CEO-centric firms: risks and remedies; Improved governance is one natural antidote to the downside of CEO domination.

• Author: Walkling, Ralph
• Position: EVIDENCE AND PERSPECTIVES

APPLE, Berkshire Hathaway, Virgin Atlantic: It's hard to think of these companies without thinking of Steve Jobs, Warren Buffett, or Sir Richard Branson. Each of these companies is CEO-centric. Indeed, the contributions of the CEO are the primary reason for the success of these companies.

In some firms the terms CEO-dependent or CEO-dominated are also descriptive. CEO centricity can certainly lead to catastrophic loss. Think of Ken Lay and Enron. The point of this analysis, however, is not to praise or criticize the CEO-centric firm--a style of leadership that can work in the right circumstances--but to recognize a few of the unique risks and governance problems that can arise and outline a few solutions.

There are at least five (often related) reasons that firms are CEO-centric: talent, personality, governance, ownership, and public perception. Some firms depend on their leaders for their intellectual and creative spark. Strong personalities create CEO-centric firms. Success can create CEO-centric firms. Indeed, many CEOs become powerful because of a string of triumphs. Enron is a good example. The problems of the firm were obscured by its apparent success. Information received by the board was inadequate to properly monitor the firm.

Weak governance can also create CEO-dominated firms. Firms with boards that are reluctant to challenge the CEO are CEO-centric by definition. Firms that combine the roles of chairman and CEO are more likely to be CEO-centric. Related to this is concentrated ownership. Some companies have a large blockholder who also is, or controls, the CEO (often a descendent of the founding family).

So while dominant CEOs can be essential for the current direction and strategy of a company, they also come with several risks.

Let's start with dependency risk. Presume a situation where firm value is increased because of the merits of the CEO. Now consider:

1) 70% to 90% of a company's value comes from the terminal value: cash flows received after the next five years. If you doubt this, take any publicly traded company and compare the dividends received over the next five years to the price and you will find that most of the value is in the terminal value, even for low-growth utilities;

2) this terminal value is very sensitive to the future growth of a company, with small changes producing large swings in value; and,

3) all CEOs are replaced at some point, and it's likely to be in this future period where the dominant CEO...