Opinion: Twitter made this shareholder-friendly move after Jack Dorsey stepped down as CEO. Here’s why.

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Investors may have made the mistake of reacting negatively to Jack Dorsey’s resignation as CEO and his replacement by a relatively unknown insider – Parag Agrawal.

The chart below shows the performance of Twitter stock against the S&P 500
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since Dorsey’s resignation on the morning of November 29, the stock has since lagged the S&P 500 index. Barron’s quotes a money manager such as attributed this lagging performance to “disappointment from Wall Street that an internal successor had been chosen” rather than a well-known outsider.

My recommendation to Wall Street: Read academic research on the importance of the CEO to an organization’s long-term success. My reading of these studies shows that Wall Street really should be celebrating that Twitter’s board has chosen an insider. Outside CEOs often do a worse job than lesser-known managers who have worked their way up the ranks of the corporation they eventually lead — like Agrawal.

This is because a company’s internal culture plays a much larger role in the success or failure of a company than the CEO. Internal candidates like Agrawal have been imbued with Twitter’s corporate culture and know how to navigate it. In contrast, CEOs brought in from the outside have no such familiarity, which is why they are often less effective leaders.

To be sure, a board of directors may want to bring in an outsider to change a company’s internal culture. Unfortunately, in a competition between an external CEO and an internal culture, the latter usually wins. Gautam Mukunda, a professor of organizational behavior at Harvard Business School, has found from her research that “most CEOs who try to completely transform companies will fail.”

‘Wall Street exaggerates the importance of the CEO.’

The implication is that Wall Street exaggerates the importance of the CEO. Rakesh Khurana, a colleague of Mukunda at Harvard Business School and a professor of leadership development, told me on the occasion of previous CEO changes that “large-scale statistical studies have not found any any direct cause-and-effect relationship between CEOs and corporate performance.” A company’s internal culture “has a much more lasting effect on its success” than a CEO.

The importance of culture

What is this corporate culture that plays such a dominant role? It’s not easily identified, which is one reason why Wall Street isn’t paying as much attention to it as it deserves. A partial list of what corporate culture includes has been provided by Recent research by three finance professors: Gary Gorton and Alexander Zentefis (both at Yale) and Jill Grennan (at Duke):

  • Unwritten code, implicit rules and regulations in interaction

  • Identity, self-image and guiding purpose

  • Exceptional values ​​and evolving norms of behavior

  • Conventions, customs and traditions

  • Symbols, signs, rituals and group celebrations

  • Knowledge, discourse, emerging understanding, doctrine, ideology

  • Memes, jokes, styles and meanings are shared

  • Shared mental models, expectations, and language models

You can easily understand why culture is not easily defined. But just because it’s hard to pinpoint doesn’t mean it has little or no impact.

An example of how much cultural influence can be when two companies merge, either through outright mergers or acquisitions. Many studies over the years have documented that the average merger destroys value, when taking into account the market value of both companies and comparing them to similar unincorporated companies. Likely culprit, according to Eric Van den Steen, a professor of business administration at Harvard Business School, is a “clash of cultures—the destructive effects of combining two organizations with different cultures”.

Not guaranteed

Obviously, choosing an internal candidate as CEO is not a guarantee of success. So there’s no guarantee that Twitter will perform well under the new CEO.

Just think back to General Electric’s disappointing performance
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stocks when Jeff Immelt was CEO. Immelt had been with GE for 19 years when he was named CEO. During his tenure, GE stock has lagged the S&P 500 index by more than six percentage points annually.

However, my reading of research shows that GE is the exception rather than the rule. Twitter has a better chance of success appointing an insider as CEO than it will cater to short-sighted Wall Street investors and appoint an outsider with a higher reputation.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be contacted at mark@hulbertratings.com

Than: Why GE’s tax-free split could boost stocks and reward patient investors

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