Investors Value Leadership: Research Results

To answer the question of how investors value firms, my colleagues and I interviewed twenty-five investors, had twelve focus groups with forty-five seasoned investors, and reviewed research on the topic (summarized in subsequent chapters). From this preliminary work, we defined three broad domains of information most important to investors: industry favorableness, company performance, and quality of leadership.

Industry favorableness refers to the characteristics of the industry, such as its growth potential, barriers to entry, competitiveness, social trends, customer opportunity, regulatory opportunities, and so forth. Industries may be more or less favorable (for example, twenty-first-century demographics favor care of the elderly and are less favorable to traditional printing).

Firm performance refers to consistency of financial results as indicated by a variety of metrics. Firm performance also refers to the intangibles related to strategy, technological advantage, and organization capabilities such as speed to market, degree of innovation, customer service, and so forth.

Quality of leadership refers to the confidence investors have in the leadership capability of the company. Investors are more likely to invest in companies with leaders who have a strong track record and have more ability to set and execute strategy, to manage current and future talent, and to develop future leaders.

Next, we determined the relative weight of each of these three domains for investor decisions by asking them to divide 100 points across the three domains and their confidence in assessing each domain. We received 430 responses from portfolio managers, institutional investors, mutual and hedge fund managers, private equity investors, and venture capitalists. These investors each had, on average, more than fifteen years of professional investment experience.

Table 1.1 reports the relative importance of each domain, along with investors' confidence in their ability to assess each area.

Investors consider company performance the most important domain for making investment decisions (38.5 percent) and also have the highest confidence in their ability to assess it (4.47). The standard deviation of 0.58 is the lowest of any domain. This result is not surprising; performance is the most objectively measurable of the domains, and it is comparable across firms and consistent with most investor training.

Industry favorableness also matters (33.1 percent) to investors, and they have high and consistent confidence in their ability to track it (average score of 4.33 with a standard deviation of 0.66).

Although ranked lowest among the three domains, quality of leadership clearly matters to investors (28.4%) in a consistent way (standard deviation of 14). But investors have much less confidence in their ability to assess quality of leadership (3.75) and they sense a much higher risk (standard deviation of 0.96) associated with their evaluations. Their comments reflect these findings:

"Quality of leadership is important but … if high quality of leadership is required for an investment to succeed, then there may be other investments out there … with fewer hurdles to success. … At the end of the day, it always comes down to people.”

"We care a lot about this. This is what drives a firm to capture opportunity. Nearly all the pathologies of leadership are easy to find if you know where to look. Too many CEOs are such great toadies (some seem to be sociopaths) that you can’t depend on just meeting them—they will charm you, and they’ll figure out what you want to hear. So, you have to get out into their operations and walk around. If you know what real leadership is and what real integrity is, you will find it or the absence of it out on the front lines where products and services are being forged and delivered to customers.”

"Leadership is one of the most important considerations that our fund makes when considering a potential investment. If we are not comfortable with the management team, we will usually not invest until changes are made.”

"This is a leading nonfinancial indicator, yet all information systems and research services are designed to provide financial metrics. Quality of leadership, culture, quality of relationships with core stakeholders are critical to understand but are also difficult to gauge. We’ve spent four years trying to get better in this area.”

Clearly, leadership matters to investors, but they often find it difficult to define, measure, or track. Investors vary more in how much confidence they have in their ability to assess leadership. This tells me that investors would indeed be glad to have a usable leadership capital index.

In our interviews with investors, my colleagues and I almost always heard a resounding "of course” to whether leadership mattered in valuing a firm, but then we heard skepticism about how to accurately assess leadership. Most investors have spent their careers studying spreadsheets and computer programs, not dealing with the more subjective and behavioral assessments of individuals. But there is a body of knowledge on assessing leadership that can be accessed by investors to help them make more informed decisions.