As an investor, you're always looking for a way to outperform the overall stock market. If not, why even attempt active investing? You can pick your choice of indexed funds, passively take what the market gives you, and hope it's enough to secure your financial future.
However, what if there was a simple way to outperform the market? According to multiple studies, there is: just invest in founder-led companies, as they tend to outperform their peers. According to a study from Purdue's Krannert School of Management, the data suggests "founder CEOs are more effective and efficient innovators than professional CEOs" and those innovations "create more financial value" than those from professional CEOs.
Another study from global consulting firm Bain and Company, by way of the Harvard Business Review, found that over the years 1990-2014, "an index of S&P 500 companies in which the founder is still deeply involved performed 3.1 times better than the rest."
Founders invest for the long term
A third study, this one from Ruediger Fahlenbrach at the Foster School of Business (University of Washington), found founder-CEO firms invest more in research and development, have higher capital expenditures, and make more focused mergers and acquisitions. The best example in recent years of a focused acquisition is by Facebook (NASDAQ:FB) and its CEO Mark Zuckerberg. A month before its initial public offering, in one of the gutsiest moves in IPO history, Facebook paid $1 billion for Instagram, a company with no revenue.
At the closing, Instagram's price tag dropped to $715 million in the cash and stock deal; shares of Facebook dropped precipitously, due to a bungled IPO and concerns the young CEO was a naive spendthrift. Five years later, Instagram is a huge driver of growth for Facebook, and is considered one of the greatest acquisitions in recent history. It's unlikely a CEO without a large voting block of shares would have had the ability to pull this off.
At that time Facebook had more concerns than perceptions regarding its CEO's capital allocation decisions. As Motley Fool co-founder and CEO Tom Gardner outlines in his Master Class, Facebook was in the midst of a shift in user behavior. The site had been designed for a desktop experience, but the world was quickly shifting to mobile. Because the company had a founder as CEO, it was able to sacrifice short-term profit in order to retrain developers to become mobile-focused. It's paid off -- last quarter, 88% of Facebook's total advertising revenue came from mobile.
Growing the pie versus trying to cut bigger slices
Additionally, founders already own a large percentage of the company. Unlike other companies where new CEOs are laser-focused on short-term board-derived metrics, often simply to earn personal stock options, founders are more concerned with growing the company. Using the example of a pie: Often non-founder CEOs are more concerned with getting bigger slices, while founders are more concerned with growing the total pie in a sustainable manner. Simply put, incentives matter.
Amazon (NASDAQ:AMZN) is a great example. Founder and CEO Jeff Bezos has been relentless in growing the company through operational excellence. He is defined by a singular vision to customer experience and innovation, outlining his commitment to both in his last shareholder letter. However, Jeff Bezos was not even the highest-paid employee at his company last year. That designation went to Andrew Jassy, the head of Amazon Web Services.
In a recent filing with the Securities and Exchange Commission, Amazon's board of directors -- led by Jeff Bezos -- said the company does not link bonuses to performance criteria, as it "could cause employees to focus solely on short-term returns at the expense of long-term growth and innovation." Additionally, the board noted that compensation is based on "customer obsession, innovation, bias for action, acting like owners and thinking long term, and frugality."
Don't overlook the management team
Mark Twain was credited with saying "history doesn't repeat itself, but if often rhymes." This is particularly apt in the case of founder-led companies. While there's strong evidence founder-led companies have outperformed their non-founder-led peers, each company is an individual case and should be approached as such. In investing, nothing is guaranteed.
Due to the sheer amount of evidence, however, it wouldn't hurt to pay special attention to a company's management when undertaking your due diligence.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jamal Carnette, CFA owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon and Facebook. The Motley Fool has a disclosure policy.