Although the conventional wisdom is that CEOs have a huge effect on a firm's performance, success or failure is actually often due to chance, according to a Texas A&M study.
Markus Fitza, the study's author and a professor of management at Texas A&M, said differences in the performance of a business during the tenures of different CEOs can be caused by at least two things: differences in CEO abilities and events that are outside of the CEO's control.
The chance factor can have both positive and negative effect on an organization's performance, according to Fitza.
"For example, a scandal at a major competitor can help a firm, while an accident at an important supplier can have negative consequences," Fitza said in a statement. "Over a long enough time period such effects tend to cancel out, thus it is unlikely that a firm is consistently high-performing just because of chance events."
However, since the average CEO’s tenure is currently only four years, there appears to not be enough time for luck to even things out. [https://www.businessnewsdaily.com ]
For the study, Fitza applied the variance decomposition, which is widely used to examine the degree to which CEOs affect a business's performance. He created sets of simulated firm data in which the level of performance was left up to chance and then conducted a variance decomposition analysis on real firm data from the 1,500 largest U.S. firms from 1993 to 2012, as well as on the simulated data.
After comparing the results, Fitza discovered that more than 70 percent of the CEO impact measured by previous research could be due to chance. He said the findings reveal that too often past studies "wrongfully attribute the effect of random fluctuations to CEOs."
In the end, the impact a CEO has on a business is much smaller than previously thought, Fitza believes. These results, he said, should give organizations more pause when deciding to quickly change CEOs.
"It might not be a good idea to replace CEOs because of low firm performance over short time periods, such as after one bad year," Fitza said.
This study could also help determine how much CEOs are being paid.
"If we do not want CEOs to be rewarded or punished for luck, then understanding their true contribution to company performance should be an important part in determining the level of their compensation," Fitz said.
The study was recently published in the Strategic Management Journal.