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Jos Antonio Marco-Izquierdo
Benjamin Graham, the father of value investing, seldom met the managers of the
companies he invested in because he felt they would tell him only what they
wished him to hear and because he didn t want to be influenced by impressions
of personality. His talented student, the legendary Warren Buffet, thought the
same: when management with a reputation for brilliance tackles a business with
a reputation for bad economics, it is the reputation of the business that
remains intact.
Value investors like Graham and Buffett believe that the sources of sustainable
returns on capital are not a company s human assets but their so-called
economic moats, structural, durable competitive advantages around revenues or
costs. Revenue moats are usually linked to intangible assets (including brands
and patents), high switching costs, and network economies. Cost moats are
linked to the ownership of cheaper or faster processes, favorable locations,
unique assets, or firm size. In some cases, companies moats have enabled them
to survive multiple technology disruptions and industry shifts over time,
making their founders some of richest people in the world: think Bill Gates,
Carlos Slim, Amancio Ortega, and Larry Ellison.
There s an interesting fact about companies with these kinds of moats or
competitive advantages that often gets overlooked: the turnover rate of CEOs
among the S&P as a whole is between ten and twenty times higher than in the big
entrepreneurial successes of the past few decades. A case in point is Inditex,
founded in 1963 and now the biggest fashion group in the world, which has only
had two CEOs succeed founder Amancio Ortega. By contrast, Germany s Deutsche
Bank, which has suffered from years of poor performance, has had three CEOs in
the last five years, none of whom has done much to improve performance despite
their glittering CVs in the sector.
This raises a basic question: can a CEO with the best track record imaginable
turn around a poorly performing company? According to MIT economist Antoinette
Schoar the answer is yes roughly 60% of the time, which is not that much better
than the odds of getting heads on a coin toss.
Chicago s Steve Kaplan s findings on the difference that managers can make are
even more sobering. He studied the relative importance of management teams in
106 venture capital-financed firms from early business plan to IPO. He found
that although 50% of venture capital investors described the management team as
the most important factor at the business plan stage, this emphasis had dropped
markedly by the IPO stage. He concluded that non-human assets i.e., their
moats were ultimately more important to firms than human assets, with their
relative importance increasing over time. The implications are clear: first
choose the right industry and company, then pick the right management. If the
managers don t perform, they can be swapped out much more easily than the basic
business idea or industry.
Of course, in a highly competitive world, even a slim advantage is better than
a coin-toss. So is there something different about the managers who do succeed?
Let s go back to Steve Kaplan, who has also studied how and why CEOs matter,
relating their features to hiring and firm performance.
His detailed assessments of over 300 CEO candidates in private equity-funded
companies suggest that CEOs with execution strengths ( efficiency ,
organization and planning , attention to detail , persistence , proactive ,
sets high standards , etc.) perform better than CEOs whose softer skills such
as team building or listening dominate. This finding is a ringing modern
confirmation of what Peter Drucker was telling us in 1967 about what makes
executives effective.
If all this is true, then the high CEO turnover you see at many public
companies is not a symptom of poor management. It suggests a deeper problem,
which is that the companies in question simply don t have a competitive
advantage and are simply engaged in a lottery, hoping to find a CEO who can
find one. The odds aren t favorable.
Jos Antonio Marco-Izquierdo is a partner at Magnum Industrial Partners, a
private equity firm focusing on investments in Spain and Portugal.