Hulbert on Investing: Beyond the Superstar CEO; Companies with a strong corporate culture are a much better indicator of long-term success

August 30, 2013, 6:10 p.m. ET

Hulbert on Investing: Beyond the Superstar CEO

Companies with a strong corporate culture are a much better indicator of long-term success.


The chief executive Microsoft MSFT -0.45% chooses to succeed Steve Ballmer will most likely fail to transform the company into the cutting-edge high-tech player so many on Wall Street say they want. That is because Microsoft is under enormous pressure to follow a CEO search process that is “irrational,” according to Rakesh Khurana, a professor of leadership development at Harvard Business School. Most companies that have been in Microsoft’s current position—a one-time industry leader whose future prospects appear to be fading—searched for a new CEO “with as much star power as possible,” he said in an interview, in order to restore shareholder confidence and boost its stock price.Investors appeared to be anticipating such an outcome on the day of Mr. Ballmer’s resignation announcement, sending Microsoft’s stock soaring nearly 9%. Since then, however, it has given back the bulk of that gain.

That isn’t surprising, Mr. Khurana says, since “most recent studies have found that any stock-price run-ups after the announcements of CEO turnover are short-lived.” He says he expects a similar fate for any price pop in the wake of the eventual announcement of Mr. Ballmer’s successor.

“A corporate savior riding in on a white horse is ill-suited to changing a company’s internal culture, yet it’s that culture that exerts a far greater longer-term influence on the company’s success,” he says.

The implication is that investors should be focusing on corporate culture. In Microsoft’s case, that means ignoring the drama of its CEO search.

That isn’t easy to do, Mr. Khurana says, since the news media “fixates the public’s attention on the personal characteristics of leaders at the expense of serious analysis of events.” It is also notoriously difficult to quantify the aspects of corporate culture that count.

There is one promising line of academic research that has found that investors can capture much of what is important about corporate culture by focusing on governance-related issues—in particular, the extent to which a company restricts shareholder rights and thereby entrenches its leadership.

Paul Gompers, another professor at Harvard Business School, said in an interview that “one of the most crucial determinants of a firm’s long-term performance is how responsive it is to shareholder concerns.”

Perhaps the most cited academic study on corporate governance was conducted by Mr. Gompers along with finance professors Andrew Metrick of Yale University and Joy Ishii of Stanford University in 2003. They focused on 24 separate restrictions on shareholder power, such as dual classes of stock that give a controlling interest to a company’s executives and so-called golden parachutes that guarantee compensation to senior executives even if they are terminated or demoted.

The study found that, over the 10-year period studied, companies with the fewest restrictions saw their shares gain an annual average of 8.5 percentage points more than those with the most restrictions.

Unfortunately, Mr. Gompers said, he knows of no firm that uses this study’s precise 24-point index to rate companies on a continuing basis. But there are Wall Street firms that focus on at least some of the same and related corporate-governance issues.

One is GMI Ratings, an independent rating firm based in Portland, Maine. To capture those qualities of corporate culture that are of most relevance to an investor, the firm has found it helpful to focus not only on corporate governance-related measures but also on the accuracy and reliability of a company’s financial reporting.

The firm doesn’t make specific buy and sell recommendations, and in any case you should always look at many indicators rather than any one in isolation—such as price/earnings ratios and other valuation measures. But the academic studies of corporate culture do show that, other things being equal, it makes sense to favor the stocks of companies that have the most shareholder-friendly corporate governance.

The five publicly traded U.S. large-cap companies that currently rank the highest on GMI’s accounting and governance scale are Cincinnati FinancialCINF -1.13% an insurance company; wireless telecom provider U.S. Cellular USM -2.15% ; Brookdale Senior LivingBKD -3.10% which owns senior-living communities throughout the U.S.; Enterprise Products PartnersEPD -0.27% an energy pipeline company; and electric and natural-gas utility Xcel Energy XEL +0.43% .

According to Greg Ruel, senior research consultant at GMI Ratings, what these companies did to earn those ratings was, in essence, not do anything wrong on the governance and accounting fronts that would lower their score.

What about Microsoft? Mr. Ruel says the company currently is neither at the top nor the bottom of GMI’s accounting and governance rankings. In any case, he adds, who Microsoft chooses to be Mr. Ballmer’s successor will have no direct impact on the company’s rating.

Mr. Khurana adds that, if Microsoft is genuinely serious about transforming itself into an innovative and cutting-edge high-tech company at the forefront of its industry, then it should be focusing its energies on making fundamental shifts to its long-term strategy and the corresponding changes to its internal culture. “Without those changes, it’s unlikely Microsoft’s CEO could ever succeed, no matter how hard he or she tries,” he says.

In fact, from his perspective of focusing on corporate culture, Mr. Khurana views Steve Ballmer as a success, given the legacy and market constraints in which he has operated during his tenure as CEO. “Neither the board nor Wall Street investors wanted him to sacrifice an incredibly profitable product line in favor of a bold bet with marginal odds of success,” he says.

And unless its long-term strategy and internal culture change, Microsoft under its next CEO won’t be all that different than it has been under Mr. Ballmer’s leadership.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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