Dr Claudia Custodio, Associate Professor within the Department of Finance, highlights the importance of general human capital and managerial skills in a modern knowledge-based economy.
Innovation is a driving force in today’s economy, but investing in new technologies, products, and services is risky. Top firm managers typically make the decisions on research and development (R&D) budgets and the prioritisation of research projects. Could a CEO’s skill set therefore be an important determinant of innovation? And if so, which skills are most valuable in producing innovation?
Managers draw on skills gained throughout a career of making corporate decisions. Researchers emphasise two types of managerial capital: general human capital (i.e., skills not specific to any organisation and transferable across firms or industries) and firm-specific human capital (i.e., skills valuable only within an organisation). Specialists tend to be associated with highly technical sectors where innovation is required to keep up with fast moving environments. However, a soon-to-be-published study by myself and colleagues examined the link between CEOs’ general human capital and innovation using data from Standard & Poor’s 1,500 firms between 1993–2003. We found that CEOs with more general skills are actually the more innovative.
Louis Gerstner, who was CEO and Chairman of IBM from 1993–2002, is a good example of a generalist executive who promoted innovation. Before joining IBM he had worked in 11 different positions, 10 firms and six industries, as well as gaining managerial experience at a large conglomerate. Considered an outsider when he joined IBM, Gerstner was largely credited with turning around the company’s business. Over the decade of his management, IBM not only produced a record-setting number of patents but also stopped development of its own operating system and withdrew from the retail desktop PC market to focus on IT services.
Knowledge and skills
In a knowledge-based economy, a key management challenge is creating a firm without boundaries: replacing hierarchies with horizontal networks, linking together functional areas through cross-functional teams, and forming strategic alliances with suppliers, customers, and competitors. A generalist CEO can take advantage of knowledge in fields beyond the company’s current technological domain. Someone who has worked in multiple positions, firms, and industries will accumulate general human capital that’s useful when a firm needs to invest in transformative change. Generalist CEOs also tend to support innovation with a higher degree of impact and originality, in particular by importing ideas from their exposure to other industries – such as a development at another organisation that is directly applicable, or a potential synergy between divisions in their current firm.
Another hypothesis examined whether specialist CEOs have more technical expertise that allows them to identify and promote innovation. Innovation tends to occur in highly specialised areas like biotechnology and information technology, where managers with an industry background may have an advantage. Managerial skills in a particular field can encourage specialists to invest in innovation, and help them identify worthy projects. Conversely, general managerial skills are more commonplace and freely available from outside providers such as consultants.
With innovation comes a significant risk for managers, as there are inherent uncertainties in going from concept to realisation of actual profits. Our findings suggest that generalist CEOs are more likely to tackle innovative projects because they are less sensitive to the risk of termination, given their more diverse business experience. A generalist can move across industries more easily, as a failure in one industry might not necessarily reflect negatively on their ability elsewhere. Thus, the broader set of outside options available to generalist CEOs acts as a labour market mechanism of tolerance for failure that can foster innovation. This mechanism can be an alternative to CEO contracts offering long-term compensation plans and job security.
An efficient labour market for executives can therefore promote innovation by serving as a mechanism of tolerance for failure. Generalist CEOs are more likely to exploit innovative growth opportunities because they have skills that can be applied elsewhere, should risky projects fail. These findings highlight the importance of general human capital and managerial skills in a modern knowledge-based economy, where innovation continues to be a key determinant of success.
This article draws on findings from the working paper, Do General Managerial Skills Spur Innovation?, by Claudia Custodio, Miguel A. Ferreira, and Pedro P. Matos.