Why Changing the CEO May Not Change the Company

How much of a difference should investors expect when General Motors—or any company—brings in a new chief executive?

Not much.

This past week, GM's chief executive officer, Frederick "Fritz" Henderson, stepped down under pressure from the company's board. His defenestration follows the announcement earlier this fall that Kenneth Lewis will be exiting as CEO of Bank of America.

Heath Hinegardner

It seems obvious that getting the right boss in place ought to make all the difference in the world. Think of Steve Jobs parachuting back into Apple and powering it to record profits, or Alan Mulally steering Ford Motor through Detroit's collapse, or James Dimon navigating J.P. Morgan Chase through the financial crisis.

Management is important, which is why Warren Buffett puts such stock in the character of the people who run the companies he invests in. But management isn't nearly as important as many investors think, which is why Benjamin Graham, Mr. Buffett's mentor, paid so little attention to it. In fact, Mr. Graham seldom bothered to meet the managers of the companies he invested in, partly because he felt they would tell him only what they wished him to hear and partly because he didn't want his judgments of business value to be influenced by impressions of personal character.

If you took the CEOs with the best track records and brought them in to run the businesses with the worst performance, how often would those companies become more profitable? According to economist Antoinette Schoar of Massachusetts Institute of Technology's Sloan School of Management, who has studied the effects of hundreds of management changes, the answer is roughly 60%. That isn't much better than the flip of a coin.

"Some people," Prof. Schoar says, "may have this almost blind belief that the manager at the top changes everything. Our results show that managers do matter, but they don't change everything."

Since the 1970s, several other studies have measured what happens when companies bring in new bosses. Most of the findings have been consistent: Changes in leadership account for roughly 10% of the variance in corporate profitability on average.

As Mr. Buffett likes to say, "When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact."

But something else is going on here, says Princeton University psychologist Daniel Kahneman, who won the Nobel prize in economics in 2002. "We believe that people with certain characteristics will produce certain consequences," he says. "But we're wrong, because there is way, way more luck involved in determining success than we're prone to think."

The real force in corporate performance isn't the boss, but regression to the mean: Periods of good returns are highly likely to be followed by poor results, and vice versa. High returns attract fierce new competition, driving down future profits; low returns leave the survivors with fewer rivals, leading to better results down the road.

Most researchers agree that a company's results are determined less by its CEO than by its industry and the economy—which, in turn, are shaped by a host of factors that most CEOs can't control, like the price of raw materials, the value of the dollar, interest rates and inflation, bursts of technological innovation and so on.

In short, good management can't solve all problems, while some problems can get solved even without good management.

Plus, a company will be much more inclined to replace the CEO after a run of bad losses—and to bring him in from a firm that has been on a hot streak. That leads to an illusion: "You change the CEO," Dr. Kahneman says, "then performance reverts to the mean, and you attribute the improvement to the new guy."

Furthermore, the hot profits at the new CEO's former company are likely to cool off—by regression to the mean alone. When investors see that, they will mistakenly conclude that he is such a good boss that his old company can no longer thrive without him.

These beliefs tend to be temporary; the rave reviews for incoming bosses C. Michael Armstrong (from Hughes Electronics to AT&T, 1997), Carly Fiorina (Lucent to Hewlett-Packard, 1999) and John Thain (NYSE Euronext to Merrill Lynch, 2007) didn't last.

Some of GM's bonds jumped roughly 5% the day after Mr. Henderson resigned. But he didn't cause GM's woes, and whoever succeeds him might not be able to cure them. The odds tend to be against investors who bet that great new management can solve bad old problems.

Email: intelligentinvestor@wsj.com