How important is it to hire the best person for the job?
Here’s a data point: On Friday, Hewlett Packard’s CEO Mark Hurd resigned unexpectedly — and pretty much instantly the value of HP stock dropped by about $10 billion. If we assume Hurd would otherwise have been around for another 10 years or so, that means shareholders think his departure will cost the company about a billion dollars a year. Which, incidentally, makes his $30 million or so in annual compensation look like a hell of a bargain.
Now maybe some part of that $10 billion reflects expected short-term losses due to the turmoil of an unplanned transition. But even if that turmoil were to cost HP a full month of revenue (which seems like a pretty extreme assumption), that’s still less than a billion — leaving over $9 billion to represent the difference between what the market expected from Hurd and what it expects from his successor.
This doesn’t mean Hurd is that much better than anyone who could run HP, but it might mean he’s that much better than anyone HP is likely to hire. Most of the world’s best executives are already occupied. Hurd’s replacement will come from the second string. So (insofar as we are reckless enough to extrapolate from this one data point), it appears that there’s a huge gap between the very best and the almost-very-best. Like in baseball, where the 1000 or so major leaguers are, well, in an entirely different league from the 1000 best minor leaguers.
If this kind of gap is the norm, then there’s a huge cost to diversity-for-the-sake-of-diversity in positions that require extraordinary talent. Do you really want to settle for a distant second best just so you can fill your Albanian quota?
Coincidentally, the news from HP comes just as President Obama is seeking a replacement for departing economic advisor Christy Romer. It’s been reported that the President believes it’s important to hire a woman.
Couldn’t shareholders be reasoning that Hurd knows more about HP than they do and that they therefore might want to take his eagerness to leave into account when deciding weather to buy/hold shares in HP? Or just short term panic?
Is it possible that shareholders regard the unexpected resignation of the CEO as a signal that some problem within HP may have lessened its value? The drop in stock value could be caused by shareholders’ interpretation of the significance of the news — a clue that something bad may be happening — rather than just their estimation of the relative merits of the old CEO compared to his likely replacement.
Well obviously if CEOs are so cheap to hire compared to their worth, HP will just go offer double to another of the anointed Big Leaguers at some other company and steal him away.
Or do we only assume efficient markets when it supports our arguments?
There’s no need to extrapolate from a single data point, CEOs leave their jobs quite regularly – a google news search on “CEO resigns” gives HP, Lattice Semiconductors, Octopus, CityJet, AKVA, GeoGlobal all in the past few days. So I imagine we could find a lot of data to judge whether the initial change in share price reflects anything genuine about the long term prospects (i.e. price stays depressed for a long time) or reflects initial panic and trend-following (i.e. share price bounces back quite quickly). Also, where a CEO leaves to join another company we could look at the share price of the new company to see if it quickly goes up and stays there to reflect genuine belief in the quality of that CEO.
Or you could believe in the real world, and not efficient markets, and realize that the stock market does idiotic things, (or that there is a rational explanation, like those given above, other than ludicrous executive valuation) – And that most CEOs have no skills worth mentioning but the ability to ass-kiss to get to their positions where they proceed to plunder their companies and the taxpayers if they can. Comparing CEOs to people with real skill, who do real, useful work, like baseball players – what a laugh.
“It’s been reported that the President believes it’s important to hire a woman.”
I am someone that has the right to vote for POTUS. I believe it is important to hire the very best person regardless of sex or ideology.
Jonathan Kariv and Jeff Semel: Good points.
Fenn: Good point. There do seem to be political constraints on CEO compensation that might weaken this point slightly, but it’s still a good point.
EricK: Not all of these data are useful, because in many cases, a CEO’s departure is triggered by news that he’s doing a less good job than previously expected. You need to confine your study to CEOs who left unexpectedly for reasons unrelated to job performance, which is probably relatively rare. You are right that a good place to start is with those who leave to join another company.
Voice of Reason: most CEOs have no skills worth mentioning. I am sure that a person who knew little enough about baseball could easily watch a professional baseball game and tell you that pretty much anyone could do just fine out there.
Steve: All the data points are potentially useful if only to act as controls. If, for instance, a similar effect occured whether a CEO was fired, quit unexpectedly for “personal reasons”, quit to get a new job, or died, then that would be good evidence that the effect was due to the market’s reaction to the uncertainty.
To pick up on SL’s baseball analogy. The difference between a 300 hitter and a 275 hitter is just one grounder every 4 or 5 games. it may not stand out at a glance. But if each extra right decision the CEO makes (each extra hit for the batter) is worth a few hundred million — it adds up.
completely off topic but someone at HP labs, has apparently published something claiming to prove P!=NP. I don’t know enough about the things he uses to check it but he seems to not fill the usual crank description.
http://gregbaker.ca/blog/2010/08/07/p-n-np/
Jonathan Kariv: I am planning to blog on this soon.
I figured that only Steve Landsburg could figure out a way to say that the CEO’s of major American companies are UNDERPAID.
Why don’t major companies poach other company’s CEOs at higher and higher salaries until they meet the market value?
Why don’t the stock market valuation of companies plummet when the CEO gets picked as a Cabinet Secretary? Did Goldman Sach value nosedive when Hank Paulson left to become Treasury Secretary?
I agree with the first-string/second-string assessment. We pay too little attention to that in many walks of life.
But, there’s no excuse for a company the size of HP to not have a succession plan with first-stringers ready to take the helm in such a scenario.
Perhaps investors are reacting to the shock of a Board of such a large company not appearing to have a good succession plan. Not having a good succession plan may also mean that the Board isn’t doing other things well.
While an unexpected non-performance-related CEO departure may not be worth $10 billion, a poor quality Board can be.
Maybe, rather than reflecting the loss of Hurd’s marginal product, the drop reflects the shareholders’ loss in the confidence of the HP BOD which voted unanimously to ask for his resignation over a relatively trivial ethics matter. Or perhaps shareholders disbelieve the stated reasons why Hurd was fired (asked to resign) and are worried that there is more bad news to come out.
Maybe HP stock is down because investors think that if Hurd could hide a personal expense scandal, then he could be hiding more substantial company financial problems. Or maybe because they lack confidence in the HP board, either because they negligently overlooked unacceptable CEO conduct, or because they foolishly overreacted to a petty matter. I think that it is very unlikely that the investors really thought that Hurd was so valuable.
Apparently allegations of harassment have something to do with it:
http://news.yahoo.com/s/ap/20100809/ap_on_hi_te/apfn_us_hp_ceo_resigns;_ylt=Agk5XoDjOx4pVdiioK8XIEms0NUE;_ylu=X3oDMTJyZWw2NG5qBGFzc2V0A2FwLzIwMTAwODA5L2FwZm5fdXNfaHBfY2VvX3Jlc2lnbnMEY3BvcwM4BHBvcwM1BHNlYwN5bl9oZWFkbGluZV9saXN0BHNsawN3b21hbmluaHBzY2E-
Another possibility is that Hurd really was fired for poor management reasons that have not been revealed. The board was just looking for a reason that would not frighten investors.
Seth, Neil and Roger Schlafly: Good points all.
Even if his reasons for leaving were above board, couldn’t the stock price have dropped to reflect the uncertainty of hiring a new CEO? Heaven help them if they hire another Carly Fiorina – that’d cost them in excess of $10B in poor decisions and leadership. If true, I would expect the stock price to rebound when HP finds a new competent CEO.
Maybe the shareholders are afraid of re-hiring Fiorina.
Maybe the stock market moves are exagerated because short term traders that react to news events (as opposed to long term investors) are inherently leveraged? Non-leveraged long term value players by definition don’t have the capital to sustain a price level forced down by a stampede of hedge fund selling and stop levels being triggered (unless they sell out of other investments but again – they don’t typically keep track of everything in their portfolio to quickly switch in and out of asset classes).
Steve,
If you are wrong and those who are scoffing at the idea that the CEO is really that valuable are right, wouldn’t there be money to be made investing in HP stock right about now? Maybe others out there will see the profit opportunity due to the irrational stock price fluctuation and bid the stock price back up by tomorrow. The longer the price stays down, the more right you look. If the price goes back up quickly then I will be more inclined to believe the scoffers.
Does the claim of a CEO at $1B/year being worth 10,000 employees at $100K/year really pass the smell test?
http://www.marketwatch.com/story/h-p-stock-price-error-caused-by-mismarked-trades-2010-08-09?reflink=MW_news_stmp
For some speculation, see 5 reasons HP’s Mark Hurd resigned.
I am sure that a person who knew little enough about baseball could easily watch a professional baseball game and tell you that pretty much anyone could do just fine out there. I am sure that a philosopher unworldly enough could look at the declining Roman Empire and say that everything was hunky-dory, because the aristocrats driving the ordinary Romans into debt-peonage were highly skilled in slave-management, theft and political corruption. These kind of skills, the kind taught at our institutes of higher learning called Business Schools or State Penitentiaries, are what highly paid modern American CEOs know – how to ass-kiss, corrupt and steal without conscience. American CEO salaries don’t pass the giggle test.
So, given that HP officially closed on Friday at $41.85. The Hurd announcement was made after the bell that same day, and shares actually rose on Monday to close at $42.86, does that mean that instead of being a $10B asset, the market thinks Hurd was a $1B liability? Should he pay all his money back?
http://finance.yahoo.com/q/hp?s=HPQ+Historical+Prices
DividedLine,
Check it out:
“Adding confusion to H-P’s stock movement Monday is its conflicting closing prices Friday. According to the NYSE, H-P’s primary exchange, the company’s stock closed at $46.30. However, because some after-hours trades on other exchanges got included into H-P’s composite price, the stock’s closing price was listed as $41.85 at many locations.
The $4.45 spread between the closing prices Friday was why some price quotes showed H-P shares Monday as rising, while others showed it falling.”
http://online.wsj.com/article/BT-CO-20100809-715870.html
I rather enjoyed listening to the chatter of the guests and hosts on CNBC about this matter when it came to the severance package. Fortunately, at least one reporter noted that HP may be required by Hurd’s employment contract to pay those amounts since his impropriety may not have been at a level to void it.
Not a one, during my time watching, ever considered that providing a “comfortable exit” for Hurd might not at all be about him (or the actions that lead to the end), but might be amount signaling the next generation about how they might be treated at exit. That is, of course, even if the impropriety was the reason for the action.