University Study of P/C Insurers Finds Bad CEOs Can Wreck Companies

When companies go out of business, their leaders often blame something other than their own performance for the failure. Lehman Bros.’s CEO Richard Fuld said his compensation package had nothing to do with his firm’s death in 2008.

Ken Lay and Jeffrey Skilling blamed an angry short seller in Florida for bringing down Enron.

A parade of CEOs for decades has claimed the economy and outside pressures were responsible for GM’s difficulties.

But a study by a University of Iowa business professor suggests that when a company goes under, it’s often the result of bad business decisions by its leadership. CEOs, he said, are more than just scapegoats.

“We found that managers of failed firms are less skilled than their peers and the consequences of their incompetence are economically significant,” said Tyler Leverty, assistant professor of finance in the Tippie College of Business. “Managers do matter when companies fail.”

In the paper, “Dupes or Incompetents: An Examination of Management’s Impact on Firm Distress,” Leverty and coauthor Martin Grace of Georgia State University, look for the ways bad leadership hurts a company. The conventional wisdom is that CEOs think and act alike, given a set of circumstances.

But Leverty’s research found that some CEOs significantly improve a firm’s performance, while others hurt it.

Researchers looked at property/casualty insurance companies to see how CEO decisions affected firm performance. The industry was useful, Leverty said, because it is a risk-intense business even in good times, so a firm’s performance is less tied to the economy.

Insurance is also heavily regulated, so one measure of a CEO’s effectiveness was how often he managed to keep his firm off the regulatory radar, and if there, how quickly the CEO removed it from scrutiny.

The P/C insurance industry also provided a good laboratory because CEOs within the industry frequently change jobs among the subsidiaries of a group, so researchers could in many instances directly compare a leader’s performance with one company or subsidiary to another.

Researchers looked at the performance of 12,000 insurance companies between 1989 and 2000, with about 2,000 observations having CEO overlap. The study measured whether management quality reduces the likelihood a firm becomes insolvent, and whether ability influences the cost of insolvency in a firm that goes out of business.

Leverty used what he considered a basic and conservative definition of management quality – does a CEO use capital and labor in the right proportion? Does the CEO minimize firm costs, maximize revenues, operate efficiently and use technology effectively? If a company spends more than a similarly sized competitor but shows poorer performance, the researchers chalked that up to a lack of management skill.

“An inefficiency is a manager’s fault,” he said. “They should identify it and fix it.”

Leverty found evidence that good managers matter; good CEOs can remove their firms from regulatory scrutiny 8 percent to 16 percent faster than a poor manager.

In companies going out of business, a more talented CEO can get a better return on the firm’s assets by up to 10 cents on the dollar.

Topics Carriers Education Universities Property Casualty