“If you take the Fortune 500, we do not have the 500 best quarterbacks in each one of those teams. In the end, part of the success of our economy will depend on having the right managers running the right businesses. Any time a business is run by a 6 when you could have a 9 in there, not only the business suffers, but the whole economy suffers. You need able people and, to the extent you can, the very best people running these companies,” explained Warren Buffett (Trades, Portfolio).
He believes most CEOs lack the elite talent seen in top athletes. Unlike Olympians carefully chosen on pure merit, CEO selection processes remain inconsistent, resulting in abundant mediocrity.
Reasons for mediocre CEOs
The Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) leader attributes the abundance of mediocre CEOs to flawed selection processes at many companies. He points out that, unlike carefully chosen Olympic athletes, CEOs are not vetted so thoroughly. There is no standardized, rigorous mechanism to surface the most talented managerial candidates.
The Oracle of Omaha observes huge inconsistencies in competencies among CEOs. Just like any profession, the set of corporate leaders contains some brilliant superstars, but also many average and even incompetent managers. Boards often pick candidates based on factors besides proven business leadership skills and end up with mediocre, unsuitable CEOs.
Some mediocre CEOs are even unable to make thoughtful capital allocation decisions in their personal investment portfolios. Yet these same individuals are entrusted with allocating billions in shareholder capital for acquisitions and investments.
Buffett has recounted seeing CEOs who cannot decide whether well-known consumer brands like Gillette are attractive investments. But the very same CEOs unflinchingly approve multibillion-dollar takeovers of entire companies based on recommendations from advisors. Such a lack of judgment contributes to inefficient capital allocation and poor shareholder returns.
Examples of mediocre CEOs
Many subpar CEOs rely excessively on external consultants instead of their own business sense. Buffett once told the story of a company making serial acquisitions, none of which succeeded. When the CEO wanted to make a ninth purchase, Buffett suggested reviewing why the previous deals failed. But the CEO plowed ahead regardless, demonstrating a stunning lack of self-awareness and a tendency to repeat obvious mistakes.
The billionaire investor has also provided examples of CEOs who cannot even manage their personal finances well, yet are responsible for leading billion-dollar corporations. The disconnect between their lack of skill in assessing simple investments versus making huge strategic decisions is a hallmark of mediocrity.
Buffett recalls seeing CEOs tout quarterly earnings targets and make overly optimistic projections. When results inevitably fail to match the hype, these CEOs are unwilling to acknowledge their mistakes. Instead, they cling to unrealistic forecasts, hurting credibility with shareholders.
Problems caused by mediocre CEOs
Buffett stresses that mediocre CEOs can have detrimental consequences on their companies as well as the overall economy. Weak management means missed opportunities and a high cost of capital. It diminishes corporate performance and competitiveness.
Poor acquisition decisions by clueless CEOs are a prime example. Overpaying for flawed deals wastes precious capital that should be directed to worthy projects. Misguided takeovers engineered by mediocre managers end up destroying substantial shareholder value.
Many subpar CEOs spread dysfunctional corporate cultures and incentive systems that promote the wrong behaviors. Setting unrealistic quarterly earnings targets feeds short-term thinking and unethical actions that sacrifice the long-term health of the business.
The lack of accountability endemic among mediocre CEOs takes a financial toll. Buffett favors clawback provisions mandating that CEOs at bailed-out banks lose their personal fortunes. Imposing downside risk would discourage reckless actions and align managers with shareholders.
The need for able CEOs
Given their pivotal influence, Buffett stresses the economy depends critically on having the most talented CEOs leading corporations. When mediocre managers are at the helm, both their companies and the overall economy suffer collateral damage.
Conversely, superstar CEOs like Bill Gates (Trades, Portfolio) stimulate tremendous innovation and prosperity. Their bold strategies and flawless execution contribute immense value to shareholders, employees and society. All stakeholders benefit from the presence of exceptional corporate leaders.
Having the right CEOs in place amplifies the performance of the entire 150 million strong workforce. If even a small percentage of major corporations were led by CEOs unfit for the role, Buffett believes the aggregate consequences would be severe.
The U.S. economy cannot reach its full potential when corporations are saddled with mediocre leadership. While America has superbly talented workers, deficient senior management prevents optimal capital allocation and business strategy.
Buffett’s solution
To address the mediocre CEO problem, Buffett wants to see greater selectivity and accountability in how corporate leaders are chosen. For example, he advocates that all CEO candidates demonstrate savvy capital allocation skills by compiling a successful investment track record managing their personal finances.
Boards should test candidates on their ability to weigh simple investment options. Assessing such skills in advance would reduce the likelihood of choosing leaders unable to make optimal capital deployment decisions.
In addition, Buffett thinks CEOs already make overly optimistic forward-looking projections. When results inevitably disappoint, they refuse to admit their error and lower expectations. Here again, testing for humility and transparency during the hiring process would weed out those unfit for the role.
Once CEOs are selected, Buffett favors increased transparency and consequences. CEOs already make forward-looking statements. If they fail to deliver and sacrifice shareholder value, he believes they should forfeit their pay and job.
Rational compensation schemes rewarding long-term results, not short-term numbers, should be implemented. When CEOs earn eight-figure paydays despite mediocre performance, it encourages the wrong behaviors.
Boards of directors must be willing to objectively evaluate CEO performance and dismiss inadequate leaders. Too often, personal relationships cloud judgment and prevent corrective action. Prioritizing the company’s welfare means replacing subpar CEOs before more damage is inflicted.
Transforming corporations through better leaders
In Buffett’s opinion, the majority of CEOs are not top caliber, but rather rank as average performers. Like professional athletes, the talent distribution consists of superstars, solid players and weaker ones. But unlike sports teams stacked with elite performers, many corporations are handicapped by mediocre CEOs.
This leadership mediocrity has far-reaching effects, negatively impacting companies and the broader economy. Fortunately, implementing measures such as enhanced selection procedures, accountability measures, incentives based on long-term metrics and active board oversight can help attract and retain exceptional, shareholder-aligned CEOs.
With the right CEOs in place, corporations can unlock their full potential, maximizing opportunities for shareholders, employees and society.
