What impact do CEOs have on firms’ financial performance?

This year’s Australian reporting season has seen the return of some triumphant and amply remunerated CEOs.

Though not the highest paid in Australia, Qantas chief Alan Joyce reportedly received A$11.8 million for helping the airline turnaround its financial results. Joyce did so by cutting costs and routes, restructuring the international operations and freezing pay – and together these actions have led to significant financial improvements.

However two things that Joyce had nothing to do with – cheaper oil prices and a lower Australian dollar – provide the real context in which Qantas’ transformation has occurred.

A central question in business research – which is indeed the subject of much debate – relates to how much CEOs really matter to firm performance. Empirical research from the US suggests that perhaps 38% of performance variation at the firm level can be attributed to CEOs’ decisions and influence on their firms’ performance.

This is quite a move upward from earlier research that had suggested perhaps 20% of the variance in performance of firms can be attributed to CEOs’ and their decisions. One problem with the research is the impossibility of separating firms, their leadership teams and the organisation as a whole. Nonetheless, a consensus has emerged that senior leaders can and do have an important influence on firms’ financial performance.

Other factors, beyond the CEO and beyond the organisation itself, clearly matter. Indeed external factors seem to matter quite a bit more than the CEO herself or himself. These other factors include the firm’s financial health prior to appointment, industry and economic conditions and the general unpredictability of business life. However CEOs that wield their organisational authority to make bold strategic decisions, to shake up organisational design and to imbue a way of operation through daily leadership actions create performance change (for both better and worse).

Not all CEOs had the same stellar year as Alan Joyce. Both the CEO and Chairman at Woolworths are leaving the company, and life at Australia Post for Ahmed Fahour remains challenging. In both of these instances, however, it has been significant pressure from outside – for Woolworths it has been the rise and rise of Aldi and for Australia Post is has been the terminal decline of letters – that has driven what have been disappointing results.

In each of the cases there have been internal and arguably avoidable problems – for Qantas its Hong Kong foray was a disaster, for Woolworths there has been Masters and for Australia Post there was the Digital Mailbox – but in each instance these isolated problems only go far in explaining what has gone well, and what has not.

More than one person

Both research, and common sense, tell us that if we seek to better understand performance we need to think about the nature and behaviour of organisational leaders and how they “fit” both the organisation and its environment. A great leader in one organisation can be a disaster in another if this alignment is not achieved. It is this three way contingency – the person, organisation and context fit, that is vital.

We can best see this by looking at how difficult it is for long-term leaders to adapt to changing organisational and external realities. A work in progress in relation to this will be the leaders at Fortescue Metals – Australia’s third largest iron ore producer. Founder Andrew Forrest and his executive team were great at doing the deals to rapidly finance growth, leading to a share price peak close to $11 in mid-2008 as the iron ore price soared.

As iron ore prices have tanked, and Fortescue’s share price has declined to less than $2, the new organisational and competitive reality requires a very different organisational agenda and skill set. Transforming Fortescue from a high growth start-up to a low cost producer will likely be a challenge for the existing leadership team.

It’s a lesson well worth remembering – personalising leaders as “good” or “bad” rarely captures their capacities, and often leads to spurious and destructive mis-attributions.

In all organisations, it is important to consider the importance of diverse skills within senior management teams, of rotating leadership and consensus approaches to big decisions and their implementation. De-personalising the role of the “big boss” and acknowledging a variety of leadership styles are necessary in large and complex organisations will lead to less superstar CEOs, but probably better organisational performance.

This article is published in collaboration with The Conversation. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Nigel Martin is Lecturer, College of Business and Economics at Australian National University and John Rice is Professor of Management at University of New England.

Image: A Businesswoman is silhouetted as she makes her way under the Arche de la Defense, in the financial district west of Paris. REUTERS/Christian Hartmann