The Matthew Effect

It seems that everytime you pick up a copy of the Wall Street Journal these days, some chief executive officer (CEO) is making headlines riding into outer space!  Just in the last month, Virgin Galactic's founder and CEO Richard Branson and Jeff Bezos, former (just recently) CEO of Amazon both flew into space.  Not willing to be left out of the fun, Elon Musk, CEO of Tesla Motors and Space X apparently signed up to fly into space in one of Virgin Galactic's spaceships.  It's a tempting question to ask - are these three gentlemen space explorers, entrepreneurs, or just attention-seeking media hounds?  The answer is that they are probably all three.  

We've grown accustomed to the high-profile, charismatic CEO.  We may even prefer leaders with charisma as opposed to ones who are just plain normal (whether charisma is a necessary leadership trait is a completely different matter).  Everyone seems to pay attention to former CEO's like Jack Welch, Bill Gates, Phil Knight, Robert Iger, or Howard Schultz.  Memoirs or leadership books by these CEO's and former CEO's are some of the most popular books on the market.  We just can't seem to get enough.

It seems like these CEO's have the proverbial Midas Touch, even when it involves risky ventures such as commercial space travel!  As the saying goes, nothing ventured, nothing gained (or my personal favorite, Fortune favors the bold).  Are these CEO's successful because they are willing to take risks? Or does society, in our love affair with charisma, simply reward these kind of individuals more than all of the rest?  The answer may surprise you.

Several years ago (see the original study here), the sociologist, Robert K. Merton described what he called the Matthew effect, which can be summarized by the old adage, "the rich get richer and the poor get poorer."  The name comes from the parable of the talents in the Gospel According to Matthew (Matthew 25:24-30) and the specific verse, For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath.  The effect has been both well-documented and well-described in a variety of settings, and I have even posted a couple of times about the Matthew effect in the past (see "I wish you bad luck" and "The Year of Karen").  

I recently came across a study that suggested that the Matthew effect can impact how different leaders (specifically, CEO's in the telecommunications industry) make strategic decisions.  Building on my earlier comments about fortune favoring the bold, this study suggests that society rewards the high-profile, charismatic, risk-taking CEO's more when they succeed and penalizes them less when they fail. 

The investigators collected data (available to the public) on 53 CEO's and 29 different companies in the U.S. cellular telephone network industry over a 19-year time period (1991-2010).  They specifically examind the different kinds of investment decisions (e.g. mergers and acquisitions, research and development, physical infrastructure, and market expansion) that each CEO made during his or her tenure.  CEO's were rated by status, using variables such as awards received (e.g, "CEO of the Year" awarded by trade or business magazine, "Entrepreneur of the Year", etc) and stock market evaluations.

Using a complex statistical analysis (just trust me on this one), they found that high-status CEO's generally made more risky investment decisions (M&A) than their low-status counterparts, who generally preferred less risky investments (R&D).  Higher risk usually leads to greater returns on the investment if the decision ends up being the right one.  However, higher risk decisions can also lead to greater losses if the decision ends up being wrong.  

Consistent with the Matthew effect, the high-profile CEO's receive accolades ("CEO of the Year") when their risky investment decisions turn out to be correct.  More often than not, when they make the wrong decision, they are quickly forgiven.  Rather than being penalized in any way, their misfortune is often blamed on "bad luck" or external factors beyond their control.  As such, they are more likely to make these riskier decisions in the first place.

Fortune may favor the bold, but perhaps it's easier to be bold when there is more to be gained and less to be lost.