My research passion for the last ten years has been in the area of top team behavior, specifically how the most senior executives in a company work together and how that level of effectiveness correlates with business performance metrics, over time. Not surprisingly, the linkages are proving to be tight and significant. As you will see on this blog over the coming months, some of the best social scientists in the world have been asking the same questions and running their own experiments. Deloitte’s CIO Journal will get the disscussion going for us, with this article that originally appeared in Deloitte’s CIO Journal in 2012, reposted here with permission:

The Financial Impact of Executive Leadership

Most businesses recognize the role their senior leadership teams play in driving financial performance. Yet measuring the direct impact of company leadership on outcomes such as corporate earnings or equity value has proven difficult for researchers.

Deloitte spent six months (August 2011 to January 2012) studying investment analysts’ perception of the relationship between corporate leadership and performance.

“We wanted to find a quantitative metric for the value of leadership,” says Adam Canwell, a human capital consulting partner with Deloitte Australia. “We set out to understand the impact of leadership on long-term equity value, its relative importance compared with other aspects of company performance, and the size of the potential increase or decrease in value that it can deliver.”

Through interviews and surveys with 445 investment analysts, Deloitte found they routinely factor the quality of a company’s senior leadership team into their valuations, and that effective senior leadership can add 15 percent to a company’s value. (For the specific leadership capabilities investment analysts seek in corporate executives, see “CIO Leadership: The Capabilities Investment Analysts Value”)

The Impact of Senior Leadership Team Effectiveness

Financial results remain the most important criteria investment analysts use to evaluate a company’s current and future success, but increasingly, analysts are incorporating judgments about senior leadership into their equity valuations.

Senior leadership team effectiveness ranked as the second most important criteria analysts use to determine company success in Deloitte’s survey. The majority of analysts (52 percent) say they routinely factor it into their valuations. They believe a company’s financial performance reflects the effectiveness of its senior leaders. In other words, the numbers demonstrate their results.

Even many of those analysts who don’t routinely ascribe equity value to senior leadership would place a premium valuation on an exceptional team. Overall, 80 percent of analysts surveyed say a company with a particularly effective senior leadership team would receive a premium valuation. The same percentage said they would lower the valuation of a company that they perceived to have a particularly ineffective leadership team.

The gap between the value of a company with good leadership and that of a company with weaker leadership could be more than 35.5 percent, according to the study. On average, analysts place a premium of 15.7 percent on companies with particularly good leadership and a discount of 19.8 percent on organizations with weak executive teams.

“Some analysts stated that concerns about the quality of a senior leadership team would be enough for them to avoid investing in a stock,” says Canwell.

Variations by Company Size

Deloitte’s research suggests that the relationship between a company’s leadership and its share price varies by company size. Across markets and industries, analysts agree that senior leadership exerts a far stronger influence—both positively and negatively—on small companies than on large companies.

“In small and early stage high-growth companies, the level of risk is higher than in large, mature organizations, and the decisions senior leaders make ultimately determine whether a company is able to navigate that risk successfully,” says Canwell.

Moreover, he adds, leaders in small companies tend to have more freedom to alter the direction of the company because they’re less constrained by long-established processes and protocols that may hinder their counterparts at larger organizations.

Variations by Industry

The importance of a company’s leadership to its equity value also varies by industry. For example, analysts who focus on consumer goods companies ascribe an average of 21 percent of a company’s equity to its senior leadership team, compared with 14 percent for analysts who cover technology, media, and telecommunications companies (see Figure 1). 

Figure 1: Equity Value Ascribed to Senior Leadership Team by Industry

Source: “The Leadership Premium”, DTTL 2012

“This finding implies that, in the eyes of the financial markets, good leaders can make a bigger impact in sectors where the product range is, to a large extent, standardized,” says Canwell. “These sectors require low levels of R&D spending and quickly see their performance reflected in financial results, making it relatively simple for analysts to assess the impact of a new leader.”

By contrast, the impact of leadership on financial performance is often delayed in industries that are undergoing rapid and radical structural transformation, such as technology, media, and telecommunications, adds Canwell. Consequently, financial analysts find the senior leadership team’s contribution to the company’s performance harder to quantify.

“It’s notoriously difficult to measure the impact of successful leadership development,” says Canwell. “We hope this research will help companies understand the material impact that leadership can have on their performance, including the risks of a talent deficit.”