How leadership diversity affects success

Venture capitalists and other investors routinely employ complex models and detailed algorithms to evaluate a company's financial position, market potential and level of quantifiable risk. But when it comes to assessing the effect of the founders and senior management team on a venture's likelihood of success, investors are limited to using their intuition or following some general industry rules of thumb.

by Stanford Graduate School of Business
Last Updated: 23 Jul 2013

Leadership research, which investors use to assess the effect of top management on company performance, has traditionally focused on individuals. But according to Charles O' Reilly, the Frank E Buck Professor of Management at the Stanford Graduate School of Business, this provides too narrow a perspective. "Anybody who has spent time in organisations knows that success is really driven by the team," he said. Research has so far largely ignored the impact of the founding and top management teams, and the effect of team composition and management turnover on a company's success.

O'Reilly recruited Christine Beckman and Diane Burton, both PhDs from Stanford, to study how the composition and turnover of founding and senior management teams impact company success. O'Reilly, Beckman and Burton found that teams with a variety of prior company affiliations and broad functional diversity tend to be more successful more quickly. They also found that turnover, specifically additions to the top management team and the exit of the founder, increases the likelihood that a company will achieve an initial public offering (IPO).

Existing research on diversity lays out "two very different hypotheses about whether or not diversity is a good thing", explained O'Reilly. One theory is that diverse teams bring more perspectives and different sets of information together and so should do a better job at solving problems and being creative; the second is that when faced with diversity people get politically correct: they don't want to offend others and are naturally drawn to consensus rather than disagreement.

O'Reilly, Beckman and Burton's study concluded that "putting together teams that are diverse with respect to both functional diversity and prior company experience is a good thing," according to O'Reilly. Companies with diverse founding and senior management teams have a higher likelihood than other firms of getting venture capital and going public.

The study also found that, contrary to common wisdom, high turnover can be positive "as start-up organisations begin to grow and require people that have different perspectives and more experience to help them succeed", said O'Reilly. Surprisingly, the researchers found that the departure of a founder significantly increased the probability that a firm would go public. O'Reilly speculated that while founders are often people who have a great idea and the passion to begin to build a company, "they aren't necessarily the people who have the skills to continue managing a firm, especially in VC-funded companies".

By contrast, when other members of the team leave, they decrease the probability of an IPO. This was potentially because their departure "reflects disagreements about the future direction of the company, which can lead to negative outcomes," said O'Reilly.

Bringing in new people to the organisation increased chances of success, the study found. But while bringing people with different experiences in can give a firm a boost, that does not mean that other people should be pushed out, according to O'Reilly. "Leaders have to manage the process pretty carefully so that people who were involved at the beginning understand that they're important, but that the company also needs to bring in other people," he said.

Charles O'Reilly, Christine Beckman and Diane Burton
Stanford Graduate School of Business

Review by Nick Loney

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