Leadership is critically important to company performance. Putting a value on it may lead to greater investment in leadership development as a result of a change in priorities for resource allocation.
In recent years, investors have learned that defining the market value of a firm cannot just be based on finances. 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.
To gain more insights into a specific firm, investors have shown more interest in intangibles like strategy, brand, innovation, systems integration, collaboration, and so on. Investors have also worked to track and measure these intangibles, even if more subjective. The next step for investors is to analyze the predictors and drivers of these intangible factors — which means focusing on leadership.
Wise, long term investors recognize that leadership affects firm performance. But too often, assessments of leadership are haphazard and narrow. For instance, in our research, we found that investors allocate about 30% of their decision making based on quality of leadership, and they have much less confidence in their ability to assess leadership than in their assessments of financial or intangible performance. Investors may say “this leader is charismatic, has a vision, or treats people well” but there is little analysis behind what has often become a “gut feel” approach.
Numerous studies have shed light on what good leadership is; synthesizing this research into useful insights for investors would help counteract intuitive leadership assessments. A leadership capital index would inform investors about the readiness of the firm’s leadership to meet business challenges.
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.
- 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.
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.
Transitioning from a “gut feel” or narrow assessment of leadership to an index that can start to predict the impact leaders have on intangible value creation changes the game of leadership assessment and development.
The leadership capital index will help investors and others improve their approach to firm valuation. When leadership capital becomes a factor in investor judgments, it will naturally receive more emphasis in day-to-day corporate life, to the benefit of many. It is now time for investors and others to use a leadership capital index.
Adapted from an original article by David Ulrich and Allan Freed , HBR April 2015