Audiences for Leadership Capital Insights

The insights from this book should prove useful for stakeholders committed to understanding leadership and value: investors, rating firms, proxy advisory firms, boards of directors, senior executives, and HR and leadership specialists.

INVESTORS

The primary audience for this book is investors looking to value the quality of a company’s leadership. Interested investors include equity and debt investors, long-term and short-term investors, and relational and transactional investors. Investors who value and assess the quality of leadership will make more informed decisions about the future value of a company. Most thoughtful investors recognize that leadership matters, but they are not clear on how to rigorously assess leadership.

A major private equity group held an annual conference for the CEOs of companies it had acquired, where it would share advice on what these independent CEOs should focus on in the next year. In 2009, soon after the market collapse, this conference focused for two days on leadership. The group executives had discovered that it often took five to seven years to turn around a distressed company—and that in 60% to 70% of the cases, the biggest challenge was the quality of leadership. Often the leaders who’d gotten the company into a position where it was purchased by the private equity group were not able to make the bold changes needed to turn around and transform their company to prepare it to be repositioned in the marketplace. The group leaders felt that if they could prepare acquired-firm leaders to be more capable, they could turn the companies faster. The group decided to hire a talent czar, someone who could assess leadership talent in companies likely to be acquired and then develop leadership in acquired companies to be better able to transform their company and prepare it to be resold. These private equity investors recognized that leadership mattered—and that they were not in a position to perform thoughtful or thorough assessments of leadership. So they retained a specialist to do so.

As this private equity group recognized, valuing leadership comes from and extends the work on intangibles. Two firms in the same industry with the same financial results may have dramatically different market valuation. This differentiated market valuation is often attributed to intangibles, which show up in business by boosting—or undercutting —investors' confidence in a firm’s performance. Leaders architect intangible value. When investors accurately assess leadership, they are indirectly but accurately assessing the future intangible value of a firm. Thus investing in leadership capital may result in a leadership premium or discount, depending on the outcome of the assessment.

RATING FIRMS

Standard & Poor’s (S&P), Moody’s, and Fitch issue about 95% of the creditworthiness ratings based on their view of a company’s ability to pay back its debt. Credit rating has been a staple of measuring firm financial performance since the early 1900s, and a firm’s credit rating influences both its cost of capital and its ability to access capital. While critics sometimes challenge the details of risk assessments, these ratings continue to have great influence.

Just as credit ratings reflect the likelihood of continued financial effectiveness, a leadership capital rating could be created to reflect the likelihood of leaders' making the right choices to drive firm performance. If universally accepted, a leadership capital index would have implications for numerous stakeholders. For example, in 2011, S&P very publicly downgraded U.S. securities from AAA to AA because of the budget deficit and rising debt burden. This downgrade influenced borrowing costs for the U.S. government, companies, and consumers. However, the underlying reason for this downgrade was not just the debt burden itself but the inability of leaders in Congress to collaborate well enough to face and solve the deficit problem. A leadership capital index that assesses the quality of leadership would complement a report on the symptom (debt burden and ability to repay), but go beyond it to assess the underlying problem (quality of leadership).

Likewise, in the 2008–2010 recession, many Western banks were "bailed out” by government support. The problem with this metaphor is that bailing water out of a boat only relieves the symptom. If the hole in the boat is not fixed, water will keep leaking in. The "hole in the boat” may be defined as poor leadership. Unless and until leaders behave differently, similar results will occur. Even after financial bailouts, leaders who spent excessively at executive retreats or on executive compensation continued to place their firms at risk. To avoid future bank risks, regulators formed bank stress tests that focused on risky assets, balance sheet quality, and the amount of capital on hold. Unfortunately, none of the bank stress tests in the United States (by the Federal Reserve Board), Asia (by the International Monetary Fund), or Europe (by the European Banking Authority) include an assessment of leadership. Perhaps this is why financial stress tests are somewhat discounted and do not receive the confidence they were intended to inspire.

PROXY ADVISORY FIRMS

Proxy advisory firms, including Institutional Shareholder Services (ISS), Egan-Jones Proxy Services, Glass, Lewis & Co., and Institutional Investor Advisory Services (IIAS) in India offer shareholders advice on how to vote their shares. These firms issue reports on how a firm’s governance practices relate to firm performance based on public financial data. For example, ISS reports four pillars of governance practices: board structure, executive compensation, shareholder rights, and audit-related activities. While all are related to leadership, none of these four pillars rates leadership capital directly. They report the alignment of total shareholder return over one, three, and five years with CEO pay and compare this to an industry peer group to measure pay for performance, but they do not offer further insights on leadership. Including more refined indicators of leadership would enable these proxy firms to offer more thorough recommendations.

BOARDS OF DIRECTORS

As trustees of a firm’s assets and shareholder interests, boards of directors have fiduciary responsibility for its performance. To fulfill this responsibility, boards review strategic plans, financial performance, firm policies, and operating choices. A primary task of a board is to select a CEO who can make astute decisions to lead the firm. In addition, the board determines compensation for the CEO and other key executives. Through these actions, boards recognize the importance of leadership capital for firm success—especially in settings like government agencies, not-for-profits, privately held companies, or countries where market value may not be a dominant logic.

A leadership capital index could help the board manage succession against a set of criteria that informs and bolsters confidence from investors and others. Executive succession is not just about the person who moves into a key position—it is about how the individual qualities instill confidence in others, particularly investors. In addition, boards sometimes invite in financial advisers to help determine how to increase total shareholder return. Often these advisers examine industry trends (to see if the firm has a strategic advantage) and financial performance (to see if it meets financial expectations). Less often do boards invite in leadership advisers to examine intangible value to see if their firm trades at a premium or discount to the industry. Boards might use the leadership risk assessments proposed in this book to review their firm’s quality of leadership, which in turn would give investors more confidence.

THE C-SUITE

C-suite executives and senior leaders want to demonstrate excellent leadership skills. Often leadership excellence is defined by the personal characteristics of the leader (authenticity, charisma, communicator, and so forth). But unless these personal leadership characteristics build confidence with investors, they are not contributing all they could to sustainable value. CEOs are also committed to building future human capital—their number one priority, according to a recent survey. Having a leadership capital index would help senior leaders know what to expect of themselves and other leaders so that investors would be more likely to invest in the company because of what leaders know and do.

HR AND LEADERSHIP SPECIALISTS

HR and leadership development specialists who design and deliver leadership improvement efforts could also be well served by a leadership capital index. Recently, my colleagues and I were in a consortium of leading companies, most of which had teams or HR professionals in attendance. One question we asked these groups to consider was, "What would you like investors to know about your quality of leadership that would increase their confidence in your future earnings and market value?”

Almost none of these senior HR professionals had considered this question, even as they worked to improve leadership in their company. Indeed, one of the consortium teams happened to be investors from one of the large global sovereign wealth funds, and these investor participants talked about what they look for in leadership when they make significant investment choices. But as they were presenting their list of desired leadership attributes, I noticed that none of the HR participants in the workshop were paying much attention.

I stopped the discussion at that point. "Do you realize what you are hearing?” I asked. "Guys from one of the largest investors in the world are sharing what they are looking for in leadership in your companies—or your rivals in the investment market. No one is taking notes. What you should be doing is rigorously writing down what they say, then sharing this with your CEO and chief investment officer so that they can communicate these messages in conference calls and investor discussions. And you should be rethinking leadership investments to ensure that you have or develop these traits.”

With some embarrassment, these HR professionals starting taking notes! And some later told me they could now engage in more business-oriented discussions with their business leaders.

Using a leadership capital index that focuses on how investors view leadership can help sharpen leadership improvement efforts. If nothing else, it will bring the concept to the table and allow it to be considered.