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Big Data Won’t Eliminate $200 Million CEO Hiring Mistakes

Yahoo! Finance
The Exchange

By Bob Damon

Let me start with a fact. A blown executive hire can cost a company hundreds of millions of dollars. Beyond business disruption, there is another cost that was aptly identified by Wharton Professor Luke Taylor as “entrenchment costs.”

"Entrenchment" costs are intangible costs. In the case of a board, the entrenchment cost is the board’s inability to fire an underperforming CEO. The board is “entrenched” in very close personal ties to the CEO.

Taylor's model found that the entrenchment cost per firing was, on average, $1 billion -- far more than the hundreds of millions in direct costs. It is why we have witnessed CEO tenure shrinking from eight years on average to four years. Boards know the waiting game is costly.

Yet, Taylor noted, “2% of Fortune 500 CEOs on average are fired every year.” He wrote in The Journal of Finance in 2010, “Why Are CEOs Rarely Fired? Evidence from Structural Estimation.”

In that article, Taylor used the assumption that replacing the CEO costs shareholders at least $200 million. His abstract states, “This cost mainly reflects CEO entrenchment rather than a real cost to shareholders. The model predicts that shareholder value would rise 3% if we eliminated this perceived turnover cost, all else equal.”

Entrenchment costs often extend way past the CEO and deep into organizations. Everyone reading this has worked with someone he or she thought was underperforming and should be fired. And just about every manager has had a low-performer he or she simply “just couldn’t” fire.

Big data meets H.R.

But, the world of hiring and human resources is changing. It is now science and art. And the science part, led by big data, is getting more and more sophisticated.

An April 2013 New York Times article by Steve Lohr reveals, “Work-force science, in short, is what happens when Big Data meets H.R.” It can burst the bubble of common assumptions: like once a job hopper, always a job hopper. However, data show that work history is not a good predictor of future results.

And in skilled jobs, big data is measuring future performance capability. This was highlighted in a follow-up story in the New York Times by Matt Richtel, “How Big Data Is Playing Recruiter for Specialized Workers.”

Science and the CEO

So, data and analysis are starting to play a big role in executive recruiting. Case in point is our own company that has become a talent management firm, though our roots are in executive recruiting.

Today the scientific tools are in place to measure board, CEO and top-executive effectiveness, leadership development, organizational transformation, and the integration of talent management.

Experts can scientifically find out about a person’s skill set and capabilities, and methodically collect data on executive effectiveness. Correlating these two streams of data gives hiring managers a window into the mechanics of leadership, but it doesn’t tell the whole story. Correlations will never account for or explain the human element behind effective leadership.

The human element is why boards are often struggling with entrenchment costs. It leads to questions: Can big data predict if a board member won’t fire the CEO that should be fired? Will it tell us if a new CEO or any leader will be able to fire the 15-year company person who is no longer performing?

The answers to these questions are "yes" and "no." The science of leadership development through 360-degree feedback gives us a hint into a person’s strengths, weaknesses and tendencies. But, tendencies are not a predictor of future results. In fact, few can predict human behavior.

We have seen this in past episodes of “The Office,” where Michael Scott is a faulty manager, yet a great salesperson. Further, we have seen executives who have huge failures turn into unabashed success.

The published list of CEOs that failed at first is amazing: Steve Jobs, David Neelman, Jacques Nasser, Donald Trump, David Murdock, T. Boone Pickens, Stephen M. Ross, Mark Zuckerberg, Bruton Smith, Richard Branson, Henry J. Heinz, Yasumitsu Shigeta, Tim Blixseth, Donald Graham and Sam Walton. As I noted, past performance is not an indicator of what a person will do next.

The 'human' factor still matters

While science and big data have improved recruiting and choosing leaders –in the end the best choices are those that combine cutting edge science with human intuition and know-how.

This is especially obvious in the NFL where highly touted, “can’t miss” college players visibly underperform the moment they hit the pro gridiron and are soon out of the game completely. Again, past performance is not necessarily an indicator of future success.

As the world of talent management gets more scientific, in the end the secrets to success lie in the alchemy of company culture, executive talent, and fit.

So let’s deal with reality. Today, we are often asked to find “digital executives” for many traditional companies. A question I like to ask is “what music do you have on your iPod?” It tells me a little about the culture and awareness of the individual. Then, I ask why. “Why that music? Why do you like to ski? Why don’t you have hobbies outside of work? Why haven’t you seen your kid’s soccer game – ever?”

Then I ask, “How do you” questions. “How do you know you will be able to succeed in this company? How do you think you would be able to work with the board?”

In the end, the right person for the right company at the right time is about fit and feel.

It comes down to what Eric Schmidt, the former CEO of Google (GOOG) was quoted as saying: “Computers will clearly handle the things we aren’t good at, and we will handle the things computers clearly aren’t good at.”

That is why, to avoid entrenchment costs, hiring managers need to get deeply entrenched in knowing whom they are hiring. Doing it right can save at least $2 00 million. Big data won’t eliminate the costs, people will.

Robert A. Damon is President, North America for talent management firm, Korn/Ferry International. Mr. Damon has more than 25 years of experience in executive searches for CEO, COO, president, board director and general management positions.