The Cult Of The MBA CEO

The MBA degree turned 111 this year. How is it doing? Great for those who hold the degree from top business schools; not so much for the businesses they run, according to a study by the Institutional Investor. The cult of the MBA CEO has led to huge increases in executive pay but not profit gains:

According to data from the Stanford Graduate School of Business, average CEO compensation at the largest firms rose from $1.8 million per year in the 1980s — roughly in line with the previous 45 years — to $4.1 million in the 1990s. By the early 2000s, it had risen to $9.2 million. And those numbers are after adjusting for inflation...

We found no statistically significant alphas — despite testing every possible school with a reasonable sample size. MBA programs simply do not produce CEOs who are better at running companies, if performance is measured by stock price return...

What makes a good CEO? The Institutional Investor has spent the last year trying to find out. From a study of 8,500 bosses, they found that holding an MBA made you statistically no more or less likely to return higher profits. There are significant traits that make an effective corporate leader, but they aren't ones that can be taught in higher education.

In the CEO’s defense, boards pay them for the marginal cost of the impact of their decisions, good and bad. For example, a CEO at a company with annual revenues of $1 million might make a decision that affects 10% of its sales. For socialists that’s $100,000. But a CEO of a company with $1 billion in sales making a similar decision would have a $100 million impact. The higher the dollar value of the impact of decisions by the CEO, the more they are paid. Boards pay CEOs for what they know, not for how hard they work.

So why don’t MBAs contribute to profit growth at companies they run? Professor Henry Mintzberg wondered about that decades ago after teaching in an MBA program. He took a sabbatical to search for answers, the results of which he put into his book, Managers Not MBAs: A hard look at the soft practice of managing and management development.

First, too early can make the right people wrong. Giving them a questionable impression of managing can distort how they practice it subsequently... 

Second, I argue that MBA programs by their very nature attract many of the wrong people—too impatient, too analytical, too much need to control.

Mintzberg found that MBA programs attract the wrong people at the wrong time in their life and teach them the wrong skills. Also, managing requires personality types that have a passion for business and a will to manage. Armed with the results, he remodeled the program at McGill University in Montreal and changed the name to International Masters Program in Practicing Management. It accepts only people with managerial experience.

In addition to the failure of MBA programs to prepare graduates to manage, the International Investor study and Mintzberg found that experience doesn’t travel well, either. Mintzberg explained:

Because grade school teachers can easily carry their skills from one classroom to another, they can still be called professionals. But not so managers, who can hardly carry their skills from one function to another within the same organization, let alone across organizations or industries. In other words, knowledge about context is not as portable in management as it is in education or engineering or medicine. That is why so many managers who have succeeded in one place fail in others (which is hardly true of teachers or engineers or physicians—so long as they stick to the skills they have).

Neither the study or Mintzberg mentioned a related problem: most MBA programs require advanced calculus to graduate. Advanced calculus is nearly worthless to a CEO and if he needs it he can always hire someone with those skills. But that requirement ensures that MBA graduates will consist mainly of math nerds with few people skills, those most necessary for management. You can teach history majors to crunch numbers but you can’t teach math wizards to get along with people.

Investors who study individual companies rather than investing in ETFs or mutual funds will find the information from the study and Mintzberg’s book helpful. Look for companies that promote from within. Those CEOs will have gained the industry and management experience to succeed. Avoid those who look for superstar CEOs, especially those from other industries.

First published at Townhall Finance.