ABSTRACT
We report here how accurately a psychologically oriented assessment system adds to the prediction of managerial success or failure. This system uses established clinical psychological assessment methods that go beyond interviewing and reference checking to examine an executive’s psychological tendencies to react in business situations in ways that create or destroy value. We present data generated using this clinical method for nine operating executives assessed on behalf of a particular private equity firm. We examine whether assessment indicators predicted the executives’ actual performance as measured by the investors. Overall, investors rated five of the nine assessments as 100% accurate in predicting how the executive would perform, three as 80% accurate, and one as 70% accurate. We discuss these findings and their implications for investors.
Summary
There is wide agreement that the quality of top managerial leadership greatly influences the success of any business. The character and personality of the leader can drive the success or failure of business outcomes.[1] Leadership quality is especially important in private equity-funded ventures, where the stakes are high and the decisions of operating managers are therefore crucial.
This paper demonstrates the application of a clinical psychology method of assessment to nine operating executives of companies invested in by a particular private equity firm. It shows how this system can provide unique insights into the leadership quality of prospective portfolio company executives. Private equity investors who use these insights appropriately can add value to their investments.
Investors have a choice when conducting due diligence on management. One choice is to look at management’s past performance. The past is a good predictor of how managers will deal with circumstances they have dealt with in the past. In private equity funded ventures, however, circumstances surrounding an executive’s performance usually differ on at least one crucial dimension: the relation between the executive and the investor group. The circumstances that surround the executive’s future performance are not the same as those that gave rise to the executive’s past performance. The past can be a sufficient basis for predicting future performance when the candidate is strong in dealing successfully with diverse circumstances. Usually, however, executives perform repeatedly well under the same circumstances. A Green Beret who has handled 23 different crises successfully is likely to have the resourcefulness and courage to devise strategies to handle a 24th challenge. An executive who has handled the same crisis successfully 23 times gives little evidence of the capacity to deal with a different crisis.
Investors have another choice when conducting management due diligence. That choice is to do what they have been doing already. We challenge you to think through your implicit assumptions when assessing management. Exhibit 1 suggests some questions you may ask yourself and your partners to assess how closely your past judgments predicted operating executives’ performance. If you discover you have not thought through what you expected. If you were happy with your results, you will be interested in thinking about the assumptions you made that helped generate those results. If you were unhappy with your picks, then you should be interested in thinking about the alternative approach this paper sets forth.
This paper has two messages. One, we can help you predict better who is going to be able to handle unpredictable circumstances. Two, no matter how good the portfolio executives and no matter how you find him or her, our assessment system can help you manage them better, enhancing portfolio returns.
I. Introduction
Can private equity investors increase the odds that the executives running their portfolio companies will perform capably under stressful conditions? For example, how will operating executives respond if energy prices go up 30% in three months or if a significant war breaks out? How will they handle especially unforeseen challenging circumstances when the stakes are high?
This paper presents data generated using a clinical psychology method of assessment for nine portfolio company executives of a particular private equity firm. It is one in a series of papers establishing the validity of a structural psychological approach to helping to select executives of private equity-funded ventures. This approach links three components: the operating executives, the enterprise business strategy, and the execution of that strategy. This paper describes our approach, which deals with each particular situation concretely, rather than trying to draw general conclusions from the observed facts.
Private equity-funded ventures operate under conditions of high stress, possess limited resources, and have short, possibly unforgiving, time spans for achieving goals. Investors depend upon portfolio company executives to manage the business to meet the desired financial returns. Many experienced private equity investors regard the quality of management to be a decisive factor in a venture’s success. Predicting how management is likely to perform under stressful operating conditions is one of the most difficult evaluations investors must make.
Typically, investors look only at what an executive has done in the past. To validate an executive’s history, they may conduct interviews or check references. That approach relies solely on measures of past performance. On its own, past performance is inadequate to forecast the future. As Warren Buffet (and the S.E.C.) has reminded us, past performance is no guarantee of future returns. Measures of past performance confound individual capability and situational factors. How an executive has performed in the past may not predict how he or she will perform in the future – especially as industry and organizational conditions change. To predict how an executive will perform in challenging and novel conditions requires a model that takes into account the dynamics of the interactions among the executive, the enterprise strategy, and the operating environment. We want to know the effects of each component and their interaction effects with a high degree of detail to strengthen our certainty that executives can perform as expected.
Here, techniques borrowed from clinical psychology can help. These techniques, combined with customary management evaluation tools, increase the accuracy of executive selection and thereby enhance portfolio returns.
Previously, we presented a psychological model for predicting leadership in challenging or changing conditions.[2] In research funded by the University of Chicago Graduate School of Business, we led the first systematic effort to identify in advance individuals with the psychological resources needed to be successful business leaders. We established the ability of measures under our hypotheses to predict leadership effects, beyond conventional standards of chance occurrence, among already high-achieving individuals.[3] Subsequently, we conducted the first-ever empirical study into the personality characteristics of successful CEOs of private equity-funded ventures.[4]
A central feature of our model is a construct called active coping (see Appendix D). Active coping is the readiness to adapt resourcefully and effectively to challenge and change. Active coping predicts the behavior and success of leaders when the setting – the characteristics of the environment to which one is making predictions – cannot be fully specified in advance.
In this paper, we examine how well this model predicts the performance of executives functioning in private equity-funded ventures. We seek to enhance investors’ due diligence by establishing whether operating executives who have a disproportionate influence on firm performance (measured as cash-on-cash returns) will successfully achieve the goals of the enterprise business strategy. The initial formulation of this strategy is a product of investors’ skill combined with their understanding of the executives who will have to implement it. Investors and the portfolio company executives will have to adjust to respond to changing circumstances.
As noted, we assume that an executive’s past performance is partially the result of happenstance, that is, factors extraneous to and uncontrolled by him or her. We do not infer that an executive’s past success automatically implies the capacity to succeed in a new environment. Rather, we disentangle the role of chance and circumstance from the executive’s objective past and ongoing ability to function under conditions of challenging uncertainty.
Just as investors evaluate a company to understand the underlying enterprise bases for earnings growth, we assess an executive to explain and predict individual performance. We measure performance success against the degree to which the executive has met the requirements of his or her role. Those role requirements follow from the investment thesis articulated by investors, and elaborated and accepted by operating management. Our prediction of how the executive will function in the management role emerges from an analysis of the person, the organization, and the environment.
Our clinical method allows us to assess the underlying psychological forces that lead to success or lack of success among already high achieving individuals. By examining the person-organization-environment interplay, we can set forth scenarios in which an executive’s underlying psychological tendencies might present risks – or opportunities – to investors, so that investors can provide appropriate support and incentives. Thus, in addition to helping in the due diligence process, our clinical method also indicates ways to structure and manage the relationship between the investor group and the operating executive.
Our model incorporates a time dimension in the definition of success or failure: the longer the interval between assessing predictor variables and measuring outcome variables, the greater the chance that outcomes could deviate from expectations. Individuals change and conditions change.
In this paper, we focus on how closely predictions generated by our system were borne out in reality. We begin by describing the characteristics of our data. Then, we report our findings. In the discussion, we describe how characteristics of our model uniquely lend themselves to predicting performance in conditions of complex and possibly dangerous uncertainty.
II. Method
A. Population and Procedures
We look at assessments performed between 2002 and 2006 carried out on behalf of one particular middle-market private equity firm. These investors had actual performance data against which to compare indicators from our assessment. The firm makes control equity investments in companies where its experience and resources can be applied to accelerate earnings growth through aggressive investment management plans. It typically does not make turnaround or venture investments. By limiting our analysis to assessments performed for this one private equity firm, we eliminate variability among investment styles of different private equity firms and focus on companies where management capability is an important factor in the success of the investment. In this paper, we formally compare our assessment findings to the operating executives’ actual performance. Firm and operating executive performance measures were provided by investors two, three, and, in two cases, five years after we had assessed the executive.
The circumstances of the assessments varied on two dimensions. First, at the time we made each assessment, the private equity firm may or may not have already invested in the company. Second, the executive may have been either part of an incumbent management or an outside candidate hired to fill a management role. In most cases, our assessment occurred in parallel with other diligence efforts prior to a deal. In two cases, our assessment took place when investors were contemplating adding an executive to an existing portfolio company.
Before we make an assessment, we gain an understanding the specific demands of the operating environment in which the executive is to perform. We ask what investors hope to achieve by making the investment – how they plan to create value – and the executive’s role in implementing strategy. This is important in understanding and interpreting the psychological assessment.
After we make an assessment, we prepare a formal written report. The report looks at competencies and capabilities organized around factors that bear importantly on the executive’s ability to perform as required. These factors are Judgment, Influence, Management, and Personality (see Appendix A for brief definitions). To determine whether an executive has the resources to deploy these capabilities consistently and effectively under the proposed operating conditions, we assess his or her personality and psychological functioning.
The methodology we use to assess executives uses standard clinical methods adapted to address concerns of interest to investors. In particular, they need to be confident of an executive’s ability to function in a stressful environment. Appendices B and C, respectively, describe our particular assessment strategy and data collection techniques.[5]
Each psychological assessment lasted approximately four hours with the executive and followed the methodology described in Appendix B and C. The executive understood that the assessment was to provide information to the private equity firm regarding his or her managerial strengths and weaknesses and leadership style as these concerned his or her fit with the management role.[1] The executive’s test outcomes provided the basis for our conclusions and recommendations.
In the spring of 2008, we interviewed the investment professionals responsible for overseeing the deals. We had also monitored the executive’s performance through discussions with the investors at various prior intervals, occurring roughly one and two years after we had conducted our assessment. Exhibit 1 details the protocol we used to collect data on the predictive validity of the assessments. Section 2 of this exhibit describes the particular deal. Section 3 documents investors’ evaluation of the executive’s performance. Section 4 details the assessment procedure and recommendations. Section 5 documents how well our assessment predicted the executive’s actual performance. In addition to this general evaluation of our assessment, this process allowed us to collected information on many specific components of our assessment process.
B. Company and Operating Executive Characteristics
Exhibit 2 summarizes information regarding the companies included in this study. The companies fell into three industry groupings: distribution; industrial products; and business and consumer services. The nature of investors’ involvement fell into three main categories: growth (six); recapitalization (one); and revitalization (one). The first company, conceived as an acquisition vehicle, had not yet made its first acquisition at the time we assessed the CEO. The other companies ranged from approximately $70 million to $450 million in revenues.
The sample comprised nine married Caucasian men. Each had at least a college degree. The mean age was 48 years, ranging from 37 to 58 years. Overall, the sample included five CEOs, one CFO, two vice presidents of sales and marketing, and one vice president of product distribution. Of the five CEOs, two were first time. Three executives, including one CEO, were founders.
III. Data
A. Deal Performance
We seek an understanding of the process of success or lack of success. Although we do not propose to explain returns on invested capital as a simple function of portfolio company management, we do want to understand the role investors ascribe to management in a company’s success or lack of success. Exhibit 3 presents data about deal performanceand the executive’s contribution to it. In the first case, we can only look at how the executive performed and whether our assessment described how he functioned. It is our first case study. We could not evaluate the deal in terms of performance because the investors to whom we limited this analysis decided not to follow through with the funding proposed at the time they commissioned our assessment. (Another investment firm did, and the deal has been successful but with a completely different management team.)
Of two of the remaining companies (Company 2 and Company 3), investors had exited and the original thesis proved correct. In these cases, the primary metric used to assess performance was cash-on-cash returns, and the secondary metric was internal rate of returns. Investors had not yet exited the other two deals but these deals had performed well on interim measures, collected two and four years into the respective investments. Company 4 had achieved each of the milestones set forth in the original investment plan. Company 5 had continued to grow revenues at a rate of 35% a year for two years. Investors rated three of the five companies as “home runs” in terms of overall investment performance (Companies 2, 3, and 5) and rated the performance of one company as “good” (Company 4).
B. Operating Executive Performance
Exhibit 4 summarizes the data on the operating executives’ performance. We asked investors to describe the operating executive’s contribution to the overall performance of the deal. In two cases, the executive (in those cases, the CEO) “drove the success of the deal.” In four cases, the executive “was one of the keys to its success.” We asked investors to define the top three criteria for the executive’s successful performance and to evaluate how well the executive had fulfilled those expectations. In six of nine cases, investors deemed the executive 100% successful in meeting their expectations. In one case, the investor rated the executive as only 20% successful, and in another case, 80% successful. Investors decided not to go forward with supplying acquisition capital to the first executive. Overall, aggregating these percentages, investors rated the eight executives whom they could evaluate relative to their success in carrying out the expectations for their roles as generally very effective.
C. Assessment Accuracy
In eight of the nine cases, investors indicated that the assessment identified weaknesses that were borne out over time. In one case, investors indicated an unidentified weakness that surfaced as they were completing their exit; however, this weakness, which broadly concerned social integrity, was an area investors had not explicitly asked us to assess. The executive’s shortcoming led us to expand our methodology to consider this area. We discuss this issue in the second of our case studies.
Overall, investors rated five of the nine assessments as 100% accurate in predicting how the executive would perform, three as 80% accurate, and one as 70% accurate. Aggregating these percentages, our system yielded 90% accuracy. We present below the three cases where the investors initially rated the assessment as 80% accurate. The one that they rated as 70% accurate will be discussed later in the paper.
- Evaluation of Inaccuracies
This paper now attempts to explain the nature and basis of the inaccuracies in the three 80%-accuracy situations.
In one of these cases (Executive 9 in Exhibit 5), the conditions under which we thought the executive’s performance would be less than outstanding never developed. We think the investment professional related to the executive’s active, sociable, successful demeanor, which we had described in our report. However, our report also pointed to underlying coping vulnerabilities. It pointed to evidence on the less conscious levels of behavior that the executive simply denied the existence of serious problems in order to seem to cope. He could seem to cope as long as nothing actually threatened him – or as long as he could avoid experiencing the perception of the threat. Our report and feedback to the investor stated that the executive’s reliance on denial of threats as the foundation for the ability to cope in an active, constructive fashion was a considerable underlying weakness, which might undermine his performance should it become impossible to ignore threats. During the two years the investor observed this executive, the executive never encountered the threats that might have exposed his vulnerabilities. Consequently, the investor’s observations did not bear out this portion of our assessment. The potential remains that those risks could still emerge. As of now, we cannot say if this portion of our assessment will turn out to have been right or wrong if those risks do emerge.
In the second case (Executive 4 in Exhibit 5), our judgment was wrong in one circumscribed area, underestimating the CEO’s competency. We rated the CEO as very strong in all areas except the area of applied strategic vision. The investors rated him as very strong in this area too, and we agree that our standard was too high given the industry.
In the third case (Executive 5 in Exhibit 5), no real discrepancy existed between our report and the investor’s observations. In the first two cases, however, we underestimated the executive’s future performance.
D. Recommendations and Investor Role
In Section 4 of Exhibit 1, we noted the areas investors wanted our assessment to probe, our conclusions and recommendations, and whether investors accepted and implemented our recommendations. In all cases, they were.
This paper has now looked at deal performance, executive performance, and the accuracy of our assessments. In reviewing what investors said about the process, we noted that they were active participants in making the assessments useful. This is not a theoretical exercise predicting the phases of the moon. The investors play an active role by taking into account our assessment in how they work with the executive to get the best out of him or her. They took the time to understand the assessment methodology in general and to understand its specific application with portfolio executives. They challenged our logic where our observations did not match their experience but they respected our judgment. Their professionalism supported the integrity of our process. They helped us to develop a consistent approach to communicating written information that struck a balance of fact, inference, interpretation, and conclusion. They used the assessment findings to tailor their interactions with operating executives to foster the most productive working relationships. The investors also requested that we give each executive feedback on the findings of his or her psychological assessment to help bring about enhanced effectiveness on the job.
E. Illustrative Total Investment Story
Examining the total investment story allows us to see in retrospect how the investors, the operating executive, the assessor, and extraneous factors interact to produce a beneficial result. The next section presents a total investment story illustrating the interaction among these components. Exhibit 4 identifies the companies, the investment theses, and the roles of the executives we assessed in each.
A basic assumption we make is that private equity investors can influence a company’s operations in ways that lead to consistently superior returns. To exert such influence, investors develop an investment thesis, stipulating how, with their support, a particular company can accelerate earnings growth relative to alternative investments.
In Company 2, for example, the family owner-operators of the Company sought institutional ownership to facilitate an estate-planning transaction. The private equity investors planned to work with the family to extend the Company’s profitable niche focus in a highly competitive industry and to generate incremental profitability through operating improvements. Two years later, owing to a general economic downturn no one predicted, the market for the Company’s product experienced a three-year decline in unit volume. In response, senior management, with support and oversight from the investors and the family, undertook several major initiatives to improve performance and reinvigorate sales growth. These initiatives included recruiting a 25-year industry veteran to become CEO. We assessed this veteran before the investors decided to hire him. When he became CEO, he quickly identified several areas for operational improvement, cost savings, and revenue enhancement. As we forecasted, the implementation of an aggressive strategic plan by this CEO yielded positive results, invigorating management, other employees, and the Company’s lenders.
When the industry recovered, the Company emerged with market leading positions, low cost manufacturing, a lean organization, and a talented and aggressive sales team. Outstanding execution by the CEO had resulted in the Company’s becoming an attractive platform from which to build a national competitor. Investors sold the Company to a financial sponsor. The successful exit generated a 23% IRR and returned 4.4x invested capital over 85 months.
At the time we prepared this article, the first company discussed in this paper was performing well with a different equity sponsor and a different management team. Companies 4 and 5 have not had an exit yet but investors are satisfied that the investments are doing well and will be profitable. Exhibit 3 summarizes these and other metrics related to deal performance.
In the next section, we present three case studies of individuals (whose names we have changed) to illustrate the many factors that determine the outcomes.
F. Case Studies
- Jack
As mentioned above, Jack was the CEO of a start up (Company 1) exploiting opportunities in a rapidly consolidating but still highly fragmented distribution industry. He was a successful, smart corporate lawyer with a mergers and acquisitions background in this industry.
Jack’s start-up enjoyed no important advantages in terms of technology or marketing. The operating business plan was to identify good targets and to close deals at attractive prices. The competition was extremely rigorous because as several of the industry’s global players were pursuing the same strategy. Management capability was therefore crucial, and Jack was part of a management team with formidable strengths.
Investors had already agreed to supply Jack’s company acquisition capital when they asked us to assess him. They cited doubts about his leadership because his earlier positions had all been transaction-oriented in their responsibilities.
Here’s what our assessment showed: Jack is hard working, self-reliant, and verbally very intelligent. Yet though he claims to be an active coper, his coping style is actually reactive and avoidant. He is especially weak when working with others. He is not good at generating goals or overcoming obstacles. He does not easily tolerate ambiguity; the more poorly defined the problem, the more passive his coping.
He becomes extremely anxious when confronted by matters that require him to take initiative, improvise, or be decisive. At such times, he is unable to withstand the tension that would accompany seeking a full understanding of issues and working to resolve them. In an effort to get rid of problems that vex him, he offers facile, simplistic solutions that gloss over crucial details. As a result, he forecloses options when he would be better off reflecting in order to develop effective solutions.
This kind of passive coping compromises the quality of his judgment to the point that would put his business at risk. Unfortunately, the issues most likely to make his business successful – such as finding targets at attractive prices and handling them in a timely manner – are precisely the issues likely to bring out his passive coping.
Here’s what we told his investors: Jack has a narrow expertise, and beyond this range, his coping breaks down. If his company were to run into difficulty – if it missed deadlines, timetables, or forecasts – his passive coping would interfere with the venture being as successful as it needed to be.
As investors worked more closely with Jack in his first negotiation with a seller, they saw the poor judgment our assessment had highlighted. He entered into an agreement with a seller on terms his investors had explicitly rejected. After Jack disregarded their directives, they put on the brakes by withdrawing their funding. Fortunately (for Jack), another private equity firm did the deal. Unfortunately (for Jack), they quickly judged him as unlikely to be able to integrate acquisitions and fired him within the first month. The company has thrived under the successor CEO, who revamped the entire management team.
Jack is an example of our correctly identifying a failure. Our next case, Wayne, is an example of correctly predicting potential for success.
- Wayne
Investors asked us to assess the COO of a company they were planning to acquire who had said that he would leave the company if he were not promoted to CEO. Investors wanted to know of significant issues that they should be aware of with respect to his leadership and management skills. Could he establish himself as the CEO – a major strategist and the executive driving operational change and growth?
As we detail below, our assessment answered with a definitive “Yes!” Two years later, investors sold the business. They rated Wayne as an “Outstanding” CEO who beat his budget every single month they owned the Company. Investors attributed the success of the investment to two factors. The first was the economic cycle: “The wind was not just at our back; it was howling at our back!” The Company had excess capacity, had already paid for the asset it leased, and customers’ demand for the asset was greater than expected. Those issues coupled with Wayne’s leadership made the Company successful (see Exhibit 2).
The following is what we reported to investors regarding Wayne’s strengths and weaknesses. Wayne is an example of not being able to rely on past performance to predict future leadership. He had never been CEO before. (The reader will infer from what follows the general framework we use to communicate our findings in terms of the Judgment, Influence, Management, and Personality factors mentioned previously.)
Wayne is extremely intelligent. He is a logical, sequential, and quick thinker. He possesses the ability to think through alternative scenarios in a sophisticated way. He possesses the readiness to think flexibly in the face of contradictory evidence. As a complex thinker, Wayne is able creatively to bring disparate pieces into a meaningful whole. This synthesizing quality gives rise to a well-developed ability to see patterns, which, in turn, fuels the speed with which he makes decisions. He also has the maturity to live with the fact that he has made mistakes, and having made mistakes, he tries to learn from them.
Wayne also has social intelligence. He has insight into himself and is aware of what transpires around him. His readiness to perceive and integrate internal and external sources of information allows him not only to formulate effective business strategy but also to motivate and work well with others in executing it. To the extent that his intuitive decision-making biases him to take action without a full consideration of evidence and counterarguments, Wayne solicits the viewpoints of others before making final decisions. This is an admirable quality and evidence of a sophistication and maturity in his functioning. Wayne’s style encourages constructive conflict as a way to explore fully opportunities and problems and to resolve them.
Unusual for an executive in his late 30s, Wayne has a mature identity as a leader. He sees himself as a father figure, at times encouraging, forgiving, and empathic toward his subordinates, at other times critical, reprimanding, and willing to mete out deserved punishment. Related to Wayne’s maturity is his serious and pragmatic style. He accepts basic social values. He plays by the rules. He seeks others’ input and makes decisions after consulting them. He prefers that his subordinates accept his leadership without his having to invoke the formal authority of his role. He wants the support of his team while clearly seeking out the responsibilities as leader.
Important to Wayne’s self-image is that he be perceived as a good person. He does not easily handle criticism that appears to question (or that he construes as questioning) his morality or his fundamental decency as a person. One of the few weaknesses in Wayne’s functioning is that he becomes defensive when he fears that others have judged him as having done something bad. His need that others perceive him in a good light makes him slightly rigid and less open and creative than he could be. It also makes him dependent on superiors for recognition and praise.
Wayne’s management style rests on a belief that his personal values apply as much to subordinates as they do to him. He pushes himself to take advantage of business opportunities and to do the best he can, and he expects the same of others. He does not tolerate subordinates who do not live up to expectations. He will not hesitate to be critical and is a demanding boss. He requires integrity, reliability, and competent performance in others. He does not tolerate mediocrity or dishonesty.
Wayne’s tendency to be somewhat rigid does not interfere with being pragmatic. He understands bottom-line pressures and responds to them in a way that is appropriate for the success of the business, which includes dismissing subordinates who do not meet expectations or are otherwise dispensable.
Wayne is likely to demonstrate the leadership that investors expect. He possesses the emotional resources to cope with the demands of the CEO role, both now and in the future. Wayne is extremely ambitious and believes he is now at a point in his career where he is ready to run an organization. We agree. Wayne has no noteworthy deficits in his leadership. Indeed, he is more than eager to demonstrate his capacities to lead. Investors’ role in working with Wayne should emphasize supporting him so that he can live up to his own high expectations.
To that end, we had three suggestions.
One, investors should be as explicit as possible with Wayne regarding expectations, goals, timetables, and resources he will have available (now and in the future). He has a tendency to get touchy when presented with demands or expectations that were not previously established. Because he is so conscientious, he tends not to respond well to what he perceives as vague and poorly defined expectations. It is in these situations that Wayne is likely to be defensive. Investors should couch their criticisms to minimize the chances that he feels perceived as a bad person.
Two, investors should give Wayne a clear understanding of how they intend to work with him. He will keep his end of the understanding and will expect them to live up to their end. He will become frustrated if investors fail to perform as promised. Investors should be up front what the process of control will be, and what the limits are. Investors should put these ground rules in writing so that Wayne cannot later complain he did not know.
Three, Wayne seeks recognition and support without being needy or exhibitionistic. He is a conscientious and moral person. It is important to him that others recognize those qualities in him. This bears on how investors should recognize Wayne’s achievements. He would like to be valued in the same moral terms he understands himself. He might like financial rewards but would also like others to see his skills and ability to grow the business. Investors should give him appropriate feedback if things are going well, and encourage him to keep up the good work.
In sum, Wayne is a conscientious but pragmatic and bottom-line focused executive. He will do what it takes to help the Company be successful, achieving expectations in a moral way. This is exactly what he did.
The one potential weakness we pointed out was that Wayne was sensitive to criticism and did not want to make a mistake. Investors related this characteristic to the observation that he could have been quicker to terminate a manager who came along with an acquisition. “[Wayne] is conservative and doesn’t have a quick trigger finger and will make sure it’s the guy who can’t succeed as opposed to the position. Ultimately we let him do what he thought was best.”
- Mack
The question around Mack was whether he had the leadership, industry knowledge, and capability to run a $250 million business. The company was underperforming its capabilities and needed change to move to its next level. The investor also wanted the assessment to probe two other areas. The first was to verify Mack’s single-minded focus on work. The second was to flesh out how he would work with the existing management given he would be part of a program of change.
Below is what we reported.
Mack has strong industry background and a history of turning around under-performing businesses. He is strongly motivated to achieve and succeed in a CEO role. He is honest and reliable and expects the same from others. Mack is demanding, hard working, and has high standards. He is extremely competitive.
Cognitively, Mack approaches the world in simple, black and white terms. Ambiguity and nuance are invisible to him. He prefers not to think in terms of abstractions. His style is to apply a familiar heuristic to problems he has previously encountered. Learning for him is a matter of proper training as opposed to having a conceptual understanding. As such, he is not especially interested in conceptual matters.
Mack’s approach to business problems is to break them into discrete, bite-sized pieces, line them up in a familiar way, and from there, to devise a solution based on what has worked for him in the past.
His way of seeing the world does not allow for creativity. His implementation is mechanical and without intuition. He shuts out important human feelings such as doubt and compassion, which, in many cases, might lead to easier ways of achieving his goals. This hard-charging, over-confident style has implications for how Mack is likely to relate to subordinates and directors.
Mack’s perception of reality presupposes all problems will conform to his ability to solve them. He determines the solution and attacks without further thought whether his solution is reasonable or whether others would agree. That others might not see his solution as appropriate or adequate is not a consideration. In this sense, Mack’s management is deficient.
What allows Mack to succeed is that he is an exceptional coper. He is intensely driven and self-confident. In the face of challenge, he does not blink. He is direct, aggressive, and focused.
In many ways, Mack’s talents are more as COO than as CEO. An excellent implementer, he will need close oversight from the Company’s directors to review and monitor his proposed plans. Conceiving strategies and understanding trends are not Mack’s strengths, and his directors will have to help him.
Mack is an authoritarian leader. He sees only the task before him for which he sets the direction for others to carry out. He positions himself at the center of all corporate initiatives. His style is rigid. He expects subordinates to execute in a logical, let’s-do-it manner. If others resist, he assumes they are wrong and will not compromise.
Mack tends to see his subordinates as occupying functional slots designed to contribute to the execution of his solutions. In this sense, any single manager is interchangeable and replaceable. Mack is not interested in deeper relations with subordinates. This means also that he is not particularly interested in their perspective; he is not interested in their understanding; he is not interested in what they have to say beyond information he needs.
Mack has a superficial, constricted understanding of leadership. He distances himself from his emotions by using logic and assumes that others will approach issues in the same mechanical, reactive way. When others have more nuanced views, Mack’s pushy style will inevitably engender struggle and conflict.
Not especially interested in what others have to contribute (as it bears on his understanding of a situation), he will not hesitate to impose his will without consulting them or assessing their capabilities (as it bears on implementing his solutions). To the extent Mack’s managerial reforms represent much-needed medicine, he does nothing to make it taste better or go down smoother.
This is not to say that his style will be unsuccessful.
Based on our assessment, we made a number of recommendations. One, Mack operates best within a chain of command. He sees the board as his superior. He expects directors to give him clear directives he can implement, which he then imposes on his subordinates.
Two, directors need to devise corporate strategy without Mack’s meaningful participation. Mack will not regard directors as advisors to consult or as a sounding board with which he will debate important matters of policy. He is not interested in these concerns. Once he understands a strategy, however, he will work hard to implement it.
Three, Mack tends to tune out open-ended discussions that do not translate well into action plans. In such discussions, Mack will probably not participate actively, as he has little to contribute.
Four, the board needs to involve itself in any matter involving the softer side of corporate culture because Mack is neither interested nor capable. Who are the key informal leaders? Whom should he accommodate? Where should Mack compromise? These are the kinds of issues he prefers to ignore, and to the extent he has to deal with them, his handling is likely to be ham-fisted and hard-hearted. Before Mack acts in a potentially irrevocable way, the board should approve important changes in management.
Five, Mack will act quickly, often without a deep understanding of the full dimensions of the problem. His abrupt way of imposing decisions tends to fray human connections. It will destabilize the company more than is good. On matters that are likely to have significant impact on morale, Mack would benefit from thinking through how changes will affect others. The board has to act as the control rod and slow him down.
To the extent his responsibilities are within his circle of competence, Mack is likely to be successful. He will do virtually anything to deliver on his commitments. Investors, however, need to keep in mind his range of competence is limited. The need to treat Mack as an executive officer, one who will implement a corporate strategy as conceived by his superiors on the board. Outside this circumscribed role, he is not likely to function as well. Critical thinking and exercising nuanced judgments to exploit opportunities are not Mack’s strengths and the board will have to assume these responsibilities.
After investors exited the Company and five years after we had conducted our assessment, we learned that Mack succeeded as we had predicted (see Exhibit 3). We also learned, however, that the emotional realm was even more important to investors’ judgment of Mack’s success than we supposed. At about the time investors prepared their exit, one of Mack’s female subordinates filed a sexual harassment lawsuit against him. The investor said the lawsuit did not diminish the financial returns of the deal but that it potentially could have had a negative impact.
IV. Amplification
This paper presented data generated using a clinical psychology method for nine executives assessed on behalf of one middle market private equity firm. By focusing on portfolio executives of one private equity firm, we eliminated much of the noise that diminishes the generalizability of findings of studies that look at manager characteristics across different firms in different operating environments. We examined the degree to which assessment indicators predicted the executives’ subsequent performance as judged by investors.
Findings indicated high overall accuracies for predicting both success and lack of success. The findings and illustrative case studies support the validity of our assessment system. Investors believed that our statements describing the executives we assessed were very accurate. Their evaluation of our predictive accuracy is congruent with what we have heard from many other investors, those whose experiences were not included in this study. We succeeded in identifying individuals with little likelihood to succeed at the task expected of them, as illustrated in Jack's case. We succeeded in indentifying individuals with the potential to succeed as CEO, even though they had no prior experience in the role, as illustrated in Wayne's case. We were accurate in identifying the weaknesses in executives who required supervision or accommodation by the investor.
We learned at least two lessons from the executives for whom we noted these weaknesses. First, in the case of Mack, we identified interpersonal callousness but we did not pursue its meaning or sources to the end. Investor feedback regarding Mack’s affair with a subordinate reinforced our emphasis on understanding the total person. We concluded that it would be impossible to draw out information that would lead to a reliable prediction that an executive would have an affair with a subordinate that could detract from investment returns. We did become more aware of the need to explore the integrity of every executive we assess.
Second, in one case where the investor gave the assessment a rating of 80% accuracy, the source of the diminished accuracy rating was circumstantial: the environment did not generate challenges that would cause the weaknesses we identified to show up. The weaknesses did not emerge during the 22 months investors observed this executive. In brief, we warned about a potential threat that did not materialize. We are inclined to suggest that it is better to warn of a threat that does not materialize than to miss one that does. In this case, we learned to emphasize to investors the nature of the predictive process inherent in our working model. That is, we identify both manifest and latent personality dispositions. The latter dispositions may show themselves under conditions where the individual's characteristic defenses break down. Thus, vulnerabilities we flag may be potential risk factors that remain unexpressed if circumstances continue to support the individual’s defenses.
We identify potential risk factors by using projective techniques. Projective techniques tap underlying desires, motives, and fears of which the individual may not be aware and which indirectly shape the individual’s everyday behavior. These tendencies become manifest only when the individual’s defenses against them become unstable. Two conditions may precipitate such a breakdown: situational (arising in the external environment) and developmental (arising from maturational processes within the individual).
As an example of an environmental precipitant, take a salesperson who feels anxious with authority figures. Such a person may develop a self-image as independent and not requiring guidance. He may seek out work where he lacks close supervision. He thrives under a department head who eschews formal authority. The company transitions to institutional ownership, a new president takes the helm, and suddenly the salesperson must report to an authoritarian boss. The anxiety that he formerly kept at bay by avoiding authority figures now undermines his effectiveness.
Developmental shifts may also release previously contained psychological conflicts. For example, a person who learned in his formative years to defer to authority, perhaps in adapting to a demanding father, may choose work roles that do not require him to command others. This person needs to defer to authority to maintain his psychological equilibrium. He may perform well as in a supportive role, such as CFO. If thrust into a role requiring him to be the ultimate authority, he too may develop inhibiting anxiety.
Our model thus relies on identifying potential strengths and weakness. As we have indicated, whether these potentials materialize depends on a number of factors, including the actual environmental circumstances that emerge over time. Some predictions may take time to establish and luck in the environmental situations that develop. Prediction at best can be only probabilistic, not certain. Forecasting leadership would be easy if one could hold environmental conditions constant: one merely needs to identify the characteristics associated with success in those invariant circumstances. As the stories in this paper illustrate, however, circumstances surrounding private equity portfolio firms generally change over time, frequently in ways that are hard to predict. One cannot rely on static models that assume circumstantial stability.[6] This is a central theme of our work.
Active coping is a crucial psychological component – a prime mover – of more observable skills that lead to success.[7] Active coping is central to our model for predicting leadership. To the extent that portfolio executives are active copers, they will have the underlying ability to develop means to confront and resolve unexpected challenges and setbacks. Knowing that business plans never play out exactly as planned, investors reduce their risk by selecting operating executives with sufficient active coping to deal flexibly and effectively with the unexpected. It is when circumstances change unpredictably that an individual’s latent weakness – or untested strengths – may emerge.
Therefore we use a combination of psychological assessment techniques that measure the individual’s behavior in both structured and unstructured situations. This multi-method approach allows us to develop a structural view of the individual. The best executives show consistent active coping across all situations and levels of their psychological functioning. Their personality structures are stable and resilient, endowing them with the readiness to lead at the time of its greatest need.
Our assessment approach thereby reduces overall risk of uncertain management capability. Some of the cases we presented demonstrated how management and investors reacted to unexpected changes in market conditions. This way of thinking about the process of success and failure is central to our work.
In order to make our case, we do not rely on a model that seeks to explain a wide variety of situations in general one-size-fits all terms. We do not seek to establish the average effect of one powerful variable on a large set of enterprises. Rather than establish the average effect we seek to tailor-make a fit. We try to understand the process, the complexities of interaction among person, organization, and the outer world, and thus optimize the success of prediction over time. Therefore, we argue that investors can increase the predictive accuracy across many particular individual, possibly highly idiosyncratic situations by assessing the process and many particulars rather than relying on fixed generalizations that use a parsimonious set of variables.
Regarding the evaluation of probabilistic predictions, it is virtually impossible to conduct controlled studies where one can compare our method to other methods. The best we can do is conduct longitudinal field studies as we have done in this paper to see whether predictions bear out over time; and when they do not, to investigate why and make appropriate modifications to improve future predictions. That is the essence of the empirically oriented clinical approach.
Another element of our process and its validation is that the predictions themselves become part of the process. Our findings and recommendations can actually change the behavior of the executives we assess and the investors who ask us to assess them. Therefore we are also assessing the impact of our conclusions in this process. If investors follow our recommendations, they can alter the degree of success or failure of the executive to help the company succeed. Thus, we use a predictive model that participates in the dynamics that it is predicting.
V. Conclusion
We evaluated nine executives. As evaluated by investors, we achieved an overall success rate of 90% in predicting the performance of operating executives. We conclude that we can increase investors’ chances of making a good hiring or investment decision by understanding how to work with the operating management. Although our assessment methodology is applicable to any corporate hiring decision, its utility is potentially the greatest with private equity-funded firms, where the success of the CEO is substantially the same as the success of the venture he is leading. Investors regard themselves as capable of evaluating the prospects associated with unproven technologies or uncertain markets but the investment’s success depends on management’s capability to deliver on those prospects. As skilled as investors are at evaluating managerial expertise, many have not relied on the most sophisticated methods to improve the robustness of their hiring decisions. This suggests that investors are assuming more risk than they realize. The system validated in this study seeks to reduce the risk to investors of uncertain management capability, and our evidence indicates that it succeeds in accomplishing that goal.
Investors have a forward-looking approach to evaluate technology and markets but often use a backward-looking approach to evaluate the quality of management. They focus on experience, credentials, and other factors gleaned from interviews. They exclude individual personality factors that bear importantly on the executive’s capacity to function in highly uncertain operating conditions.
Moreover, the executives likely even to receive scrutiny from private equity investors are individuals who have already excelled on the very criteria on which investors seek to make discriminations among them in order to make hiring decisions. The winnowing that first brings them to the attention of investors (e.g., executive recruiters and industry contacts) means that superficially, at least, all candidates will appear capable. This artifact of selection into pools of executives whom private equity investors may review limits the range of behaviors those executives exhibit and makes it difficult to identify individual differences that will predict the quality of an executive’s future leadership. Investors need not limit themselves in this way.
The clinical approach described in this paper is the most reliable methodology we know of that addresses an executive’s likely functioning under conditions that investors cannot reliably predict. For example, when the business is under stress – when market conditions turn down, as in the case of Company 2, or when it must respond to an unexpected opportunity, as in the case of Companies 1 and 3 – do its executives have the flexibility to respond appropriately? The CEO of Company 1 did not. The CEO of Company 3 did. We identified these differences accurately.
Furthermore, our methodology examines behaviors that are difficult to observe in groups of executives who are candidates to be CEOs. This allows us to make fine-grained distinctions between superficially very similar individuals. We saw that Wayne, the CEO of Company 3, would be an extremely capable CEO even though he had never been CEO before. His experience had not yet tested him in the ways that would lead to confidence in his ability to handle future and unknown challenges. We saw that Jack, the CEO of Company 1, would flounder, despite his intelligence, industry knowledge, and technical expertise.
To choose a manager is to make a prediction. Specifically, the choice “predicts” that the chosen executive will produce more value than any others will. This study supports the value proposition that clinical psychological analysis adds independent information that reduces the “prediction error” of top management selection.
Appendix A: Overview of Our Competency Approach
The competencies we assess encompass four significant domains of individual capability: Judgment, Influence, Management, and Personality.
Judgment includes the technical, professional, intellectual, and creative competencies that enable individuals to make sense of the world around them. Can they see the forest for the trees; analyze complex data; break problems down into their component parts; reach logical conclusions; and generate alternative and new solutions so that they can understand, assess, and determine what needs to occur? Traditionally assessing this area involves looking at academic and professional qualifications, career history, and psychometric tests. High-level competencies within the Judgment domain include pattern recognition, intuitive decision-making, applied strategic vision, and openness to change.
Influence includes the communications, interpersonal, persuasion, and political competencies that enable managers to work effectively with and relate to colleagues and customers: explain, persuade, sell, cajole, network, negotiate and lobby so that they can successfully influence others and gain their support to get things done in their jobs. This area has to do with influencing and gaining support in non-hierarchical circumstances. In this domain lie personal impact, networking skills, organizational influencing, and conflict resolution.
Management encompasses competencies needed to produce results through other people: planning, organizing, scheduling, monitoring, and controlling work; developing, counseling, and directing people; building teams and resolving conflicts to ensure services are delivered, results are produced, and projects are completed. High-level management competencies we assess include strategic leadership, management team building, business effectiveness orientation, and product and process knowledge.
Personality includes the personal traits and tendencies such as drive, self-confidence, decisiveness, tenacity, flexibility, coping, and resilience. These qualities enable individuals to meet and overcome the stresses, challenges, conflicts, and obstacles that may affect performance in the other three domains.
Appendix B: Overview of our Assessment Approach
We take what psychologists call a structural look at personality. We examine relations among different levels and functions of the individual’s self, including motives, coping, interpersonal style, values, and integrity. Such a view allows us to begin to frame where instabilities in the individual’s psychological make-up can translate into adaptive problems at work. Our assessment strategy uses a combination of objective and projective techniques. Objective techniques refer to self-report statements classified using psychometric procedures. Projective tests reflect more indirect, symbolic, and more covert ways of self-expression that frequently are beyond the range of a person’s understanding. By using a combination of objective and projective techniques, we can observe how consistently the same conceptual variable (e.g., coping, motivation) appears across different levels of an individual’s consciousness.
We characterize levels of consciousness in terms of the degree of awareness the individual possesses of personality strivings and functioning, ranging from overt and consciously controlled to covert and less consciously controlled. Behaviors which appear one way at levels subject to the individual’s conscious control often operate differently at deeper levels, where the individual has less (or no) control over their expression. Such discrepancies indicate that the individual is in a state of intrapsychic conflict or personality disequilibrium. Strivings beyond the range of the individual’s awareness may influence conscious feelings, cognitions, and actions. This appreciation of personality structure and dynamics is important to understand when making predictions about an executive’s future performance. We describe our assessment in depth elsewhere (e.g., Pratch & Jacobowitz, 2004; Pratch, 2001; Pratch & Jacobowitz, 1998; Pratch & Jacobowitz, 1996).
To assess the structural dimensions of the self, we use three instruments: a self-report objective personality test to measure motivational tendencies at a surface level of personality functioning; a semi-projective sentence completion technique, which elicits a more spontaneous presentation of self; and a projective story telling technique, which taps covert, indirect, and less conscious revelations of self. Information gathered using these three instruments taken together allows us to determine the congruency or stability of an individual’s personality. Are the individual’s coping abilities, manifest either behaviorally or in a self reported way, congruent with other motives or drives – or are they in conflict? Knowing this is important because if the personality system is in conflict, the individual’s behavioral style may break down over time and cause instability in his or her leadership.
Appendix C: Data Collection Techniques
Business Role Diagnostic. In accord with the assessment approach we outline in Appendix B, our first step in the assessment is to understand the business culture and the job. We interview the investment professionals to understand the role’s relationship to corporate strategy. What are the business context and the competitive strategy? What are the critical business imperatives of the role? What is the team that the candidate would join? What is the culture of the organization? This information helps us understand the business culture and context in which investors expect the executive to operate. At different times, different organizations require different kinds of leadership. The assessment of an executive is particular to the kind of venture, its stage in the organizational life cycle, investors’ needs and interests, and the threats and opportunities the company faces.
Intelligence, Work Skills, and Experience. When executives come to us for an assessment, they have already met the investors’ screens for industry knowledge and functional expertise. Even so, we will begin by again reviewing the candidate’s CV, asking him to explain inconsistencies, anomalies, turning points, and highlights of their career. This knowledge helps us build an understanding of the individual’s work skills and intellectual abilities. To provide a formal measure of general intelligence, we use an empirically validated non-verbal assessment instrument intended to make distinctions among already very bright individuals.
Personal History Interview. We conduct a personal history interview, asking about original family setting, formative developmental experiences, and education. We also ask about the executive’s current family situation and aspects of the executive’s life that can affect functioning in the business arena. By examining the executive’s ability to balance and integrate different areas of his life, we are able to get a holistic view of his functioning. The personal history also allows us to identify the presence of salient developmental issues that may influence behavior in future and which can facilitate or inhibit managerial functioning critical to the venture’s success.
Structural Personality Assessment. Finally, we assess personality structure and dynamics. We examine relations among different levels and functions of the individual, including motives, coping, interpersonal style, values, and integrity. Such a view allows us to begin to frame where there may be instabilities in the individual’s psychological functioning that can translate into adaptive problems at work.
Appendix D: Active Coping
Conceptually, active coping is a characteristic of a psychologically healthy personality structure. Individuals who possess such personality structures can tolerate the tension inherent in openly perceiving internal and external events that may be challenging, threatening, or conflict arousing. Moreover, they maintain the ability to formulate and implement strategies to meet or resolve the challenges, conflicts, or threats they encounter. These strategies, which operate consciously and unconsciously, are designed to seek an adaptive balance between external environmental demands, regulations, and constraints, on one hand, and psychological aspirations, needs, and morals, on the other hand.
Active coping is manifested in the propensity to strive to achieve personal aims and overcome difficulties rather than passively retreat or be overwhelmed by frustration, whether the problem originates in the self or in the external environment. The opposite of active coping is passive coping. Whereas active coping seeks to confront and resolve, passive coping is reactive and avoidant. Passive coping is refusing to tolerate the full tension that a situation imposes, for instance, reacting before the facts are fully understood.
Active coping relates to a relatively stable, albeit complex, psychological orientation across time and circumstance. It is not meant to predict situation-specific, consciously decided-on strategies of handling problems. Neither is it viewed as a trait in the narrower sense of the word. Cognitive, behavioral, and trait constructs of coping focus on situation-specific dimensions of individual functioning. Within that temporal framework, human behavior is essentially fragmented and reactive to either fixed, methodical, and in many respects, mechanical inner thoughts or dispositions or to externally imposed pressures and reinforcements. In effect, the person has no choice but to respond in a predetermined, limited manner. Such a circumscribed mode of response is characteristic of passive coping, an inclination to submit automatically to internal or external demands.
Active coping, by contrast, implies the potential to transcend these compulsions and to select consciously and unconsciously from among an array of possible responses the one that seems most constructive in maintaining the sought-after balance between self, including one’s values and beliefs, and environmental demands. In many cases, the response selected is a novel one, created for the unique situation that is encountered. Active coping contributes to healthy personality growth and adaptation by optimizing an individual’s response to a specific problem and also by fostering continuing psychological complexity, differentiation, self-confidence, and resourcefulness. Success and failure, if integrated into the personality structure, create an expanded experiential knowledge base that makes possible subsequent coping activity. Active copers “feed” on experience; they not only store their experiences and their reactions to them, but also synthesize these experiences into their psychological organizations. This integrative activity contributes to the structural complexity of the psychological system. In turn, the system becomes more competent in its capacities to tolerate tension and devise new strategies for adaptation and growth. This adaptation and growth leads to more effective management and leadership and from that, to better organizational performance.
References
Bertrand, M. & Schoar, A. (2003). Managing with style: The effect of managers on firm policies. Quarterly Journal of Economics, 118(4), 1169-1208.
Bloom, N. & Van Reenen, J. (2007). Measuring and explaining management practices across firms and nations. Quarterly Journal of Economics, 122(4), 1351-1408.
Pratch, L. (2001). Assessing potential leaders of private equity funded ventures. Journal of Private Equity, 15-29.
Pratch, L., & Jacobowitz, J. (1996). Gender, motivation, and coping in the evaluation of leadership effectiveness. Consulting Psychology Journal: Practice and Research, 48(4),203-220.
________ (1997). The psychology of leadership in rapidly changing conditions: A structural psychological approach. Genetic, Social, and General Psychology Monographs, 123, 169-196.
________ (1998). Integrative capacity and the evaluation of leadership: A multimethod assessment approach. Journal of Applied Behavioral Science, 34(2), 180-201.
________ (2004). Successful CEOs of private equity-funded ventures. Journal of Private Equity, 8-31.
________ (2007). Optimal psychological autonomy and its implications for selecting portfolio CEOs. Journal of Private Equity, 53-70.
Shanan, J. (1973). Coping behavior in assessment of complex tasks. Proceedings of the 17th International Congress of Applied Psychology, (Vol. 1), Brussels, Belgium: Editest.
Stern, G., Stein, M., & Bloom, B. (1956). Methods in Personality Assessment: Free Press.
| Exhibit 1: Follow Up Protocol. The exhibit shows the form we used to gather information from investors regarding the operating executive’s performance relative to the demands of his or her role. | |
|
|
| Firm and Investment Professional(s): | |
|
|
| Investment Date: | |
| Exit Date: | |
| Portfolio Company and Description: | |
| What was your investment thesis when you went into the deal? What were you trying to achieve? | |
| Did your thesis prove to be true? If it changed, how did it change and why? | |
| What metrics, including returns, did you use to assess deal performance? | |
| Please rate the overall performance of this deal: |
|
| Investment Story: | |
|
|
| Operating Executive and Role: | |
| Please describe the executive’s contribution to the overall performance of the deal: |
|
| What were the top three criteria for his or her successful performance? | |
| How successful was the executive in meeting those expectations? |
|
| Explain: | |
| What particular strengths did the executive show? | |
| What weaknesses did the executive show? | |
| What functional skills did the executive need in order to maximize performance? | |
| What other factors affected the ultimate outcome, independent of what the executive did? | |
|
|
| What did investors want to find out? What were the referral questions? | |
| What did we recommend? | |
| Did investors carry out our recommendations? If not, why not? | |
|
|
| Did the assessment identify weaknesses that were borne out over time? | |
| Were there unidentified weaknesses that surfaced? | |
| In light of the operating executive’s actual performance, how accurate was the assessment? How well did the assessment indicators match the executive’s on-the-job performance (i.e., once he or she was hired or the deal was done)? |
|
| How accurate was the assessment in predicting Judgment factors? | |
| How accurate was the assessment in predicting Influence factors? | |
| How accurate was the assessment in predicting Management factors? | |
| How accurate was the assessment in predicting Personality factors? | |
| Were you surprised (either pleasantly or unpleasantly) by what the executive did? | |
| Explain: | |
| Do you have other thoughts that you would you share with us that might improve the accuracy or usefulness of our assessment process? | |
|
|
| Technique 1 | |
| Technique 2 | |
| Technique 3 | |
| Technique 5 | |
| Technique 5 | |
| Synthesis | |
| Was there anything wrong with our thinking? If so, what was wrong? | |
| Exhibit 2: Investment and Investment Thesis. This exhibit shows the nature of the investment, the investment thesis, and if it changed, how it changed. | |||
| Company and Nature of Investment | Industry Group | Investment Thesis as Reported by Investor | Changes to Investment Thesis As Reported by Investor |
|
Distribution | Create an acquisition vehicle to consolidate smaller players in a fragmented distribution industry | It took a different management team to make and integrate acquisitions in a mature industry. |
|
Industrial products | Extend profitable niche focus through acquisition and generate incremental profitability through operating improvements. | “The Company benefitted more from the market growth than we had anticipated. The fact that all boats were rising helped our strategy more than we expected.” |
|
Business and consumer services | Increase asset utilization, balance capital spending with long-term industry supply and demand expectations, and grow and diversify the Company’s revenues organically and through acquisitions. | “We underestimated the ability to raise prices: we grossly underestimated the deferred maintenance of [the Company’s] customers.” As the economy recovered, demand for the assets leased grew, and the price of material for making these asset rose, making possible increased utilization and higher prices for leasing assets the Company already owned. |
|
Business and consumer services | Improve the Company’s basic operations; focus management on U.S. centers and core products; and reposition the business by converting existing centers to a new operating concept. | The Company sold a non-core division, its non-U.S.-based operations, and its manufacturing products in order to focus on its core business. The management team was in place to shift the paradigm from an athletic to an entertainment model. |
|
Business and consumer services | Continue the Company’s top-line growth; transition from founders to professional management; add new products that would benefit from the Company’s unique distribution model. | Revenue growth rate continued at 35% a year, compounding on bigger and bigger numbers; margins have held steady. Leadership is almost completely transitioned. The only part of the plan that has not yet been actualized is to add new product categories. |
| Exhibit 3: Deal Performance and How the Executive Contributed to Deal Outcome. The exhibit shows the contribution of the executive to the performance of the deal. The first column identifies the executive in terms of company and role. The second reports the period over which investors observed the executive. The third column reports investors’ characterization of the performance of the deal on scale from 1 (“Loss”) to 5 (“Home run”). The fourth column reports investors’ characterization of the executive’s contribution to the performance of the deal using a scale of 1 (“Made no contribution”) to 5 (“Drove the success of the deal”). | ||||
| Operating Executive | Time Period Over Which Executive Was Observed by Investors | Deal Performance as Reported by Investors | Executive’s Contribution to the Performance of the Deal as Assessed by Investors | Comments by Investors |
|
3 months | N/A (first investor group decided not to go forward with the deal) | N/A for first investment firmInvestors who did the deal replaced him and his team | Investors who did the deal replaced the existing CEO, whom we had assessed, within a month. Under new management, the company has successfully implemented original plan |
|
48 months | “Home run” (5)4.4xIRR of 23% | “Was one of the keys to its success” (4) | The CEO was one of the top three reasons for the Company’s success; the Company suffered from absence of leadership in its decline phase and the CEO brought a focus |
|
24 months | “Home run” (5)3.3xIRR of 115% | “Drove the success of the deal” (5) | Price of raw material used to make the asset the company leased rose, demand for the asset rose, the Company had already paid for the asset and had excess capacity; economic cycle |
|
42 months | “Good”(4) “CEO hitting budget most months”1x received (dividend)3x total return anticipated by investors | “Drove the success of the deal” (5) | “The transaction will turn out to be good, not great, for us. The execution of our investment management strategy has been excellent; however, it took longer and it was more challenging than we expected. We have taken out a dividend equal to our original investment and will probably make a total return of 3x.” |
|
22 months | “Home run” (5)Meeting or exceeding performance indicesRevenue growth rate has continued at 35% a year, compounding on bigger and bigger numbers, and margins are steady | “Was one of the keys to its success” (4) | He was a low-risk choice to run the business. |
|
24 months | “Home run” (5)See number 5 for investor characterization | “Was a factor” (2) | Technical skills to manage responsibilities of CFO and COO roles |
|
24 months | “Home run” (5)See number 5 for investor characterization | “Was one of the keys to its success” (3) | Has his replacement in place and is training him |
|
24 months | “Home run” (5)See number 5 for investor characterization | “Was a factor” (2) | Creative guy with strange quirks in his personality; a disappointment; at this point has disengaged though he still offers constructive ideas as a board member. |
|
24 months | “Home run” (5)See number 5 for investor characterization | “Was one of the keys to its success” (3) | CEO has empowered him. He is substantially responsible for driving the revenue numbers, since former VP has disengaged. He’s done well above an average job as compared to anyone else that might have been in that role. |
| Exhibit 4: Performance Criteria Used to Evaluate the Executive. The exhibit displays the criteria investors used to evaluate the executive’s performance; investors’ assessment of how the executive performed relative to those criteria on a scale ranging from 1 (“ ”) to 6 (“100% successful”); investors’ opinion of the executive’s strengths and weaknesses; and the functional skills investors considered necessary for the executive to maximize performance in his role. |
|||||
| Executive | Criteria Investors Used to Evaluate Performance | Executive’s Performance Relative to Criteria | Executive’s Strengths | Executive’s Weaknesses | Functional Skills Needed to Maximize Performance |
|
Make acquisitionsIntegrate themAchieve synergies in a mature industry | Not at all successfulLost credibility with first investor group which did not go forward with him; subsequent investor fired him within the month | Verbally very intelligentKnowledgeable about the particular industry and experienced doing M&A transactions | Not collaborativeIgnored investors’ explicit directives in first targeted acquisitionCould not initiate projects | Identify and woo targetsMake the acquisitions and integrate them |
|
Provide leadershipCreate a sense of urgencyCreate an action plan | 100% successful“He provided a leadership function that was missing; he created a sense of urgency and an action plan. He knew where there would be low-hanging fruit and he grabbed it.” | LeadershipImplementationFocus: he said, “People I’m here with you, we got to focus now, here’s what we got to do to get out of this mess.” | “Not the sharpest tool in the shed; a basic blocking-and-tackling kind of guy.”His breadth is narrow. “He knows there are 4 or 5 things companies [in this space] do wrong, and he fixes them.” | Taking complex pieces of information and zeroing in on what matters. |
|
Utilization: the timing and allocation of new capital investmentManaging the growth: expanding organization | 100% successful“He was conservative, very analytical, on top of the numbers, serious, humble.” | Drove operational change and growthA strategistProactive: the management team beat plan every month | If investors had to attribute a weakness to him, it would be that his cautiousness meant he did not terminate a manager quickly enough. | StrategyDriving operational change and growth |
|
Tireless work ethicAbility and willingness to drive change throughout the organizationHands-on management style | 100% successful“He is outstanding. He is dedicated, his work ethic is amazing, he’s where he needs to be, he is on top of the high-level detail and is tireless about getting after it. He was good at saying ‘here are all the things we have to fix before we get people in the door’ and is very good at measuring the results along each of those lines.” | Management team building: “He has made 1,000 hires and all of them have been good (except one, the CFO). He has turned over all the centers, all the regional and district managers.High-level operational strategy and openness to change: “There was a ton of heavy lifting the Company had to do and he was not afraid to upset the apple cart. He anticipated it, had plans in place to do it.”“Positioning the Company to be more attractive 2-3 years down the road.” | “Finance is not his area”Investors thought he misjudged the CFO and was too slow to replace him (although the CEO had his reasons for the timing of his decision). | Management team buildingHigh-level operational strategyBusiness strategy: Big Picture company positioning |
|
See through the leadership transitionNot upset the folksy culture that fostered successPerpetuate and accelerate the growth profile of the business | 80% successful“High grades on transitioning the leadership and on not upsetting the culture.”“Only a B on accelerating the growth profile.” | “More of a coach than a leader; he doesn’t desire the limelight or even the control. He steers people in the right direction.”“He has reconfigured the organization, headcount has increased by 50%; he has done some retooling and has done it well: there is a high level of cohesion at the company.” | “No significant progress on new growth avenues”“Sales and marketing is not his strong suit” | Management team buildingDevelop sales and marketing |
|
Direct ITProvide data to the sales force and manufacturersCoordinate HR in areas such as payrollDeal with almost all financial matters of the company, such as pricing and financial documentation | 100% successful“He has been put in a position where his point of view is more influential and he’s done well with that.” | “He is unbelievably hard-working. He stepped into more responsibility than anyone anticipated: he absorbed the roles of two founders, is fully devoted to business efficiency and productivity, is good at conflict resolution, high integrity, is very direct and straightforward.” | “Not a self-promoter”“He can articulate his point of view and be persuasive when necessary but that is not his strong suit.” | Enhance current organizational efficacyDevelop a long term view of how to expand the business |
|
Getting product to customerTraining his replacementFitting into more professional management structure | 100 % successful“He is grooming his replacement.” | “High integrity, extremely affable, communicative, extremely hard working, drives people hard, always wants to be the hardest working guy on his team, is not easily knocked off track by anything, is very logical, very much of a problem solver.” | “Not a strategist but he understands it and is capable of executing it” | Hire and train his replacementFit into more professional management structureContinue delivery service at high rates of customer satisfaction |
|
Develop new customersTrain his replacement | 20% successful“Post close, he was useful in some ways but most of the forward momentum was created by others. He failed as VP of Sales and Marketing; he wasn’t able to do a job with specific accountabilities to others.” | As a board member, he “offers up constructive ideas but he is no longer involved in the day-to-day affairs of the Company.” | “Had remorse for selling and did a number of things early on to undermine the credibility of the new President. He would not conform to any traditional management structure.” It became counterproductive and [the others] urged him to bow out. | Management skillsSales and Marketing skills |
|
SalesTo fit in and conform | 100% successful.“He’s done sales well and has fit in and conformed – and then some.” | “He is most effective dealing with complex selling challenges and he has shown he can lead.” | Administrative part of the job is a weakness: “he is not a classic manage-by-the-numbers Sales VP.” | Develop a sales force and manage them |
| Exhibit 5: Referral Questions and Recommendations. The exhibit lists the questions investors wanted the assessment to answer and the conclusions and recommendations generated by the assessment. | ||
| Operating Executive | Questions Investors Wanted the Assessment to Answer | Conclusions and Recommendations |
|
Can he lead? What is his ability to manage in a rapidly changing environment? Does he have the ability to make tough management decisions? Will he be slow to pull the plug if someone isn’t performing? How decisive is he? Does he have strong convictions or will he simply tell the board what he thinks it wants want to hear? What will his management style be with his team? Is he a consensus builder or a dictator? How does he handle delegation? What is his ambition, drive, follow through, and self-confidence? | He has considerable capacity. By buttressing the deficits in his coping, investors can help him play to his strengths and avoid his weaknesses. The central recommendation is to put into place reporting structures that will shield him from his shortcomings. If important managerial concerns can be surfaced in a non-threatening way, he will be able to engage his considerable intellectual strengths. It is by no means certain, however, that this strategy for managing him will be easily implemented. (See the first of the three case studies, called Jack.) |
- His relations with investors will be arm’s length. On his own, he is not likely to consult beyond formal meetings. The board should have no illusions that it can foster a more intimate, collegial relationship through more frequent contact.
- He will answer questions as best as he knows. He will listen, sort through issues on his own, and present facts and conclusions in a cut-and-dried fashion. He will not volunteer information nor will he speculate about matters that have no precise answers. Contemplating the future competitive environment is too vague and undefined an activity to benefit greatly from his linear style. The board will have to get these kinds of insights elsewhere.
- Managerial issues need to be bite-sized and well defined. Investors should reduce problems to issues he can reasonably handle. Challenge his assumptions and counteract his passivity – if he thinks there is nothing that can be done about a problem, confront him and demand a solution. Because he prefers to avoid problems, investors must require he provide a frequent, iterative cycle of reporting issues, obstacles, and opportunities and the steps taken to address each.
- At the same time, investors must be alert that he tends to address complicated, diffuse matters with facile solutions. He must be encouraged to sit on the impulse to foreclose options, insights, and alternatives. This is especially important if the industry faces the kind of turmoil that leads to unexpected opportunities – and threats.
- CEO
Does he have the leadership, industry knowledge, and capability to run a $250 million business? He has no outside interests other than family; what is going on here? How will he work with existing management given he will be part of a program of change?To the extent his responsibilities are within his circle of competence, he is likely to be successful. He will do virtually anything to deliver on his commitments. Investors need to keep in mind, however, that his range of competence is limited. They will need to define his objectives and the parameters for his decision-making. He needs to be treated as an executive officer who will implement a corporate strategy conceived by his superiors on the board. Outside this circumscribed role, he is not likely to function as well. Critical thinking and exercising nuanced judgments to exploit opportunities are not his strengths and the board will have to assume these responsibilities.He will act very quickly, often without a deep understanding of the full dimensions of the problem. His abrupt way of imposing decisions tends to fray human connections, and it will destabilize the business more than is good. On matters that are likely to have significant impact on morale, he would benefit from being forced to think through how changes will affect others. The board has to act as the control rod and slow him down. Often, this may mean nothing more than simply slowing down the timetable. Other times, it may mean rethinking his plans.He would also benefit from slowing down his implementation as a way to side-step potential power struggles. His operating style tends to be threatening to managers who have long gone their own way. He needs to learn to consult with them before acting. The board can help him on this. (See the last of the three case studies, called Mack.)
- CEO
Are there significant issues that investors should be aware of with respect to his leadership and management skills?He is a conscientious but pragmatic and bottom-line focused executive. He will do what it takes to make the Company successful, achieving expectations in a moral way. He has no noteworthy deficits in his leadership. Indeed, he is more than eager to demonstrate his capability to lead. Investors’ role in working with him should emphasize supporting him so that he can live up to his own high expectations. (See the second of the three case studies, called Wayne.)
- CEO
Can he lead a revitalization effort?Yes. Although pragmatic and disciplined, he is not naturally strong at standing apart from day-to-day activities to discern alternative Big Picture scenarios or develop a vision for the future. A related concern is he may act before understanding the full dimensions of a problem because he would prefer to avoid the conflict a full airing of the problem would raise. When this blind spot is pointed out, he acknowledges it and confronts it head on to resolve it, but his general tendency is to avoid confronting conflict.He would make a capable CEO of the Company. His strengths as a leader of a team of operating managers are exactly what the Company appears to need at this point in its history. He is detail oriented, pragmatic, and action oriented. He is more likely to succeed in situations where he can determine the Company’s future. If hired, he needs very careful instructions regarding roles and responsibilities. Then he should be allowed to do what is required for him to deliver on expectations. Once free of rigid authority, he behaves in a responsible and determined way.
- CEO
What is his leadership style? What is his motivation to lead? What is his judgment regarding organizational change and strategic vision?He possesses the business skills and personality to be a successful CEO of the Company.Should he be hired as CEO, he needs to develop a strategic plan for growth that includes not only optimistic visions for the future but also a plan to transition in new managers and especially to create contingency plans for possible reactions by competitors.
- CFO
What are his capabilities as CFO? What is his potential to develop even further?He is a talented executive who is competent in the technical and financial aspects of his role. He is sensitive, empathic, and honest, and is well liked and respected at work. He works hard and effectively. He prefers to highlight the positive and minimize the negative. He believes the environment is benign and kind and rewards those who work steadily and well. He tends to hold back his competitive, aggressive, and self-assertive side in deference to the need to avoid conflict and confrontation, particularly with authority figures. He tries to be humble, constraining any exhibitionistic inclinations. These tendencies, though socially admirable, may impair his ability to anticipate and deal with threatening situations. His accommodating and compromising predispositions may let other, more forceful leaders take the rein from his hands. Ultimately, he needs to form a leadership style that joins his empathic and thoughtful side with a determined, proactive, and authoritative side.
- VP Product Distribution
As one of the founders, will he accept a new president? How motivated is he to continue to do what he has been doing? What are his general strengths and weaknesses with respect to a management role?He is a caring, ethical, highly experienced, industrious, and determined individual who has played a key role in the success of the Company over the past eight years. He has built and directed effectively its delivery division and has garnered the respect and appreciation of its customers. He is motivated to remain with the Company and contribute to its growth after it is sold. He is hopeful the Company’s basic humanitarian values and customer-orientation will remain intact.Given his limitations as a strategist, we recommend he should continue as director of the delivery division during the planned growth period. His leadership should be invaluable in gradually augmenting the size and capacity of the service to handle growing demand. He has neither the desire nor skill set to take on a higher-level managerial role in the company. In conjunction with the new President, he needs to begin actively selecting and training the person or persons who would succeed him.
- VP Sales and Marketing
He transitions out in two years. What is his motivation to praise his direct report? Does he want to retire? Is that what causes him to praise this direct report? The person is not impressive on first blush.He is an experienced, creative, successful, personable, industrious, and perceptive individual who has played a key role in the success of the Company over the past eight years.His career has seen a shift from working in highly organized and large organizations to the relatively unstructured and casual community-like setting of the Company. He has prospered in the latter framework, wherein he could freely put his creative bent to profitable use. Psychologically, he is shifting even more to the call of an inner world that is seeking creative freedom, self-expression, and pleasurable experiences. Family and fun are on his future agenda. Consequently, the key issue is how to use his expertise while training his successor and establishing a plan for continued sales growth. He may feel content to the extent that he can continue to be self-directing and creative but frustrated should the Company develop into a larger, more formalized, controlled, and conventional organization.
- VP Sales and Marketing
Is he as capable as his superior portrays him? How would he function as head of sales and marketing? Does he have the ambition, strategic thinking, and management capabilities to perform well in that role?He is an ambitious “go getter” but operates most effectively when he has clear goals and considerable autonomy. Highly invested in the current business model, he envisions the Company continuing on its current course. Although such a view may be tactically correct, he has tunnel vision when it comes to imagining challenges and threats to the business. He fails to engage in strategic thinking that embraces the complexity of changing markets. He is weak in communication skills, conflict resolution, and teamwork. These deficits become liabilities if the Company expands. He lacks the capability to manage change flexibly. He would be most valuable if he were to continue in his current role, where his strengths are optimized. If he were to assume the position as overall head of sales and marketing, he would need oversight to facilitate communication and anticipate problems.
| Exhibit 6: Accuracy of Overall Assessment: The exhibit reports whether weaknesses identified by the assessment were born out; whether any weaknesses that were not identified by the assessment surfaced; whether investors were surprised by how the executive behaved; how investors rated the accuracy of the overall assessment; and the accuracy of particular indicators. Ratings of assessment ranged from 1 (“Not at all accurate”) to 6 (“100% accurate”). | |||||
| Operating Executive | Were Weaknesses Correctly Identified? | Did Any Unidentified Weaknesses Surface? | Were There Any Surprises? | Accuracy of Overall Assessment | Accuracy of Particular Assessment Indicators |
|
Yes | No | No | 100% accurate | “Spot on” |
|
Yes. “He is not an overly intelligent individual but with the right guidance, he would focus on success and be a very hard worker” | After investors existed, a story about PEIs in that industry misquoted the CEO in a way that did not reflect well on investors, who surmised CEO didn’t know how to handle the press. | Sexual harassment suit was a surprise. What was surprising was not the affair but his approach to the woman. | “60-80%% accurate: the only thing the assessment missed was his potential to stray.” | Very accurate |
|
Yes. “He is cautious and doesn’t want to make a mistake. In hindsight, he may have been too slow to terminate a manager who came with an acquisition.” | No | No | 100% accurate | Very accurate |
|
Yes. His general tendency is to avoid confronting conflict. | No | “I expected that he would have the skills that were needed to achieve our objectives; however, the effort he has given us has been extraordinary.” | 80% accurate | Underestimated his strategic thinking |
|
Yes. He is more likely to depend on his intuitive and pragmatic sense than on the ability to perceive complex and abstract patterns and possibilities. | Investor noted that he avoided conflict with [a founder]”; unclear if this was a weakness or an effective way to deal with that person given the individual’s role in creating the company’s culture and developing its customer base | “Ultimately, he was a low-risk choice to run the business. He is an active coper and good at mentoring others.” | 80% accurate | He may be more able to foresee and think through complex contingencies than assessment indicated: “it is hard to say as he has chosen not to complicate the business.” |
|
Yes. “He is not a self-promoter though he will assert his point of view if called upon to do so.” | No | “Pleasant surprise” | 100% accurate | Very accurate |
|
Yes. “He is not a perceiver and planner of complex possibilities.” | No | “Exactly as advertised, no surprises, he has done exactly what I expected.” | 100% accurate | Very accurate |
|
Yes. He does not know how even to think about interpersonal conflict; he will exit the situation rather than try to promote or communicate his ideas. | No | No. “He was a disappointment.” | 100% accurate | Very accurate: “Not a team guy. He wasn’t able to do a specific job that was accountable to the rest of the organization.” |
|
Yes. “He is sarcastic when he doesn’t agree with you.” | No | “Skills on the sales side were a positive surprise, as were some leadership skills. He’s grown. He is strong with complex selling challenges.” | 80% accurate | Underestimated strategic thinking, team building, and conflict resolution. He gets along well with the new President, who has empowered him. |
[1] See for example, Bertrand and Schoar (2003), and Bloom and Van Reenen (2006).
[2] See Pratch and Jacobowitz (1997).
[3] See Pratch and Jacobowitz (1996; 1998; 2007) for the empirical findings.
[4] See Pratch and Jacobowitz (2004).
[5] See for example Pratch and Jacobowitz (1996; 1998) for various reliabilities and validities of the measures.
[6] See for example, Stern, Stein, and Bloom (1956).
[7] See Pratch & Jacobowitz (1997).
Other publications related to Predicting Leadership Performance