What do bosses do?

The news that bosses' pay has soared raises a question no-one seems keen to ask: what, exactly, do bosses contribute to company performance?
Truth is, it's not clear that they add anything.
Take Terry Leahy, CEO of Tesco. He's probably the most respected FTSE 100 boss. So you'd expect Tesco's performance to be much better than its competitors. Is it? Well, these figures show that in 2005-06, Waitrose made a profit of £11,830 per full-time equivalent worker. Figures here suggest Tesco's profit per worker was £8350. Leahy's allegedly superior management nous doesn't translate into obvious out-performance of a worker-owned competitor.
And this might be true generally: other evidence suggests worker-owned firms beat orthodox capitalist ones.
So, do bosses matter? The best recent evidence that they might comes from this paper. The authors looked at what happened to Danish companies after bosses die. They found that profits fall by an average of 18% in the two years after the death of a CEO. This suggests CEOs do create profits. What's more, profits also fell if the CEO suffered a death in the family - a child, spouse or parent but not (in vindication of Les Dawson) mother-in-law. This suggests company performance suffers if the boss takes his eye off the ball*.
Sounds convincing? No.
First, the study found that it's only CEOs' deaths that reduce profitability; the death of board members makes no difference, which suggests most top executives don't add to profits.
Secondly, the CEOs who die might not be a random sample of all CEOs. They might be better than average ones - say, because they are unusually highly driven and so more prone to heart disease.  If so, falling profits after their deaths might merely show that better-than-average bosses create profits, not that the average boss does. Evidence for this is that corporate profits were higher than average in these firms before the CEO died.
Thirdly, the paper leaves unanswered the mechanism whereby CEO death depresses profits. If profits fall because candidates to replace him jockey for the top job rather than do their own job, then this is evidence that hierarchy is bad for firm performance.
Fourthly, this might be evidence not that management works, but rather that the belief in management works. Maybe centuries of indoctrination by leadership ideology has led people to think that they can and should work hard only if a boss is there to lead or motivate them.
An analogy might help. Say a medieval scholar wanted to find if God existed. So he looked at villages whose priest died. And he found that sin in these villages rose relative to villages where the priest stayed alive. He infers that God as mediated by the priest is a force for good.
But this inference wouldn't necessarily be correct. Maybe God doesn't exist, and the priest is just a charlatan, and all the scholar has found is that people believe erroneously in the magic of the priesthood.
I draw this analogy because Alasdair MacIntyre did:

"Managerial effectiveness" functions much as Carnap and Ayer supposed "God" to function. It is the name of a fictitious but believed-in reality, appeal to which disguises certain other realities.

Perhaps in a few decades' time, we shall regard CEOs in the same way atheists today regard the corrupt medieval clergy - as people who exploited a fictitious and regressive ideology to accumulate power and wealth at the expense of others.

Comments

[Mark Wadsworth]

Picking up on your analogy with the priest/charlatan, the last few centuries have shown that less religious societies (to wit, the West and Japan) have vastly outperformed societies run by Communist or Islamic dictators/theocrats.

So if worker-managed companies do so much better, how come there aren't more of them? Why have the manager-managed companies not fallen by the wayside?

(Which is not to say that most FTSE-100 Board Members aren't rapacious back-stabbers, or anything).

[chris]

There are more partnership firms than stock-market quoted companies - there's only around 3000 of the latter. As for why there aren't even more co-ops, I tried an answer here:
http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2007/03/why_arent_there.html

[Jim Donovan]

I suspect you're guilty of letting selective data confirm your prejudices. A 41% edge in profit/worker sounds significant to me (BTW: Waitrose have a boss too), and most so-called partnerships still elect a leader.

Other factors can also come into play. A bad boss may be mitigated by a good business, good decisions by predecessors, favourable market conditions, or good luck; and a great boss may be struggling with a bad business, bad decisions by predecessors, bad market conditions or bad luck.

Large listed companies often have some scale and momentum which mutes the impact of 1 person. What about smaller listed firms and private companies?

Anyone who's worked for a great boss or a bad boss knows they make a difference - and it usually shows up in the results. Most boards and workers know empirically that a bad boss is bad for the company, and that a good boss is better than a bad boss. Bosses have impact.

[chris]

Granted, a good boss might be better than a bad boss; no doubt Tesco would have done worse under someone other than Leahy. But the average company - by definition - has an average boss. What contribution does he make?
And if bad bosses can seriously damage a company, doesn't this show the folly of giving one individual so much power?

[Jim Donovan]

There's a Darwinian process of getting to be the boss, and the average boss is a better boss than the average person.

[Mark Wadsworth]

But the average company - by definition - has an average boss

But surely, an average hospital has average nurses and doctors, an average office cleaning company only has average cleaners (and so on ad infinitum).

They are still (nearly) all adding a bit of value, they (nearly) all have their place in the scheme of things and (nearly) all are making the world a slightly better place, are they not?

[Bob B]

"Waitrose made a profit of £11,830 per full-time equivalent worker. Figures here suggest Tesco's profit per worker was £8350."

Focusing on ratios can seriously mislead - the cost-per-kill ratio of bows 'n' arrows is superbly low so why don't we scrap the costly Eurofighter?

If you must focus on ratios, how does Tesco's return on capital employed compare with Waitrose's?

[Mark Wadsworth]

"the cost-per-kill ratio of bows 'n' arrows is superbly low"

Bob B, are you factoring in the notional cost that all grown men had to spend all Saturday and Sunday at archery practice? That must be about 15% of GDP.

[Stuart]

I would assume that the profit/worker ratio is (entirely?) due to focusing on different market segments. It might also be due, in part, to Tesco's success in recent years; but either case would say little on how cooperative companies perform against their more heirarchical competitors.

I'm not saying you're wrong - I'm happy to admit my ignorance here - just that the given Tesco/Waitrose example doesn't justify the conclusion drawn.

And to further admit my ignorance, who cares about profit per worker? I'm guessing Tesco's shareholders are quite happy to keep the _total_ profit generated, presumably in least in part by Leahy.

Of course, I read somewhere that Tesco was the only main supermarket to have a unionised workforce, so presumably they more closely resemble a co-operative than, say, Asda; In which case Tesco's success might even support your argument.

[Bob B]

Mark - LOL! In fact, a serious if mostly forgotten issue is involved here and one that led to protracted RAND Corporation debates in the late 1950s and early 1960s when some in America took to citing cost-benefit ratios and cost-per-kill ratios as decision criteria for shaping US defence policy.

At the time, Roland McKean: Efficiency in Government Through Systems Analysis (Wiley, 1958) pointed out if applied rigorously, minimising cost-per-kill ratios led to scraping costly ballistic missile systems and adopting bows 'n' arrows as a preferred weapons system.

He went on to suggest that wasn't very convincing as a US military strategy and that the Soviets would likely win any engagement should the US adopt it. The right criterion is to maximise the present value of the difference between the revenue stream (or kills in military contexts) and the cost stream. Applied to business, maximising the difference maximises shareholder value. There was a later debate in the capital-budgeting literature between advocates of ranking business projects by profit-capital cost ratios and ranking projects according to Net Present Values. The latter maximises shareholder value while the former, in general, does not.

Something similar applies here. If Waitrose invests more per employee - in better fitted and kitted stores than Tesco and locates the stores in more costly locations (so as to attract more refined customers - as The Economist once nearly put it) - then it really isn't surprising that Waitrose earns more profits per employee than Tesco does. Indeed, if Waitrose didn't it would be in serious trouble.

[jameshigham]

...Truth is, it's not clear that they add anything...

Chris, you never change. Fictitious but believed in reality? The management I see today operates anything but this way.

[Mark Wadsworth]

Bob B, I was being serious.

If I had to choose between wasting every weekend practising archery, or paying and extra 1% income tax for some nice juicy nukes, I'd go for the latter.

Actually, being a pacifist I'd prefer a neither/nor option, but hey.

[dearieme]

"There's a Darwinian process of getting to be the boss, and the average boss is a better boss than the average person." Very likely. But more certainly 'the average boss is better at getting to be the boss than the average person'.

[potentilla]

Your suggestion that worker-owned firms perform better than orthodox capitalist ones may or may not be true (although comparing public domain figures - which may well be apples and pears - for a single pair of companies gives us more or less no evidence either way).

But what on earth does this have to do with "do bosses matter"? The JLP has a boss; he earned £833,000 for the year to 27/1/07. If you look at the JLP website, there is absolutely no evidence that the way it is run is any different from any listed company.

I have a lot of sympathy with the view that the role of the CEO is over-hyped; I think that much of what happens (good or bad) during a CEO's tenure is actually due to chance. BUT that's quite different from suggesting that worker-owned companies do better financially than capitalist ones because they are run differently in respect of the role of the boss. They aren't.

[Morten Bennedsen]

Dear Chris,
I was very surprised to discover that our little study has caught your eyes, deads are always sexy stuff. It is always fun to readers how people outside our small academic circles interpretate your work. A few comments to your 4 arguments:

Re 1)You are right that the death of individual board members had no effect. It is generelly hard to measure individual board members contribution to a firm's profit. However, it is also true that boards as such matter in our study. In Denmark 1/5 of the firms do not have boards. CEO deaths are significantly more costly when the firm has no board. Our interpretation is that boards are valuable when firms are in crisis.

2) This interpretation is flawed. Denmark has registers for everything and we know the courses of death as well as the length of hospital stays etc etc. Thus, we can look at different groups of deaths (heart deseases, cancer etc) as well as expected (long hospital stays) vs non-expected deaths. We find no evidence for your story.

3)Interesting point. We do not know yet the answer to this question. However, we are embarking on a follow up study that will address the mechanism through which the ceo contribute value. E.g. we know all the hirarchy in the firms and can test which organizational structure that has most/least valuable CEOs.

4)Now if you read the paper we say that the CEO creates value not that he/she (in Denmark mostly "he") works hard. There are many interpretations of this, even if he is just the priest, the corporation is more value with him than without. To be honest I am more concerned about another interpretation that you may like: Maybe the CEO centralizes power and makes himself indispensable by not delegating anything. Acoording to this story, he does not need to have any value (ex ante)when he is hired, however when he dies he has monopolized all information and decision power. That would generate that the firm looses when he dies eventhough that he is not really adding any value. Read the next version of the paper for more on this.

[Mark Wadsworth]

Cool, a Danish blogger.

What I want to know (in plain English) is, how does property/land/home taxation work in Denmark?

A lot of people say it is a 1% tax each year but other people say it is much more complicated than that.

[dreamingspire]

Chris, I have been trying to apply the thread here (blog article plus comments) to the problem of too often poor performance in the public sector when public servants have to deliver services. 'Yes, Minister' may have been closer to the truth than we realise, in what it didn't show: actually the senior civil servants want to please the Minister (the boss), whether or not that delivers good services.

[reason]

"There's a Darwinian process of getting to be the boss, and the average boss is a better boss than the average person." Very likely. But more certainly 'the average boss is better at getting to be the boss than the average person'.

Yup!

But maybe it is like hitch-hikers guide to the galaxy - maybe the best bosses are people who don't want to be the boss. Then the Darwinian process would fail.

[SamH]

I think it's just that Waitrose have insanely high mark-ups, Waitrose don't have pressure to compete on price terms as they go for the high end of the market.

[dearieme]

But are their pork pies as good as Marks Expensive's?

[Kevin Carson]

Jim Donovan,

Bosses matter precisely because, by the nature of hierarchy, so much depends on their performance. That's a good argument against hierarchy in my opinion.

Mark Wadsworth,

One reason cooperatives don't supplant traditional capitalist enteprises, perhaps, is that they are competing in a structural environment that favors capitalist enterprises. One might just as well ask, "if the capitalist corporation is so efficient, why didn't it do better against state enterprises in the Soviet planned economy?"