New research shows evidence that subjective investor perceptions of CEOs during the roadshow have a significant impact on company valuation and subsequent stock performance. The study, completed by Elizabeth Blankespoor of Stanford Graduate School of Business together with Greg Miller of the University of Michigan and Brad Hendricks of the University of North Carolina, used 30 second video clips from CEO presentations at real IPO roadshows with the sound altered so as to ensure that perceptions were not swayed by the material data of the pitch. Respondents were then asked to rate the CEO’s performance on competence, attractiveness and trustworthiness with the results demonstrating positive correlation between higher scoring CEOs and the stock valuations of their companies at IPO.
Irrationality or an innate assessment of management capability?
The results of the report may seem surprising given that, at the roadshow, the CEO is merely presenting data that is already available to investors in the prospectus. However, this highlights the extent to which IPO pricing is based on cognitive bias and apparently irrational perceptions of management rather than the rigorous and scientific analysis of the company’s financials and strategy.
Furthermore, the findings are consistent with other recent academic and practitioner research on modern leadership which suggests that, instead of IQ and technical ability, emotional intelligence and the ability to inspire and lead are the “sine qua non” through which senior management can influence their employees and steward their organisation through a process of change, of which taking a company public is an example. Blankespoor’s study seems to suggest that investors are highly attuned to signs of emotional intelligence and the ability to influence employees and stakeholders, which will be a key factor in determining the extent to which the IPO is successful.
The findings also support Marble Hill Partners’ approach to assessing the right mindset and characteristics of senior management in order to ensure the optimal fit with the private equity (PE) backed businesses we work with. Our research shows that, in addition to technical skills and intellectual capacity, it is vital for a CEO to demonstrate a number of personality traits if they are to succeed in managing a private equity backed business. These include the following:
- the ability to drive results through embracing change;
- the ability to create a shared vision and inspire people through real leadership;
- strategic flexibility and the capability to handle uncertainty;
- being adept at managing multiple stakeholders through using open, honest and timely communication; and
- a strong focus on delivery, which involves taking ownership and assuming accountability.
The specific management requirements of PE-backed businesses arguably require a more rigorous assessment of a CEOs emotional intelligence and intangible skills than for non-backed companies.
Does the right CEO mean superior returns for PE-backed IPOs?
A study completed by Mario Levis at Cass Business School into the performance of private equity-backed IPOs suggests that PE backed companies benefit from a lower level of underpricing at IPO compared to both non-backed and venture capital backed IPOs and that PE-backed deals also enjoy superior returns over the 36 months post-IPO compared to non-backed and venture-backed flotations. Although no explicit link has yet been made between these statistics and the effectiveness of individual CEOs during the roadshow, the results suggest that ongoing private equity involvement in the company, perhaps through the incumbent PE-backed CEO remaining in place after the float, might have a strong positive impact on these returns.
Of course, the company’s strategic underpinning, financial forecasts, operational management and macro environment will always form the basis for any valuation. However, evidence of investor scrutiny of CEO behaviour from Blankespoor’s study and the influence and rigour associated with identifying the right CEO for a PE-backed business create a compelling picture of how the right CEO can be a powerful tool through which PE-backed companies can gain a higher valuation at IPO and improved stock performance in subsequent years.
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