New research finds that business failure is usually the result of bad leadership, a lesson that could be very useful to small business owners.
While CEOs frequently attempt to pin the blame for failure on external factors, the research reveals that more often than not the failure is the result of bad business decisions by leadership.
"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 at the University of Iowa who partnered with Martin Grace of Georgia State University on the research.
The researchers looked at the performance of property-casualty liability insurance companies to see how CEO decisions affected firm performance. The study measured:
- How quickly CEOs were able to remove their firms from regulatory scrutiny;
- Whether management quality reduces the likelihood of a firm becoming insolvent;
- Whether CEO ability influences the cost of insolvency in a firm that does go out of business.
Leverty used a series of performance-based criteria to determine management quality:
- Does a CEO use capital and labor in the right proportion?
- Does the CEO minimize firm costs and maximize revenues?
- Does the CEO operate efficiently and use technology effectively?
Leveraty looked at the performance of 12,000 insurance companies between 1989 and 2000 and measured how quickly CEOs were able to remove their firms from regulatory scrutiny, whether management quality reduced the likelihood a firm becomes insolvent, and whether CEO ability influences the cost of insolvency in a firm that does go out of business.
The researchers observed that good CEOs removed their firms from regulatory scrutiny 8 to 16 percent faster than poor managers. And in insurance companies that were going out of business, a more talented CEO got a better return on the firm’s assets by up to 10 cents on the dollar.
A good personality didn’t hurt performance, either.
“Since our measure was outcome-based it does account for managerial characteristics that allow managers to more effectively use the firm’s resources,” Leverty told BusinessNewsDaily. “For example, perhaps more charismatic CEOs are better able to utilize the firm’s resources (capital, labor).”