Per author William Thorndike, CEOs need to do two things well to be successful:
- Operate efficiently
- Allocate the cash generated by operating efficiently
Capital allocation requires carefully deploying cash in the best investment opportunities available to the firm, which requires that a great CEO operate as both a capital allocator and investor.
As Warren Buffet observed in a 1987 letter to shareholders, very few CEOs come prepared for this task:
I would say that the controlled company offers two main advantages. First, when we control a company we get to allocate capital, whereas we are likely to have little or nothing to say about this process with marketable holdings. This point can be important because the heads of many companies are not skilled in capital allocation. Their inadequacy is not surprising. Most bosses rise to the top because they have excelled in an area such as marketing, production, engineering, administration or, sometimes, institutional politics.
Once they become CEOs, they face new responsibilities. They now must make capital allocation decisions, a critical job that they may have never tackled and that is not easily mastered. To stretch the point, it’s as if the final step for a highly-talented musician was not to perform at Carnegie Hall but, instead, to be named Chairman of the Federal Reserve.
Thorndike identifies the 8 best CEOs as measured by their ability to allocate capital. Per the author, a CEO has five choices for capital allocation:
- Invest in existing operations
- Acquire businesses
- Issue dividends
- Pay down debt
- Repurchase stock
To identify these 8 CEOs, Thorndike concludes that you only need to look at three variables:
- The compound annual return to shareholders during the CEO’s tenure
- The return over the same period for peer companies
- The return over the same period for the broader market (measured by the S&P 500)
The CEOs described in this book were legendary capital allocators as measured by the variables provided. “On average they outperformed the S&P 500 by over twenty times and their peers by over seven times…”
Thorndike comments that these CEOs also shared many personal traits:
They were generally frugal (often legendarily so) and humbly, analytical, and understated. They were devoted to their families, often leaving the office early to attend school events. They did not typically relish the outward-facing part of the CEO role. They did not give chamber of commerce speeches, and they did not attend Davos. They rarely appeared on the covers of business publications and did not write books of management advice. They were not cheerleaders or marketers or backslappers, and they did not exude charisma.
The book is fantastic and I cannot recommend it enough. Divided into 8 sections, the book covers the CEOs listed below.
- Tom Murphy: Capital Cities Broadcasting
- Henry Singleton: Teledyne
- Bill Anders: General Dynamics
- John Malone: TCI
- Katherine Graham: The Washington Post Company
- Bill Stiritz: Ralston Purina
- Dick Smith: General Cinema
- Warren Buffett: Berkshire Hathaway