Managing across the Corporate Life Cycle: CEOs and Stock Prices!

 

 

 One of the big news stories of last week
was Jack Dorsey stepping down as CEO of Twitter, and the market’s
response to that news was to push up Twitter’s stock price by almost
10%. That reaction suggested, at least for the moment, that investors
believed that Twitter would be better off without Dorsey running it, a
surprise to those in the founder-worship camp. As the debate starts
about whether Dorsey’s hand-picked successor, Parag Agrawal, is the
right person to guide Twitter through its next few years, I decided to
revisit a broader question of what it is that makes for a “great CEO”
and how there is no one right answer to that question, because it
depends on the company, and where it stands in its life cycle. In the
process, I will also look at the thorny issue of what happens when there
is a mismatch between a company and its CEO, either because the board
picks the wrong candidate for the job or because the company has changed
over time, and the CEO has not. Finally, I will use the framework to
look at the relationships between founders and their companies, and how
mishandling management transitions can have damaging, perhaps even
devastating, consequences for value.

The “Right” CEO: A Corporate Life Cycle Perspective

 
 The notion that there is a collection of characteristics that makes a
person a great CEO for a company, no matter what its standing, is deeply
held and fed into by both academics and practitioner. In this section, I
will begin by looking at the mythology behind this push, and why it
does not hold up to common sense questioning. 

The Mythology of the Great CEO

    Are
there a set of qualities that make for a great CEO? To answer the
question, I looked at two institutions, one academic and one
practice-oriented, that are deeply invested in that idea, and spend
considerable time advancing it. 

• The
  first is the Harvard Business School, where every student who enters
  the MBA program is treated as a CEO-in-waiting, notwithstanding the
  reality that there are too few openings to accommodate that ambition.
  The Harvard Business Review, over the years, has published multiple
  articles about the characteristics of the most successful CEOs, and this one for
  instance, highlights four characteristics that they share in common:
  (a) deciding with speed and conviction, (b) engaging for impact with
  employees and the outside world (c) adapting proactively to changing
  circumstances and (d) delivering reliably.
• The
  second is McKinsey, described by some as a CEO factory, because so many
  of its consultants go on to become CEOs of their client companies. In this article, McKinsey lists the mindsets and practices of the most successful CEOs in the following picture: 
  

The Corporate Life Cycle

    I
believe that the discussion of what makes for a great CEO is flawed for
a simple reason. There is no one template that works for all companies,
and one way to see why is to bring in the notion that companies go
through a life cycle, from start-ups (at birth) to maturity (middle age)
to decline (old age). At each stage of the life cycle, the focus in the
company changes, as do the qualities that top managers have to bring
for success:

Early
in the life cycle, as a company struggles to find traction with a
business idea that meets an unmet demand, you need a visionary as a CEO,
capable of thinking outside the box, and with the capacity to draw
employees and investors to that vision. In converting an idea to a
product or service, history suggests that pragmatism wins out over
purity of vision, as compromises have to be made on design, production
and marketing to convert an idea company into a business. As the
products/services offered by the company scale up, the capacity to build
businesses becomes front and center, as production facilities have to
be built, and supply chains put in place, critical for business success,
but clearly not as exciting as selling visions. Once the initial idea
has become a business success, the needs to keep scaling up may require
coming up with extensions of existing product lines or geographies to
grow, where an opportunistic, quick-acting CEO can make a difference. As
companies enter the late phases of middle age, the imperative will
shift from finding new markets to defending existing market share, in
what I think of the trench warfare phase of a company, where shoring up
moats takes priority over new product development. The most difficult
phase for a company is decline, as the company is dismantled and its
sells or shuts down its constituent parts, since any one who is put in
charge of this process has only pain to mete out, and bad press, to go
with it. Have you ever read a book or seen a movie about a CEO who
shrunk his or her company, where that person is painted as anything but a
villain? In fact, I used “Larry the Liquidator” as my moniker for that
CEO, to pay homage to one of my favorite movies of all time, “Other
People’s Money”:

   –

As
you watch the video, note that the CEO of the company, under activist
attack, is played by Gregory Peck (the distinguished gray-haired
gentleman who sits down at the start of the video), who presumably
embodies all the qualities that Harvard and McKinsey believe embody a
great CEO, and Danny DeVito plays “Larry the Liquidator”. Talk about
type casting, but this company needs more DeVito, less Peck!

Mismatches, Transitions and Turnover

    If
you buy into my structure of a corporate life cycle, and how the right
CEO for a company will change as the company ages, you can already see
the potential for mismatches between companies and CEOs, for three
reasons. 

• A Hiring Mistake:
  The first is that the board of directors for a company seeking a new
  CEO hires someone who is viewed by many as a successful CEO, but whose
  success came at a company at a very different stage in its life cycle. I
  think Uber dodged the bullet in 2017, when they decided not to hire Jeff Immelt as CEO for the company.
  Even if you had believed that Immelt was successful at his prior job as
  CEO for GE, and that is arguable, he would have been a horrifically bad
  choice as CEO at Uber, a company that is as different from GE as you
  can get, in every aspect, not just corporate age. 
• A Gamble on Rebirth: The
  second is when a board of director picks a mismatched CEO
  intentionally, with the hope that the CEO characteristics rub off on the
  company. This is often the case when you have a mature or declining
  company that thinks hiring a visionary as a CEO will lead to
  reincarnation as a growth company. While the impulse to become young
  again is understandable, the odds are against this gamble working,
  leaving the CEO tarnished and company worse off, in the aftermath. It
  was the reason that Yahoo! hired Marissa Mayer as a CEO in 2012, hoping
  that her success at Google would rub off on the company, an experiment that I argued would not end well for either party (and it did not).
• A Changing Business;
  The third is a more subtle problem, where a company is well matched to
  its CEO at a point in time, but then evolves across the life cycle, but
  the CEO does not. Using the Uber example again, Travis Kalatnick, a
  visionary and rule breaker, might have been the best match for Uber as a
  company, in early years, when it was disrupting a highly regulated
  business (taxi cabs), but even without his personal missteps,
  he was ill-suited to a company that faced a monumental task of
  converting a model built on acquiring new riders into one that generated
  profits in 2017.

In NY case, a CEO/company mismatch is a problem, though the consequences can range from benign to malignant. 

In
the most benign case, a mismatched CEO recognizes the mismatch, sets
ego aside and finds a partner or co-executive with the skills needed for
the company. In my view, and many of you may disagree with me, the
difference between the first iteration of Steve Jobs, where he let his
vision run riot and almost destroyed Apple as a company, and the second
iteration, where he led one of the most impressive corporate turnarounds
in history, was his choice of Tim Cook as his chief operating officer
in his second go-around and his willingness to delegate operating
authority. In short, Jobs was able to continue to put his visionary
skills to work, while Cook made sure that the promises Jobs made were
delivered as products on the ground. In the most malignant form, a badly
mismatched CEO is entrenched in his or her position, perhaps because
the board of directors has become a rubber stamp or by tilting voting
rules (shares with different voting rights) in favor of incumbency, and
continues on a pathway that takes the company to ruin. In the
intermediate case, the board of directors, perhaps with a push from
activist investors and large stockholders, engineers a CEO change,
albeit after some or a great deal of damage has been done.

The Compressed Life Cycle: Implications for Founder CEOs

 
  It is a testimonial to how much technology companies have changed the
economy and the market that some of the best-recognized names in
business are those of the founders of successful technology company. I
would wager that almost everyone has heard of Bill Gates, Jeff Bezos and
Elon Musk, and that very few would recognize the names of Mary Barra
(CEO of GM) or Darren Woods (CEO of Exxon Mobil). While there are some
who venerate these founders, in what can only be called founder worship,
there are others who have a more jaundiced view of them, both as human
beings and as CEOs. The corporate life cycle framework provides a
useful structure to think about how the technology companies, that
dominate the twenty first century business landscape, are different from
the manufacturing companies of the last century, and why these
differences can create more management tensions at these companies.

Aging in Dog Years?

    While
every company goes thought the process of starting up, aging and
eventually declining, the speed at which it does will vary depending on
the business it is in. More specifically, the more capital it takes to
enter a business and the more inertia there is among the existing
players (producers, customers) are, the longer it will take for a
company to get from start up to mature growth, but the same forces will
play out in reverse, allowing the company to stay mature for a lot
longer and decline a lot more gradual:

The
great companies of the twentieth century took decades to ramp up,
facing big infrastructure investments and long lags before expansion,
had long stints as mature firms, milking cash flows, before embarking on
long and mostly gradual declines. To illustrate, Sears and GE had
century-long runs as successful companies, before time and circumstances
caught up with them, and GM and Ford struggled for three decades
setting up manufacturing capacity and tweaking their product offerings,
before enjoying the fruits of their success. In contrast, consider
Yahoo!, a company that was founded in 1994, that managed to reach a
hundred billion in market capitalization by the turn of the century,
enjoyed a few years of dominance, before Google’s arrival and conquest
of the market, before finally being acquired by Verizon in 2017. This
compression of the life cycle has played out in tech company after tech
company and the graph below captures the difference:

Implications for Founder CEOs and Management Turnover

    Companies
have always had founders, and while the conflict between founders and
others in the company have been around for decades, the compressed life
cycle has exacerbated these tensions and magnified problems. In
particular, the research on founder CEOs has yielded two disparate
findings. The first is that in the early stages of companies, founder
CEOs either step down or are pushed out at much higher rates than in
more established companies. The second is that those founder CEOs who
nurse their companies to more established status, and to public
offerings, are more entrenched that their counterparts at mature
companies.

    To understand
the first phenomenon, i.e., the high displacement rate among founder
CEOs of very young companies, I will draw on the work of Noah Wasserman at Harvard Business
School who has focused intensively on this topic. Using data on top
management turnover at young firms, many of them non-public, he
concludes that almost 30% of CEOs at these firms are replaced within a
few years of inception, usually at the time of new product development
or fresh financing. Much of this phenomenon can be explained by venture
capitalists, with large stakes, pushing for change in these companies,
but a portion of it is voluntary, and to explain why a founder CEO might
willingly step down, Wasserman uses the concept of the founder’s dilemma,
where founders trade off full control of a much less valuable firm
(with themselves in control) for lesser control of a much more valuable
firm (with someone else at the helm). In the corporate life cycle
structure, it is a recognition on the part of founders or capital
providers that the skills needed to take a company forward require a
different person at the top of the organization, especially as a firm
transitions from one stage of the life cycle to the next.

    The founders who do manage to stay at the helm of companies that make it through to early growth status are
put on a pedestal, relative to CEOs of established companies. While
that may be understandable, in some cases, it can take the form of
founder worship, where founders are viewed as untouchable, and any
challenge to their authority is viewed as bad, leading to efforts to
change the rules of the game to prevent these challenges. In the United
States, where prior to 2004, it was unusual to see shares with different
voting rights in the same firm, it is now more the rule than the
exception in many tech companies. 

    Endowing
CEOs with increased powers to fend off challenges seems like a
particularly bad idea at tech companies, since their compressed life
cycles are likely to create more, rather than less, mismatches between
companies and their founder/CEOs, and sooner, rather than later. To see,
why consider how corporate governance played out at Ford, a twentieth
century corporate giant. Henry Ford, undoubtedly a visionary, but also a
crank on some dimensions, was Ford’s CEO from 1906 to 1945. His vision
of making automobiles affordable to the masses, with the Model T, was a
catalyst in Ford’s success, but by the end of his tenure in 1945, his
management style was already out of sync with the company. With Ford,
time and mortality solved the problem, and his grandson, Henry Ford II,
was a better custodian for the firms in the decades that followed. Put
simply, when a company lasts for a century, the progression of time
naturally takes care of mismatches and succession. In contrast, consider
how quickly Blackberry, as a company, soared, how short its stay at the
top was and how steep its descent was, as other companies entered the
smart phone business. Mike Lazaridis, one of the co-founders of the
company, and Jim Balsillie, the CEO he hired in 1992 to guide the
company, presided over both its soaring success, gaining accolades for
their management skills for doing so, and over its collapse, drawing
jeers from the same crowd. By the time, the change in top management
happened in 2012, it was viewed as too little, too late.

    In
my view, the next decade will bring forth more conflict, rooted in the
compressed life cycle of companies. If I were a case study writer, and
thank God I am not, I would not rush to write case studies or books
about successful tech company CEOs, because many of those same CEOs will
become case studies of failure within a few years. If I am an investor,
I would worry more than ever before about giving up voting power to
founder/CEOs, even if they are well regarded, because today’s star CEO
can become tomorrow’s problem. I wonder whether the way Facebook has
dealt with its privacy and related problems over the last few years
would have been different, if investors had not allowed Mark Zuckerberg
to effectively control 57% of the voting rights with less than 20% of
the outstanding shares. It is worth noting that Twitter was one of the
few social media companies that chose not to split its voting rights
across shares, and that may explain the Jack Dorsey departure.

• I
  have always liked Amazon, as a company, and one reason for that was
  Jeff Bezos. Many younger investors are surprised when I tell them that
  Bezos was not a household name for much of Amazon’s early rise, and that
  it was The Washington Post acquisition in 2013 that brought him into
  public view. One reason that I attached lofty values to Amazon as a
  company, even when it was a tiny, money-losing company was that Bezos
  not only told the same story, one that I described as Field of Dreams story,
  where if you build it (revenues), they (profits) will come. but acted
  consistently with that story. He built a management team that believed
  that story and trusted them to make big decisions for the company, thus
  easing the transition from small, online book retailer to one of the
  largest companies in the world. It is a testimonial to Bezos’ success in
  transitioning management that Amazon’s value as a company today would
  be close to the same, with or without him at the helm, explaining why the announcement that he was stepping down as CEO on July 5 created almost no impact on the stock price.
• I valued Twitter for the first time,
  just ahead of its IPO in 2013, and built a model premised on the
  assumption that the company would find a way to monetize its larger user
  base and build a consistently money-making enterprise. In the years
  since, I have been frustrated by its inability to make that happen, and in this post in 2015,
  I laid the blame at least partially at the feet of Twitter’s
  management, contrasting its failure to Facebook’s success. I don’t know
  Jack Dorsey, and I wish him well, but in my view, his skill set seemed
  ill suited to what Twitter needed to succeed as a business, especially
  as he was splitting his time as Square’s CEO, and talking about taking a
  six-month break in Africa.
   In fact, eight years after going public, Twitter’s strongest suit
  remains that it has lots of users, but its capacity to make money of
  these users is still questionable. One reason why the market responded
  so positively, jumping 10% on the news
  that Dorsey was leaving, is indicative of the relief that change was
  coming, and the reason that it has fallen back is that it is not clear
  that Parag Agrawal has what the company needs now. He has time to prove
  investors wrong, but he is on probation, as investors look to him to
  reframe Twitter’s narrative and start delivering results.
• A few weeks ago, I valued one of India’s new unicorns, Paytm,
  an online payment processing company built on the promise of a huge and
  growing online payment market in India. In my valuation, I told an
  uplifting story of a company that would not only continue to grow its
  user base and services, but also that it would increase its take rate
  (converting users to revenues) and benefit from economies of scale to
  become profitable over the course of the next decade.
  

  I valued Paytm at about ₹2,200,
  but in telling that story, I noted one big area of concern with
  existing management, that seemed to be more intent on adding users and
  services than on converting them into revenues, and pre-disposed to
  grandiosity in its statement of purpose and forecasts. In the months
  since, the company has gone public, and while the offering price, at ₹2150, was close to my value, the stock price collapsed in the days after to less than ₹1400 and has languished at about ₹1600-₹1700
  since. It is always dangerous to try to explain why markets do what
  they do over short periods, but I do think that the company’s founders
  and spokespeople did not do themselves any favors, ahead of the IPO.
  Specifically, if you were concerned about Vijay Sharma’s capacity to
  convert the promise of Paytm into eventual profits, before the IPO, you
  would have been even more concerned after listening to him in the days
  leading into the IPO. It is still too early to conclude that there is a
  company/CEO mismatch, but if I were top management of the firm, I would
  talk less about users and gross merchandise value, and focus more on
  improving the abysmally low take rate at the firm.