Calculating the Market Value of Leadership
In recent years, investors have learned that defining the market value of a firm cannot just be based on finances. GAAP and FASB standards require financial reporting of earnings, cash flow, and profitability – all measures that investors have traditionally examined. But recently, these financial outcomes have been found to predict only about 50% of a firm’s market value. Another challenge is that this financial information has become widely known and shared, meaning that the investor insights it affords are hardly unique.
The leadership ratings index we have developed has two dimensions, or domains: individual and organizational. Individual refers to the personal qualities (competencies, traits, characteristics) of both the top leader and the key leadership team in the organization. Organizational refers to the systems these leaders create to manage leadership throughout the organization and the application of organization systems to specific business conditions. Using these two domains, previous leadership and human capital work may be synthesized into a leadership capital index that investors can use to inform their valuation decisions. Each domain consists of five factors:
Personal proficiency: To what extent do leaders demonstrate the personal qualities to be an effective leader (e.g. intellectual, emotional, social, physical, and ethical behaviors)?
Strategist: To what extent do leaders articulate a point of view about the future and accordingly adjust the firm’s strategic positioning?
Executor: To what extent do leaders make things happen and deliver as promised?
People manager: To what extent do leaders build competence, commitment, and contribution of their people today and tomorrow?
Leadership differentiator: To what extent do leaders behave consistent with customer expectations?
Culture capability: To what extent do leaders create a customer-focused culture throughout the organization?
Talent management: To what extent do leaders manage the flow of talent into, through, and out of the organization?
Performance accountability: to what extent do leaders create performance management practices that reinforce the right behaviors?
Information: To what extent do leaders manage information flow throughout the organization (e.g., from top to bottom, bottom to top, and side to side)?
Work practices: To what extent do leaders establish organization and governance that deal with the increasing pace of change in today’s business setting?
While it may not be easy to precisely track each of these 10 elements, when investors include them in interviews, observations, surveys, and reports, they will dramatically increase their ability to realize full firm value. Equity investors (venture capitalists, private equity, portfolio managers, mutual/hedge fund managers) will use this index to complement existing financial and intangible analysis and gain a more thorough and rigorous understanding of firm’s full market value. Debt holders will have more confidence in a firm’s ability to repay its debt. With this index, rating agencies (ISS, government groups, Moody’s) can offer a more refined assessment of the firm’s full value by including leadership in their ratings process. Boards of directors can have a more thorough process for evaluating the quality of leadership within their organization. C-suite executives who have primary responsibility for firm value can include leadership as part of this discussion. Leadership development specialists charged with developing leaders can focus less on personal characteristics of leaders and more how investors might view them.
Realizing the market value of leadership could also have a significant impact on many organization processes: risk management, governance, social responsibility, reputation, and leadership development. Each of these processes could be upgraded with a disciplined and through approach to assessing leadership.