The use of variance decomposition in the investigation of CEO effects: How large must the CEO effect be to rule out chance?

December 2014 | Parrish, Blake

Variance decomposition analysis is often used to examine the degree to which CEOs influence
their companies’ performance (the so-called CEO effect). Such studies play an important role
in a body of literature that investigates the effect of leadership on organizations. In this paper, I
argue that these previous studies have an important underlying flaw. Empirically, these studies
wrongly attribute the performance effect of randomness—of chance—to the CEO. I demonstrate
how randomness can affect the measured effects in a variance decomposition analysis, and I
show that this is especially problematic for the measurement of CEO effects. I demonstrate how
this results in a greatly inflated CEO effect and develop an approach to correct for it.

Author

Mays

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