Effect of Ceos

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THE EFFECT OF CEOS ON FIRM PERFORMANCE

ALISON MACKEY Assistant Professor of Management Orfalea College of Business California Polytechnic State University San Luis Obispo, CA 93407 Tel: (805) 756-1232 Fax: (805) 756-1473 mackey@calpoly.edu

Keywords: Executive Leadership, CEOs, Firm Performance, Leadership, Variance Decomposition, Managers Forthcoming in Strategic Management Journal

THE EFFECT OF CEOS ON FIRM PERFORMANCE

ABSTRACT The extent to which CEOs influence firm performance is fundamental to scholarly understanding of how organizations work; yet, this linkage is poorly understood. Previous empirical efforts to examine the link between CEOs and firm performance using variance decomposition, while provocative, nevertheless suffer from methodological problems that systematically understate the relative impact of CEOs on firm performance compared to industry and firm effects. This paper addresses these methodological problems and re-examines the percentage of the variance in firm performance explained by heterogeneity in CEOs. The results of this paper suggest that in certain settings the “CEO effect” on corporate-parent performance is substantially more important than that of industry and firm effects, but only moderately more important than industry and firm effects on business-segment performance.

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Do CEOs have an impact on firm performance? And if they do, where in a firm do they matter most—at the corporate or segment level? These questions have captured the attention of business scholars and practitioners for over a century (Bass, 1991; Carpenter, Geletkanycz, and Sanders, 2004; Yukl, 2002). On the one hand, some theorists (Barnard, 1938) and many

practitioners (e.g., Drucker 1954; Collins, 2001) have argued that leadership—especially in a firm’s senior positions—has an important impact on firm performance and survival at all levels. Barnard (1938), for example, argued that top leaders formulate a collective purpose that binds participants in an organization; Selznick (1957) described how top leaders infuse an organization with values; Schein (1992) argued that top leaders help create an organization’s culture; and Tichy and Cohen (1997) argued for the crucial role of top leaders in deciding an organization’s course of action—especially in the face of technical and environmental change (Woodward, 1965; Lawrence and Lorsch, 1967; Thompson, 1967). All these effects of leadership are thought to be leveraged throughout an organization (Rosen, 1990), resulting in a substantial impact on a firm’s performance. On the other hand, some scholars have argued that leadership influence on firm outcomes is limited by environmental, organizational, and legitimacy constraints, which restrict executive choice (e.g., Hannan and Freeman, 1989; Pfeffer and Salancik, 1978; DiMaggio and Powell, 1983). Without choice, CEOs can do little to influence firm outcomes (Hambrick & Finkelstein, 1987). From quite a different perspective, other scholars have suggested that leaders, such as CEOs, play more of a symbolic than substantive role in organizations (Pfeffer, 1981). In this view, performance outcomes are attributed to CEOs as a way to make sense out of complex organizational outcomes (Calder, 1977; Pfeffer, 1977; Meindl, Ehrlich, and Dukerich, 1985). Empirical support for these perspectives is often linked to a body of research that estimates the percentage of variance in firm performance explained by a firm’s CEO (e.g. Lieberson and 3

O’Connor, 1972; Weiner, 1978; Thomas, 1988). Overall, this empirical literature suggests that the impact of CEOs on firm performance is modest, at best (Finkelstein and Hambrick, 1996), which has led some scholars to conclude that the search for explanations of variance in firm performance needs to focus on other variables, since “factors outside the control of any single individual drive organizational performance” (Podolny, Khurana, and Hill-Popper, 2005: 2). This paper...
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