How to pick CEOs when you have skin in the game
By Jeffrey Cohn, Managing Partner, Elevate Partners and J.P. Flaum, Founder and Chairman, Green Peak Partners
With special thanks to Andy Caine for his excellent contributions during this year-long research initiative
We got curious recently about how private equity partners--widely considered financial engineers and quant jocks--choose CEOs after they acquire a company. Do they have a more scientific, rigorous methodology than the typical board of directors? When we surveyed 32 managing partners to find out, most reported that they'd climbed a steep learning curve - in part because it's a decision you can't quantify. But you can make it rigorous, deliberate, and systematic, and this they do.
We were especially curious about that learning curve, since PE partners typically hire more CEOs than any board of directors ever will. What wisdom can the rest of us gain can from their trial-and-error experience?
When we looked for patterns in their answers to our questions (some objective and fact-based, some open-ended), two interesting things stood out. One, they collectively reported that they had typically over-weighted one set of factors, early in their CEO-picking careers. And second, they had since come to value a different set of factors more highly.
Factors that Tend to Be Over-Valued
Track record. Nearly all our interviewees affirmed that track record is a critical factor in hiring decisions, but that the nuances of track record must be examined under a microscope. Does the resume summarize the candidate's direct contributions at a previous organization, or, as is often the case, does the resume highlight an organization's accomplishments? If so, exactly who in the organization was responsible for what? Mark Gillett of Silverlake Partners put a finer point on this: "We ask a lot of about the 'physical-izing impact' of the CEO in a prior role. What did the candidate physically do to drive change?"
Furthermore, even the most positive track record may not correspond with current strategic imperatives at your organization. Peeling back the onion on track record often reveals a misalignment between what a candidate has accomplished and what you want him or her to accomplish going forward. Innovating, for example, is a lot different than driving cost efficiency. For that matter, driving cost savings in one company can require different skills than in another company. Past accomplishment and current challenge is rarely an apples-to-apples comparison.
Or, a candidate's wins could have everything to do with outcomes - financial performance, for example - but less to do with the process used to achieve those outcomes. You may want to look at how a CEO candidate has driven strategic planning, management reporting, and the overall cadence of interaction with the team. As Hellman & Friedman Managing Partner Anupam Mishra explained, "We have been burned when we over-rely on performance and the strategy; there is a lot of drip between lip and cup on getting to execution."
Industry or domain experience. Should prior industry or business-sector experience trump other factors in your decision? Maybe not. Our study participants confirm that over-weighting domain expertise has led to CEO hiring failures. So often, reliance on track records yields candidates who have 25 years in your industry - but they recycle the same playbook because it has worked in the past. Riding that wagon can lead to a mis-hire, particularly inside a company that requires significant change.
This suggests that general management and leadership competencies are every bit as important as track record, if not more so. Tony DeNicola Co-President of Welsh, Carson, Anderson & Stowe says, "There have to be some adjacencies in historical background, but not from the exact industries. Instead, consider the challenges the business will face in the next couple of years and then hire for those." Brooke Colburn of The Carlyle Group concurs and now relies less on prior industry experience and more on a strong "athlete's" profile. He explained, "A good athlete is a quick study who can come into a new situation and quickly pick up the fundamentals. A good athlete can figure out which levers to pull to drive change and value creation."
Aggressiveness and persistence. In a 2008 white paper titled "Which CEO Capabilities Matter," our friend Dr. Steven Kaplan (and Mark Klebanov, Morten Sorensen) contrasted "hard" qualities such as aggressiveness with "soft" qualities such as the ability to listen, openness to criticism, and willingness to engage in team play. Professor Kaplan - along with many other academic experts and top advisors -- has long asserted that hard qualities matter more than soft qualities in hiring CEOs, but our current study data suggests that PE thinking on this is changing. Previously, most PE firms wanted to unleash the tiger. That is, they thought an aggressive, persistent, fast-moving CEO would perform better than one who listens, adjusts, and forges consensus. However, today most so-called Tiger CEOs can be over-focused on goals to the exclusion of evolving market realities and corporate culture. Thus, they shut themselves off from new ideas.
Intellectual horsepower. It's hard to argue against a high IQ. But genius is not the only intelligence that matters in business, particularly in the fast-paced, change-oriented world of private equity. When intellectual strength repeatedly manifests as Smartest in the Room behavior, it repels others. PE firms currently tend to back CEO candidates with more than sheer book smarts, whether you call it EQ, instinctive intelligence, or relational intelligence. While he used to endorse "the Super IQs," Peter Chung now says, "You need a certain amount of intellect to grasp the business: regulatory issues, technology issues, etc. But then EQ really takes over. The good CEOs know when to motivate and when to cheerlead." Chung also noted that you can augment a CEO with other smart people: "Building your team and surrounding the CEO with A Talent is essential."
Confidence and charisma. Many CEO candidates project a "wow factor" in interviews that can seduce even the savviest PE executives. Often charisma can arise from something as intangible as a commanding walk, good posture, height, or an especially authoritative speaking cadence. Yet, when confidence and charisma factor too heavily in a CEO selection process, the result can be devastating. In fact, confidence and charisma can help a leader sway followers down the wrong path. And since these candidates ooze confidence, you don't know you've failed until it's too late.
Rakesh Khurana, a Dean at Harvard University, has written about how eloquence and charm too easily lead to a "false positive" read. Today's most successful CEO pickers fully agree. A study participant from Francisco Partners Management explained, "I weight presentation skills and presence lower than I used to." Brooke Colburn of The Carlyle Group concurred, "You can't be seduced. Some of the most effective CEOs are soft-spoken or even introverted." In fact when we coach introverted, but high-potential CEO candidates, we often suggest they read a book called "The Power of Introverts," by Susan Cain. Cain argues convincingly that introverted leaders can be every bit, or even more effective than charismatic extroverts.
Ideally, a CEO is able to morph between an egalitarian mien and a more polished persona. The most promising CEO candidates, as confirmed by our study, transition easily among varied constituencies as "ambiverts," shuttling from a quiet office conceiving a new strategy to the factory floor, kicking the tires and gaining grass roots support for a new direction.
Name Brand. Private equity leaders try not to put undue emphasis on experience gained inside a well-known company or a diploma from a prestigious university. Recruiting and hiring from marquee companies often yields CEO candidates who are unable to return to mid-stage environments. These candidates have difficulty rolling up their sleeves and working in the trenches. A CEO in a PE-backed environment must be as comfortable in the weeds as at a 30K-foot altitude. One interviewee noted that CEOs with brand name credibility "may not be open-minded enough to adjust ... People who can do well in an up market can't [necessarily] replicate that success in any other market."
Likewise, the most successful CEO-pickers are immune to the seduction of academic pedigree. They respect the value in a diploma earned from top tier schools, but they do not regard it slavishly. Noted David Kerko, Director of KKR, "I would much rather have the person who went to the University of Buffalo, knows how to make money, and can inspire followership and loyalty with a team."
Factors that Tend to Be Under-Valued
Which predictive factors, then, does the typical CEO search tend to overlook? The PE managers we interviewed learned over time to put credence in factors you may currently undervalue.
Self-Awareness and Authenticity. The highest performing PE fund leaders have recognized the importance of emotional intelligence and other "softer" qualities. Centerbridge Capital's Brandt McKee noted, "Soft skills are important in driving performance. Human beings are so complex. Different people have different motives. Understanding and being able to recognize different agenda and work to bring a team together and harmonize an agenda is critical." In reality it's the "soft" leadership qualities that enable a CEO to achieve "hard" results like facilitating change and growing revenue. The people we interviewed generally believed that a candidate's soft skills correspond with a better return than a single-minded focus on IRR.
Empathy, too, is of course important. CEOs in newly acquired companies must attract and retain talent, build productive teams, and explain things in ways others understand. They must also align diverse players - PE investors, board members, customers, unions, government offices, etc. Even more on point: A CEO must be able to make others want to work with him/her. A lack of empathy can be a CEO's downfall when it kills morale or sparks mass exodus. That said, empathy comes in degrees, and shouldn't be taken too far. Too much empathy, for example, can turn into compassion, which in turn can inhibit CEOs from acting with urgency or making tough, people-related decisions. " I'm not down on empathy, but there are times when empathy needs to take a back seat to urgency. Some highly-empathetic leaders are not able to make the tough personnel decisions that need to be made - which compromises performance, explains Mark Gillett from Silver Lake Capital.
In addition, successful CEOs hired by private equity firms score high in terms of self-awareness. They know what they don't know. They acknowledge blind spots, build teams to augment their gaps, solicit advice and act on it. Additionally, they embrace feedback and develop accordingly, rapidly enough to impact the current scenario. Sean Barrette summarized, "At L Squared Capital we look for the fine line between confidence and arrogance."
Another factor often overlooked or underweighted in CEO selection: comfort in their own skin, authenticity, and the willingness to speak up. Ridgemont Equity's Jack Purcell said, "The guys I like most will pick up the phone and call with bad news as quickly as good news. I like the guys who say it is what it is. No gamesmanship. No sandbagging." We are reminded of a line from The Godfather, "Thank you for dinner and a very pleasant evening; if your car could take me to the airport. Mr. Corleone is a man who insists upon hearing bad news immediately." Delivering bad news quickly is often viewed by PE executives as a close proxy to authenticity and integrity, as painful as it may be for the portfolio company CEO.
Courage and willingness to embrace risk. Successful chief executives must be able to navigate extremely stressful situations. They must be willing to face intense fire defending their views - and back those views with facts. They must also be willing to "tinker" to get the job done - and this often requires taking calculated risk.
Resilience. Even the most successful CEOs in the most successful businesses will hit walls. Otherwise they're probably not pushing hard enough. PE executives want to know if candidates can bounce back after failure - and they dig to find hard evidence. Successful PE firms want to see that a candidate has faced setbacks, made errors and run adrift - yet lived to fight another day. Resilience is a close cousin to courage. Peter Chung said, "I like to know what has been the biggest failure in their life. Along the way, everyone has had a disappointment. I want to know how someone has responded to it so they can handle or avoid it in the future."
Ability to keep pace. Speed is a powerful advantage in business today and the best CEO pickers recognize and account for this. That's why they pay close attention to this factor when evaluating candidates. Many CEO wannabes will balk at a PE-driven pace, particularly if they have grown accustomed to plusher, more heavily-resourced environments.
Sleeves Up/Sleeves Down. In a PE-backed company, the CEO often has to get back in the trenches and do the work directly. Thus, private equity executives seek to find business leaders who exhibit an "all in this together" mindset.
At the same time, though, outside the PE world CEOs primarily accomplish through others - and must be willing to do so. They must delegate confidently. They must be comfortable directing versus doing. Particularly for first-time CEO candidates, this mindset shift is critical. More than likely, the ambitious upstart or loyal stalwart who has crossed the line first in a CEO horserace has felt pride and accomplishment in previous roles by getting things done every day. When this person lands in a CEO seat, he or she must empower others. Will he or she be able to make the shift?
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Given how fast-paced the world of private equity is, the amount of time spent on CEO-hiring decisions is surprisingly high. Ridgemont Partner's Jack Purcell said, "To go through a change at top takes a long time. We'll spend three to six months working with recruiters, if we're lucky. Then, a new CEO will have to learn strategy and team and culture. That takes 18 months or so total; almost a third of the life of the investment. The friction costs of making a change are high. So, it's not something we enter into lightly."
Jeffrey Cohn is Managing Partner at DHR International and author of "Why are We Bad at Picking Good Leaders" as well as many Harvard Business Review articles and case studies.
J.P. Flaum is Managing Partner at Green Peak Partners and co-author of the HBR.org article "Improve Your Ability to Learn" from June 2015 with Becky Winkler, PhD.