Corporate CEOs have gotten a bad rap of late with certain high-profile leaders getting negative popular press.
And while the academic literature offers a more measured assessment of CEO power, it’s hardly a kind one. Recent studies have shown a correlation between increased CEO power and poor corporate outcomes, from reduced profitability and stock prices to an increased incidence of fraud. So why would any firm endow more power in a chief executive?
New research by Tuck professor Gordon Phillips suggests that the answer is highly dependent on market conditions. Powerful CEOs add significant value to the companies they lead if those firms are engaged in rapidly changing and competitive product markets, where success often depends on decisive action, Phillips’ research shows.
“Using comprehensive evidence for public firms over a 12-year period, we show how having more powerful CEOs may be valuable to the firm when it needs to respond quickly to investment opportunities and also faces entry threats,” says Phillips, faculty director of the Center for Private Equity and Venture Capital and the C.V. Starr Foundation Professor of Finance at Tuck School of Business.
Investors tend to reward announcements of increased CEO power, but only if the firm competes in a fluid (rapidly changing) and competitive market; absent those conditions, the same announcement is likely to depress share prices. In such dynamic markets, companies with powerful chief executives exhibit higher market value, register faster sales growth, and invest more in new products and advertising than firms whose CEOs are more constrained, Phillips’ finds.
The paper, “CEOs and the Product Market: When are Powerful CEOs Beneficial?” is forthcoming in the Journal of Financial and Quantitative Analysis. Phillips authored the paper with Minwen Li and Yao Lu of Tsinghua University in Beijing.
The researchers created a simple and robust model to quantify chief executives’ institutional authority, as well as their social influence within the firm. “We show that the positive effects of CEO power are not limited to explicit sources of CEO power such as whether the CEO chairs the board or is a founder, but also extend to ‘soft’ sources arising from the CEO’s connections to key officers and board members,” they write.
Powerful CEOs tend to shine in markets characterized by high levels of fluidity (a measure of change in a firm’s product space due to actions of its competitors) and positive demand shocks. Phillips and his colleagues use these factors as proxies for two market conditions that favor powerful CEOs: The presence of entry threats from competing firms and positive investment opportunities.
Phillips found an ingenious way to measure fluidity by analyzing product descriptions in rival firms’ 10-K filings to the Securities and Exchange Commission. For example, after Apple introduced the iPad, the word “tablet” began to appear in its reports. As rivals rushed to enter the space they, too, added the word “tablet” in their product descriptions. Applying this method to a range of industries, Phillips and his colleagues were able to quantify “fluidity,” an essential characteristic of markets in which powerful CEOs add value.
Another characteristic is growth. The researchers focused on demand spikes because they indicate growth opportunities that require timely investment, something powerful CEOs are uniquely positioned to accomplish. After all, any CEO can cut costs without fear of board blowback, but spending money on bold initiatives is the province of the most powerful chief executives.'s
Endowing CEOs with such power has produced mixed results. Phillips cites a 2005 study that associated powerful CEOs with the best-performing and worst-performing firms examined. Phillips’ research illustrates that firms in a fluid product market will more likely end up on the right side of that divide, and it thus provides a new understanding of how market conditions relate to CEO power and when it is advantageous for corporate boards to grant more power to CEOs.