Getting the Right People at the Top

The CEOs and senior executives of Enron Corp., WorldCom Inc. and other disgraced companies have certainly gotten their fair share of press, but the huge scandal that nobody talks about is the multitude of cases in which top positions are filled with mediocre people. After almost 20 years of experience in helping companies to find and recruit people for senior positions, I am convinced that the problem of poor appointments is serious, pervasive and highly dangerous. (See “About the Research.”) But many firms are either unaware of the problem, slow to react to it or severely hampered by a number of psychological obstacles.

Understanding the Problem

Three factors explain why companies have such trouble making the best people decisions at the top. First, even for organizations that are adept at selecting winners, the deck is still stacked against successfully finding those individuals. Second, assessing people for senior positions is inherently difficult for a number of reasons. Finally, powerful psychological biases impair the quality of the decision-making process. A closer look at those three factors explains how each contributes to the failure of companies in making crucial appointments.

A Stacked Deck

To understand why companies have such trouble finding top-notch executives, first consider the way in which certain sophisticated skills are distributed across the managerial population. When it comes to complex jobs such as that of a senior executive, the distribution of talent is highly skewed. (See “A Good Performer Is Difficult to Find.”) The implication is that the best executives will perform at a much higher level than that of their peers. In fact, the performance spread grows exponentially with the complexity of the job. Simply put, the more complex the job, the larger the expected difference between top performers and others.1 The problem is that the odds are against companies finding those outstanding individuals because there are so very few of them around.

The deck is further stacked by the large impact of assessment errors, even for high levels of accuracy. To understand this issue, answer the following hypothetical question: Assuming that you want to hire only the top 10% of candidates for a position and that you are 90% accurate in assessing them, what will your success rate be? Many people might expect it to be 90%, but the true answer is just 50%. Here’s why. If you assess 100 candidates, 10 of those will be the top 10% (although you don’t know which 10). Of those 10, you will rightly assess nine as “top” because you are 90% accurate. So far, so good. But the problem is the other 90 candidates. Because of your 10% assessment error, you will mistakenly categorize another nine candidates as “top.” So, out of the 100 candidates, you will have classified 18 as top performers when half of them really aren’t.

Assessing the Unknown

When assessing candidates for a job, companies need to predict two things: What skills and attributes are truly needed, and what will each person actually deliver? Both predictions are extremely difficult to make for the top jobs at any organization.

Junior positions — for example, the brand manager for a consumer goods company — typically require general skills that are relatively easy to define. Senior jobs, in contrast, are often unique. Because of that, companies generally have great difficulty determining what is truly needed at the top. To complicate matters, senior positions frequently have little stability: Their requirements and priorities can shift dramatically as a result of macroeconomic, political, competitive or technological changes. Simply put, what is needed today can be quite different from what is required tomorrow.

Even when a company knows exactly what it’s looking for, determining whether a particular candidate fills the bill is an entirely different matter. That’s because the differentiating competencies for top leaders are usually in “soft” areas, such as the ability to develop people, lead teams, collaborate with others and manage change efforts. Each of these skills is very difficult to measure in any reliable way.

Finally, to exacerbate the problem, most senior executives have precious little time for a thorough evaluation and are likely to be extremely concerned about the confidentiality of the process, especially if they aren’t looking for a new position. As a result, their participation in any assessment will likely be very limited.

The Many Psychological Traps

Finding the right person for any job is hindered by various psychological forces that can easily sabotage the hiring team. As evolutionary psychologists have shown, the accelerated rate of change in modern society has far outpaced the ability of the human mind to process information judiciously. As a result, people’s decision-making processes are often impaired by a series of emotional biases, and the higher the stakes (that is, the more senior the appointment), the stronger these forces tend to be.

First, people tend to procrastinate when making big decisions. Especially in the absence of any crisis, the tendency is to exaggerate the risks of change and disregard the opportunity costs of sticking with the status quo. Most boards thus react late, firing an executive only after the damage has been done. Interestingly, studies of CEO turnover have consistently shown that top executives perform much better during the first half of their tenure.2

Second, executives frequently believe that the people they hire or promote are more capable than they actually are. That belief is usually based on two faulty assumptions: (1) that people can change more quickly and to a greater degree than they actually can (and that the company can afford to wait during that time); and (2) that two essential attributes — namely, the motivation to perform and the actual ability to do so — are closely correlated. But the simple truth is that even highly motivated executives can fail miserably if, for example, they lack a crucial skill.

Third, people often make snap judgments, quickly categorizing things and other people. When sizing someone up, they place too much weight on first impressions and secondhand information. One piece of negative gossip sometimes will eliminate a candidate who, on balance, might have been the best person for the position. Or people may rely too heavily on an unreliable indicator, such as a candidate’s charisma, to predict the future performance of that individual. These pitfalls are all the more dangerous because most executives believe they are quite adept at picking winners, despite their lack of preparation, their limited experience and even their own history of bad misjudgments.

Fourth, people tend to seek information that confirms what they already think instead of searching for any contradictory evidence. This explains the failure of many projects that looked good on paper: People simply ignored the warning signs. Assessing candidates in depth requires enormous discipline in order to sift through both positive and negative data and arrive at each individual’s true qualifications.

Fifth, people hate to fail, and when they do so, they will sometimes resort to extreme measures to save face. Paradoxically, as demonstrated by Chris Argyris of Harvard University, the smartest people can become quite stupid when they feel embarrassed or threatened and their need to cover their mistakes overwhelms their better judgment. When executives have backed a particular candidate, for example, they will often discount or even hide any negative findings about that individual.

Sixth, people like to stick with the familiar. Of course, any organization must be compatible with its employees, but all too often the practice of “hiring for fit” is really a mask for something else: looking for what’s comfortable and familiar instead of seeking an individual with the best combination of competence and complementarity, which necessarily requires diversity. This is why many corporations promote from within to fill most senior positions. And even when looking for outside talent, people still seek familiarity. Thus former consultants will hire other consultants, often from the same firm. Familiarity certainly can bring stability to any community, but it can also lead to dangerous myopia, particularly when a change is needed that requires a completely different set of competencies.

Seventh, people fall prey to emotional “anchoring,” judging candidates relative to one other or with respect to someone familiar rather than to the individual needed. A related factor is the attention bias of the sequence effect: People tend to remember both their first and last experiences the clearest. Thus, in a round of interviews, the earliest and most recent candidates will likely receive undue attention.

Finally, people often fall into the psychological trap of herding. In a group, the safest place is the center, and a key aspect of herding is imitation — the tendency to follow the majority rather than to act independently. Even high-powered executives are sometimes hesitant to express an opinion about a candidate that contradicts the views of their colleagues.

Many of these biases are illustrated by the experiences of a global technology company that needed to hire a team to head a major new service. Leading that recruitment effort, the CEO, who was a former partner at a top management consulting firm, hired each of the key team members directly, either through his personal relationships or by referrals from acquaintances. In doing so, he stuck with the familiar — several of the new hires were management consultants — and the decisions to bring them aboard were based on snap judgments. The company never conducted a thorough analysis to determine the competencies needed, such as strong technical skills and the ability to collaborate. Instead, the candidates were selected based on their impeccable educational backgrounds, outstanding employment history, impressive appearance and superb speaking skills. And the company made no effort to search for any disconfirming evidence, either by interviewing the individuals extensively or by conducting in-depth reference checks. The CEO also compared the candidates with the wrong reference — other management consultants. By the time the board members knew enough to become concerned, the CEO had already made the appointments. Saving face thus quickly became a factor. Reversing the decisions would require confronting the CEO, whom the board had hired; not only would the CEO have to admit his mistake, but the board would also have to acknowledge that it, too, bore some responsibility for the lapse in judgment. Herding further delayed any decision to stop the nominations, which could have been done earlier at a relatively low cost. Instead, the team was hired, and the result was a debacle. Gross technical errors and unacceptable tensions with the rest of the organization finally forced the company to kill the project, disband the team and fire the CEO, all at a cost of hundreds of millions of dollars.

What to Do?

Remember that the performance spread grows exponentially with the complexity of the job. Because of this, companies that are able to identify and attract the most qualified managers will have a considerable advantage. That’s why executives like Jack Welch, former CEO of General Electric Co., and Larry Bossidy, the retired head of AlliedSignal — arguably masters of people decisions at the top — would invest up to half their time in such activities. In fact, companies’ efforts should increase exponentially with the seniority and complexity of the job.

When assessing upper management, companies should always consider the opportunity costs of having the wrong people in those positions. Typically, executives worry mainly about not making mistakes, that is, avoiding outright failures. Looking at a company’s opportunity cost is a much more ambitious goal. Even if a person promoted or hired is not a clear failure, the company may still have a significant opportunity cost in terms of the forsaken performance had the right individual been appointed. Avoiding such costs requires substantial time and effort (considering more candidates and assessing them properly). That investment, though, is simply the price of success. Obviously, finding the right people for the corner offices is hardly a simple task, but a set of basic practices can help companies avoid the many common pitfalls.

Define Before Looking

Many firms make the mistake of commencing an executive search before they know what they’re really looking for. Successful organizations instead have the discipline to define clearly what they need before considering any candidates.

Consider the case of a major global dairy company that needed a new CEO. Before starting the search process, the board met several times to determine the firm’s strategic direction and managerial priorities, which then enabled it to arrive at a short list of crucial competencies, defined in behavioral terms. For example, the new CEO had to relate well with more than 10,000 local dairy farmers who were the cooperative owners of the company. The board not only determined what overall competencies were necessary but also weighted those attributes, with 40% going to organizational leadership and the remaining 60% being split equally among four other requirements. Additional work helped characterize each of those, enabling the recruiters to ask very specific screening questions. Of course, this process is critical when a company is filling any job, but it’s all the more crucial for senior positions, which typically involve unique competencies that must be specified in great detail.3

Cast a Wide Net

All too often, companies unnecessarily restrict their searches to certain markets, industries or geographic regions. But because the percentage of candidates who are top performers is tiny, firms should always cast the widest net possible to find those individuals who are truly outstanding.

When a U.S. computer hardware company needed to hire a country manager in Asia, it first identified all CEOs, COOs and other top-level executives at certain target companies in the region. These firms included other hardware vendors as well as relevant software and service providers, suppliers and even firms from less-related sectors, such as the telecommunications industry. In addition, the company compiled a second list — of Asians with relevant backgrounds working in North America, Europe and elsewhere. A third list included former executives of all the target companies. Finally, a fourth list was compiled, consisting of candidate executives from other sectors, such as consumer and durable goods. The hiring team then reduced the size of the aggregated lists, which contained more than 100 people, to arrive at a short list of a dozen individuals, who were then interviewed.

Compare Apples With Apples

To shorten any list of candidates, companies need a good benchmarking process. The primary concern here is consistency: Everyone involved in the assessment should have a defined methodology so that they all are evaluating and rating executives in the same way. Furthermore, internal and external candidates need to be compared on an equal footing, especially when crucial “soft” skills like the ability to lead a team are being evaluated. Such skills are usually somewhat known for internal candidates but are a bit of a mystery (and difficult to assess) for outsiders. Often, some people on the hiring committee will have a bias favoring internal candidates (related to the “not invented here” syndrome and the “similar to me” effect), whereas others might be more inclined toward external executives (a consequence of the “grass is greener” bias). Although comparing internal and external individuals is inherently difficult, the process is well worth the effort. Studies have shown that the best external hires are those selected after several internal candidates also have been considered and that the best internal promotions occur when a large number of external candidates also have been evaluated.

Evaluate Thoroughly

Once a company has arrived at a short list of candidates, two processes will help determine whether each of those individuals are actually as good as they seem. First, the candidates need to be interviewed in depth using behaviorally based questioning. If, for example, one of the required competencies is stakeholder management, the candidates need to be probed about how they’ve developed external relationships with customers, shareholders, partners, governments and the broader business community in which they’ve operated.

Second, a company needs to conduct in-depth reference checks, not only with people nominated by the candidate but also with those who have actually observed the individual in relevant situations. If the position is senior enough, board members should know people, either directly or indirectly, who are likely to be objective and frank in providing that information. An executive search firm can also provide access to such persons. Although there is no rule of thumb for the minimum number of references required, quality definitely trumps quantity. Specifically, the recentness of the reference, the relevance of the situation, the judgment and candor of the source, and the detail of information provided are critical. Just three references with those characteristics would reveal considerably more — and confuse the hiring committee much less — than dozens of generic references.

Filter Biases

The best defense against the many biases that impair the decision-making process is proper groundwork. Consider, for example, what happened to a large retailer that was suffering from massive brand confusion and loss of market share. To fix those problems, the board conducted a CEO search and found that the best person to head the firm was someone who lacked any experience in the retail sector. That choice bucked several strong forces. Sticking with the familiar would cry for promoting an insider —or at least someone with intimate knowledge of retailing — as had been the tradition throughout the entire company’s history. In addition, the chairman had to face staunch opposition from several board members and internal executives. Their tendency toward herding was amplified by the extensive media coverage, which repeatedly questioned the wisdom of such an atypical nomination. Eventually, though, the outsider was hired and has since been successful in turning the company around.

How was the chairman able to overcome such strong forces of resistance? First and foremost, he and others had done their homework, analyzing the situation logically to determine that retail experience wasn’t likely to be necessary. What the company really needed was someone who was financially literate, preferably international in outlook, adept at charting a long-term course for the company, able to attract and retain competent senior executives and skilled at managing a large, complex, multibusiness corporation. Therefore, from the outset of the search, everyone involved knew that retailing experience was desirable but not really necessary.

Limit the People Involved

Increasing the number of people in the assessment process can actually subtract, rather than add, value, especially if some of the participants are not fully qualified for the task. A big concern here is the possibility of “false negatives”: incompetent assessors mistakenly eliminating strong candidates. Another reason to limit the people involved is because candidates for senior positions typically have little availability, so a company needs to make the most out of a minimal number of interactions. For a CEO search, a small, highly qualified team should include two or three board members who can lead the entire effort, from defining the company’s needs to integrating the new executive. For lower-level jobs, the team might include the direct manager for the position, that individual’s boss and a human resources executive who is senior to the position.

Close the Deal

In the end, all of the preparation and assessment work will be wasted if the best candidate declines to join the company. Consider the case of a major foreign retail organization that conducted an extensive executive search in the midst of a number of business difficulties. Top talent was brought to the table and a finalist identified. But the company balked at the $2 million compensation package that the person wanted and ultimately promoted an internal candidate who wasn’t nearly as strong. That decision turned out to be penny-wise but pound-foolish, as the firm eventually went bankrupt. Another point worth remembering is that the fate of many deals often hinges on ancillary factors, such as access to a special school for a candidate’s children.

Facilitate the Integration

No amount of effort will help the wrong candidate survive, but the proper preparatory and support work can definitely improve the chances of someone who’s right for a position. The most common mistake that companies make is to assume that good outside executives can fend for themselves. This explains why the vast majority of external hirings are made virtually without any effort to integrate those individuals, for example, by cultivating the necessary internal support for them. To exacerbate matters, people from the outside are often hired when the management challenges are most demanding. Furthermore, the expectations for those individuals are frequently unrealistic. Studies have shown that immediate performance is typically expected of outsiders, whereas a gradual development time is usually allowed for people who have been promoted internally.

The Value of Good Decisions

Companies questioning whether all this effort is worth the investment should consider the following: Although a return on assets of 5% is the average for many markets, standard deviations are typically on the order of 10 percentage points or higher. This means that two standard deviations below the average would result in a negative return of 15%, while two standard deviations above would produce a positive return of 25%, or five times the average. Thus, for a company with assets of $1 billion and a valuation of 20 times net profits after taxes, the gap in value between superior versus average performance would be $4 billion.

Of course, that difference is not all related to leadership. Other factors, including specific competitive pressures and organizational issues, certainly play significant roles. Nevertheless, research has shown that leadership matters tremendously.4 In fact, the leader effect on performance is similar to that of the industry effect. That is, the choice of CEO has as large an impact on profitability as the decision of whether an organization should remain in its current industry or move to another. In some markets, the leader effect accounts for more than 40% of the variance in performance or value. For such cases, even a medium-sized U.S. company could increase its value by $1 billion through better people decisions at the top.

A few decades ago, consumer goods companies realized that smarter spending in advertising would boost their profitability, and statistical models were developed to quantify the expected value of such investments.5 One clear finding was that companies as a whole were significantlyunderinvesting in their advertising. When those same models are applied to calculate the expected value of increased spending to find and hire the best people for senior executive positions, the findings are dramatic: Even with very conservative assumptions, the return of such investments can easily be within an order of magnitude of 1,000%. That, in a nutshell, is the power of better people decisions at the top, and companies would do well to appreciate it fully.