THE CONSTANT INVESTOR | At Vertium, corporate governance plays a large role in how we invest. Of all the governance factors, we believe CEO behaviour to be the most important because a CEO can directly influence a company’s value. If a CEO’s behaviour is not effectively monitored, their decisions can lead to corporate collapse. HIH Insurance, Enron and Royal Bank of Scotland are prime examples.
A common element among many corporate collapses is an overconfident CEO. Typically, they create a ‘group-think’ environment to reduce their likelihood of being challenged. In an ‘emperor wears no clothes’ environment, these CEOs tend to over-commit on projects.
Our framework of analysing CEO behaviour is based on the type of company they run. For companies in innovative industries, highly confident CEOs are required because they can create tremendous shareholder value and galvanise all stakeholders to embrace their vision. These CEOs tend to over-commit on internal projects, such as research and development, which can sacrifice short-term profits to create future value.
However, in mature companies, a CEO’s hyper-competitive drive can create a destructive workplace of group-think and bullying. Alternatively, a CEO with a long history of success in a mature company may breed an environment of complacency because of their ‘halo’ effect. Without constructive feedback, these CEOs may over-commit on external projects, such as large acquisitions, which may eventually lead to shareholder value erosion.
Having an inflated sense of self-worth is not a pre-requisite to shareholder value erosion, but it is a potential warning sign. It is only when an overconfident CEO is placed in the wrong environment that the seeds for poor future returns are sown. Greater vigilance is required to monitor governance issues under these circumstances.
As featured in The Constant Investor