Domain 1: Individual Leader Competencies

The individual dimension of leadership capital focuses on the personal qualities of leaders within an organization. Leadership obviously begins with the CEO, but it extends to the top team and even the middle managers who assume leadership responsibilities throughout an organization. Too often investors look only at the CEO to represent overall quality of leadership, relying on either personal interactions or reports like the extensive analysis of CEO pay (correlation of CEO pay to performance, CEO base versus at-risk pay, ratio of CEO pay to next highest officer, and CEO pay versus peers) published by the ISS. This information is easy to compile because it is publicly reported in SEC reports, but it does not really cover the entire topic.

Investors can look at the individual attributes of leaders throughout the organization, and they can assess personal leadership competencies through observations, interviews, surveys, general reputations, and demonstrated behaviors. Their real challenge is not how to assess but what to assess. What makes a leader effective? Sometimes, isolated experiences with leaders may not give investors a full view of the leaders' overall abilities, and a given leader may have strengths in some areas and not in others.

APPROACHES TO INDIVIDUAL LEADER COMPETENCY

Many studies of leadership acknowledge the general importance of people and overall leadership as the driver of organizational value. Some have focused on the individual skills of the top and senior leaders as inputs to key investment decisions. A sampling of approaches to examining personal leadership competencies is captured in Table 2.1.

Based on studies like those in Table 2.1, thoughtful investors interested in long-term investing (portfolio managers, institutional investors, mutual and hedge fund managers, private equity investors, and venture capitalists) are all likely to recognize that leaders matter in valuing the firm. But when asked about leadership, analysts emphasize more how to get information than what information to seek. Without a guiding framework for what makes an effective leader, each analyst draws on personal assumptions. This is no surprise. Most analysts who drive investment decisions are proficient in accessing and assessing financial information. They have little experience, training, or guidance on how to define and assess the quality of individual leaders. While their instinct for assessing leadership may be accurate, they need tools to bring rigor and repeatability to their results. Returning to the real estate metaphor, they may like living in a house, but they do not fully appreciate the architectural design and infrastructure that makes it livable.

For analysts to move from novice to informed observers of individual leadership, research suggests three themes that will enable better assessment:

Look at leadership rather than leaders: It is convenient to assume that the CEO or another top leader represents the collective leadership within an organization. More realistically, valuing leadership requires looking at not only current but also future leaders. Future leaders will be the ones to respond to forthcoming opportunities.

a. Geoffrey Smart, "Management Assessment Methods in Venture Capital,” Frontiers of Entrepreneurship Research (1998): 600–612; Geoffrey Smart, "Management Assessment Methods in Venture Capital: Toward a Theory of Human Capital Valuation” (doctoral dissertation, Claremont Graduate University, 1998); Geoffrey Smart, "Management Assessment Methods in Venture Capital: An Empirical Analysis of Human Capital Valuation,” Journal of Private Equity 2, no. 3 (1999): 29–45; Geoffrey Smart, "What Makes a Successful Venture Capitalist,” report, ghSmart and The Ignite Group, 1999, Http://Www.Ghsmart.Com/Media/Press/What_Makes_A_Vc.Pdf; see more at http://www.iijournals.com/doi/abs/10.3905/jpe.2013.16.3.057#sthash.d7h4X2j6.dpuf.

b. Roshan Tantirimudalgie, "Human Capital Valuation by Private Equity Firms” (master’s thesis, Swiss Federal Institute of Technology, Zurich, 2012).

c. Geoff Smart and Randy Street, Who (New York: Ballantine Books, 2008); Brad Smart and Geoff Smart, Topgrading: How to Hire, Coach, and Keep A Players (Dallas: Pritchett, 2005).

d. Simon Holland and Margot Thom, The Leadership Premium: How Companies Win the Confidence of Investors (Deloitte, 2012).

e. McKinsey, Perspectives on Merger Integration (2010), http://www.mckinsey.com/Client_Service/Organization/Latest_thinking/-/media/McKinsey/dotcom/client_service/Organization/PDFs/775084%20Merger%20Management%20Article%20Compendium.ashx

f. Spencer Stuart and National Venture Capital Association, Emerging Best Practices for Building the Next Generation of Venture-Backed Leadership (2010), www.spencerstuart.com.

g. Susan Dunn and Bruce Avolio, "Monetizing Leadership Quality,” People and Strategy 36, no. 1 (2013): 12.

h. E. Ted Prince, "The Fiscal Behavior of CEOs,” Sloan Management Review 46, no. 3 (2005): 22–26; E. Ted Prince, The Three Financial Styles of Very Successful Leaders: Strategic Approaches to Identifying the Growth Drivers of Every Company (New York: McGraw-Hill, 2005).

i. Mark A. Ciavarella, Ann K. Buchholtz, Christine M. Riordan, Robert D. Gatewood, and Garnett S. Stokes, "The Big Five and Venture Survival: Is There a Linkage?” Journal of Business Venturing 19, no. 4 (2013): 465–483.

Likewise, while it is convenient to look at a single great leader, it is more important to look at collective leadership and next-generation leaders.

Remember that the situation can define the type of leadership needed: One of the most common succession planning mistakes is to expect future leaders to require the skills that past leaders needed. As situations change, leadership must change. While my colleagues and I do believe in the existence of a core set of skills that all leaders must master, those skills are not enough. Leaders must also have the bandwidth to adapt to changing situations. Investors need to look at the business requirements before defining desired leadership competencies.

Don’t try to specify a single strength or trait as the one that matters: No single strength or trait characterizes every effective leader. Leadership requires multiple skills. It’s easy to become enamored with a particular strength, be it communication, planning, or execution. However, wise investors see individual leadership assessment as multidimensional and examine many characteristics of leaders.

Out of the myriad studies that have attempted to define the qualities of an effective leader, my colleagues and I have defined the metaphor leadership brand, which consists of the core leadership code and a number of differentiators.

The leadership code addresses the question of whether leaders in a firm can accomplish their basic duties. Then the leadership differentiator addresses the question of the extent to which leaders engage in behaviors that are uniquely suited to the firm, given its external brand. (My colleagues and I have found that about 60% to 70% of effective leadership consists of doing the basics well; 30% to 40% involves making sure that a leader’s actions inside a company reflect customer expectations outside the company.)

The leadership capital index addresses five factors from the individual leader domain—four from the basic code and a fifth from the differentiator:

1. Personal proficiency: To what extent does the leader demonstrate the personal qualities required for effectiveness? (See Chapter 3.)

2. Strategic proficiency: To what extent does the leader articulate a point of view about the future and strategic positioning? (See Chapter 4.)

3. Execution proficiency: To what extent does the leader make things happen and deliver as promised? (See Chapter 5.)

4. People proficiency: To what extent does the leader build the competence, commitment, and contribution of their people today and tomorrow? (See Chapter 6.)

5. Leadership brand proficiency: to what extent do leaders inside a company act in ways customers expect? (See Chapter 7.)

These five elements offer a framework for what investors should pay attention to in assessing individuals as leaders. Investors who assess leaders at the top and throughout an organization will know if they have the personal qualities that define effective leadership. These five elements, outlined in Figure 2.2, provide a graphic roadmap for Part 2, Chapters 3 through 7.

Finally, with these five elements in mind, investors can do a more rigorous job of assessing leadership capital. Investors who are serious about leadership can perform a leadership audit through interviews, observations, and surveys of potential investments. Of course, it is difficult to extract this sort of information. Investors can do such leadership audits themselves or use an advisory service that specializes in that type of work. While such audits may take more time than relying on financial advisory services, they offer investors a clear advantage. The information asymmetries they create can mitigate investment risks and increase the probability of success.