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How To Spot Good Company Leadership

Logic tells us that leadership teams with high degrees of both integrity and competence tend to generate higher returns for shareholders.  But it is integrity, rather than competence, that is the more important of the two.

And it’s not just me who sees it that way. Famously, Warren Buffett said that:

“…in looking for people to hire, you look for three qualities: integrity, intelligence, and energy. And if you don’t have the first, the other two will kill you. You think about it; it’s true. If you hire somebody without [integrity], you really want them to be dumb and lazy.”

If you agree with that sentiment — and I do — then judging management becomes more about judging integrity than anything else. However, this is at odds with the view popularised in articles with title such as How To Find Intelligent Fanatic CEOs Early. That article says an intelligent fanatic is ‘calculated’ as follows:

Intelligent Fanatic = (Long Term Vision + Focus + Energy + Integrity + Intelligence) x Execution

Now, as it happens, I find the missives of Ian Cassel (who penned the ‘formula’) above, well worth reading. But the point Buffett was making negates his formula, in my view. By extension, the Buffett quote implies that if a leader doesn’t have integrity, then you don’t want them to have those other traits. That makes integrity a necessary condition. In my view, Cassel could improve his formula by switching ‘execution’ with ‘integrity’, thus putting more importance on the latter.

While I applaud the fact that Ian Cassel is talking to his readers about management quality (which is hard to measure, so often avoided), I think he might be exaggerating our ability to identify top management ‘early’. It’s a worthwhile task, but very difficult.

Surely, we have all met someone who at first struck us as weird or uninteresting, but who turned out to be a great and loyal friend. And how many times have we all been charmed by someone who turned out to be untrustworthy? And not only that, but people do change over time. I don’t believe there are a single set of characteristics you can recognise that makes someone a good leader. And since companies are usually run by teams, rather than individuals, the job of judging leadership is made even more difficult.

So, while I find it interesting food for thought, I cannot agree completely with Cassel’s proposition below. He says:

“If you want to find intelligent fanatics early, look for intelligent iconoclasm…. [An] Iconoclast [is] a person who attacks cherished beliefs or institutions. I’ve found the best resource describing these behaviors in William Thorndike’s great book, The Outsiders: Eight Unconventional CEO’s and Their Radically Rational Blueprint for Success.”

The Problem? Thorndike’s Book Is Not Predictive

While I do agree that investors should look for CEOs with intelligence, (and I like the concept of ‘intelligent fanatics’) I don’t agree that reading about 8 successful CEOs will give you any special insight in identifying others in advance of their success. Reading a single hagiography will not help you spot all the saints.

Thorndike’s book takes eight successful CEOs, and then looks for similarities between those people. However, this does not prove that those traits are predictive of success. If Thorndike had surveyed all the CEOs who exhibited these traits and behaviours, then looked at the performance of their companies, overall, then we might be able to argue that certain CEO traits predict success. But he didn’t do that. He wrote a historic account of eight successful leaders and emphasised the similarities between them. His book is a great read, but I do not think it can help us spot the best CEOs particularly early.

For example, Thorndike reportedly once “endorsed” the former CEO of Valeant Pharmaceuticals (NYSE:VRX), J. Michael Pearson as “an Outsider-esque CEO.”

A few years later, under Pearson’s leadership, Valeant had become “a poster child for criticism of high drug prices and a target of congressional inquiries”, according to The Wall Street Journal. At around that time, Pearson stepped down from his role.

Now, the point here is not to pretend that Thorndike (or anyone else) should have known that Pearson would turn out to be a fairly disappointing CEO. I have certainly misjudged some leadership teams in the past. There’s no shame in getting it wrong from time to time.

Rather, the point here is that we can’t easily and accurately judge others from afar… and certainly not over short periods of time. All we can do is monitor their behaviour over long periods of time, and gradually get a better understanding of someone (or a team), over time.

And that’s the secret…

The only way to judge the quality of a leadership team is to monitor their words, and compare those words with their actions, over a long period of time. Sure, it’s a good sign that a CEO owns a large number of shares today, but if they sell those shares next month, it’s not so comforting.

The longer we watch how people behave, the more confidence we can have that they act with intelligence and integrity. No-one is perfect, so over shorter periods, we are prone to misjudging each other. Someone who displays high intelligence and integrity over the course of their life might make some stupid mistakes, at some points.

And someone who looks very clever for years, might be shown lacking when the tide goes out. The secret to spotting a good leadership team is time.

The bad news is that there’s no fast way to spot a top team. But the good news is that if you watch certain companies for many years you will have a genuine competitive advantage over other investors because you will have a keener sense of the quality of management and the board.

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Motley Fool contributor Claude Walker does not own shares in any of the companies mentioned in this article. The Motley Fool owns shares of and recommends Valeant Pharmaceuticals. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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