STEVEN MOORE FOR HBR

Benjamin Graham, the father of value investing, seldom met the managers of the companies he invested in because he felt they would tell him only what they wished him to hear and because he didn’t want to be influenced by impressions of personality. His talented student, the legendary Warren Buffet, thought the same: “when management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

Value investors like Graham and Buffett believe that the sources of sustainable returns on capital are not a company’s human assets but their so-called “economic moats,” structural, durable competitive advantages around revenues or costs. Revenue moats are usually linked to intangible assets (including brands and patents), high switching costs, and network economies. Cost moats are linked to the ownership of cheaper or faster processes, favorable locations, unique assets, or firm size. In some cases, companies’ moats have enabled them to survive multiple technology disruptions and industry shifts over time, making their founders some of richest people in the world: think Bill Gates, Carlos Slim, Amancio Ortega, and Larry Ellison.

There’s an interesting fact about companies with these kinds of moats or competitive advantages that often gets overlooked: the turnover rate of CEOs among the S&P as a whole is between ten and twenty times higher than in the big entrepreneurial successes of the past few decades. A case in point is Inditex, founded in 1963 and now the biggest fashion group in the world, which has only had two CEOs succeed founder Amancio Ortega. By contrast, Germany’s Deutsche Bank, which has suffered from years of poor performance, has had three CEOs in the last five years, none of whom has done much to improve performance despite their glittering CVs in the sector.

This raises a basic question: can a CEO with the best track record imaginable turn around a poorly performing company? According to MIT economist Antoinette Schoar the answer is yes roughly 60% of the time, which is not that much better than the odds of getting heads on a coin toss.

Chicago’s Steve Kaplan’s findings on the difference that managers can make are even more sobering. He studied the relative importance of management teams in 106 venture capital-financed firms from early business plan to IPO. He found that although 50% of venture capital investors described the management team as the most important factor at the business plan stage, this emphasis had dropped markedly by the IPO stage. He concluded that non-human assets — i.e., their moats — were ultimately more important to firms than human assets, with their relative importance increasing over time. The implications are clear: first choose the right industry and company, then pick the right management. If the managers don’t perform, they can be swapped out much more easily than the basic business idea or industry.

Of course, in a highly competitive world, even a slim advantage is better than a coin-toss. So is there something different about the managers who do succeed? Let’s go back to Steve Kaplan, who has also studied how and why CEOs matter, relating their features to hiring and firm performance.

His detailed assessments of over 300 CEO candidates in private equity-funded companies suggest that CEOs with execution strengths (“efficiency”, organization and planning”, “attention to detail”, “persistence”, “proactive”, “sets high standards”, etc.) perform better than CEOs whose softer skills such as team building or listening dominate. This finding is a ringing modern confirmation of what Peter Drucker was telling us in 1967 about what makes executives effective.

If all this is true, then the high CEO turnover you see at many public companies is not a symptom of poor management. It suggests a deeper problem, which is that the companies in question simply don’t have a competitive advantage and are simply engaged in a lottery, hoping to find a CEO who can find one. The odds aren’t favorable.