, there’s something to be said for boards keeping CEO tenure relatively short. The longer they sit on the corporate throne, the more likely they are to consolidate board power and surround themselves with directors and executives beholden to them.
Perhaps it’s time for boards to stop coveting highly successful executives and courting them with enormous compensation packages. They might be better off with upstarts that have a lot to prove and haven’t yet filled their own heads with hot air. Besides, as the research shows, pay for performance clearly does not work as intended.
Directors might also weigh behavioral factors such as maturity, self-discipline, self-awareness, and humility more heavily. In my experience, those qualities reflect individuals with feet planted firmly on the ground. A little success isn’t likely to cause their heads to float off into the clouds.
Keep in mind that the self-limiting aspect of success is not limited to corporate America. Small business owners beware. Also any organization that has no competitors where people can’t be fired – union-protected government bureaucrats and tenured university professors come to mind – is to me a far worse situation.
It may be costly to oust underperforming CEOs, but at least they can be fired.