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Superstar CEOs

from: http://www.economist.com/node/21530953

The company HP can be described as “a scrappy start-up that grew into a high-tech powerhouse thanks to relentless innovation and solid management principles” (par 2), but now, according to the article, the company’s success is starting to slip.

Several chief executives of HP have already left since 1999, and in some cases, these executives either left or were fired due to some scandals, including Mark Hurd, “after a sex-and-expenses scandal” (par 3); Tom Perkins, who left due to a spying case; and more recently, Léo Apotheker, “Mr Hurd’s successor”. Now, HP’s replacement for Mr. Apotheker is Meg Whitman, who was a former boss of eBay. This frequent changeup of the executive board is an indicator of potential instability within HP.

Though the author proposes several reasons to explain “what went wrong with HP”, the author implies that the most probable reason is “hat HP has fallen victim to the cult of the corporate savior. It keeps reaching outside its ranks to hire a superstar as CEO. This is something HP never did during its glory days. And it never seems to work” (par 5). This practice seems appealing to flagging companies, but history shows that it is a risky practice that usually does not work:

Messrs Cazier and McInnis studied 192 CEOs who had been brought in from outside between 1993 and 2005. They discovered that companies usually recruit CEOs from companies that have done well in the past—no surprise there—and that they usually pay them a fat premium. But then comes the rub: the pay premium is negatively correlated with the future performance of the firm that does the hiring. In other words: the more dazzling the outside recruit, the worse he performs in his new role (par 8).

Moreover, “Rakesh Khurana of Harvard Business School argues that looking outside for a ‘corporate saviour’ erodes the morale of the talent within” (par 7). One explanation that the author proposes for this is that perhaps these big CEOs might “have an inflated opinion of their own abilities” (par 9). They might think they are the reason for their previous company’s success, according to the article, when in reality, it was the joint effort of everyone involved.

How does this practice of hiring outside “superstars” (par 9) involve networks? Perhaps one way to explain the practice is through game theory: let the players be the companies, and the strategies are to hire or not hire superstars. It may be the case that a company may perceive that it is always their best response to hire, mostly due to perception: if company 2 hires, then to keep up, company 1 will also respond by hiring. If company 2 does not hire, then company 1 will hire the new CEO in an attempt to get ahead. However, this is largely due to perception: many think that the new CEO will bring success even though it has historically not been very effective. This hypothetical game is also a huge simplification of a company’s business strategies and connections.

Another plausible (and simplified) explanation for hiring superstars is the power in network edges. If multiple companies and CEO are nodes, and edges represent possible business connections, individual “free-agent” CEOs will have more edges with companies than companies have edges with CEOs because there are many companies and fewer superstar CEOs. There is large demand for those CEOs, represented by the many edges that CEO has. Therefore, with more edges, the CEO has more power in his connections, and the CEO can demand a lot of money, that “fat premium” (par 8 ) when firms ask him or her to work for them.

In any case, hiring an outsider “superstar as CEO” has mostly not proven unsuccessful, despite the several success stories. There is a more successful practice, however, which is stated by Jim Collins in the article: “great companies almost always recruit CEOs from within” (par 7).

Sources:

http://www.economist.com/node/21530953

Networks, Crowds, and Markets: Reasoning about a Highly Connected World

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