Does leadership style matter? Investment committee decision-making study

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1 Does leadership style matter? Investment committee decision-making study Vanguard research June 2011 Executive summary. In a 2010 survey, Vanguard examined the impact of various leadership styles on investment committee decision-making. The survey, titled Investment Committees: The Dynamics of Leadership Styles, studied three leadership styles: autocratic, democratic, and laissezfaire. Respondents were queried on best practices; factors considered when selecting and evaluating managers; committee attributes, including the level of expertise; group decision-making behavior; and use of external consultants. Authors Jill Marshall Liqian Ren, Ph.D. Surprisingly, the answer to the question, Does leadership style matter? was not a lot, according to survey respondents. The vast majority of investment committees said they had a democratic leadership style, rather than the outcome we expected that of a more even distribution of leadership styles. Most respondents were very satisfied with their democratic style. However, committee behavior was generally quite similar, irrespective of leadership style. Connect with Vanguard > vanguard.com

2 Results of this survey reinforce the presumption that there will always be powerful situational determinants that drive leadership effectiveness. This reality should serve as a reminder to all investment committee leaders to focus on what they can control. We suggest that a good place to begin is with Vanguard s view of investment committee best practices (Gordon and LaBarge, 2010); namely: have a clear understanding of the portfolio s purpose; create a charter that outlines members responsibilities; adopt a clear investment strategy; and follow a straightforward process for hiring and terminating managers. Encouraging healthy debate and avoiding common behavioral biases within group decision-making can also do more to pave the way for long-term success than focusing on uncontrollable factors such as shortterm performance. Leadership, the process of inspiring others to work together to achieve a common goal, is an inevitable element of group dynamics. Yet, the relationship between a leader s participation and his or her effectiveness in accomplishing goals is complex. Leadership style, a term that has been defined in numerous ways, most commonly refers to the characteristic manner in which an individual leads others. Researchers have suggested that a participation theory of leadership (Vroom, 1959), which assumes that a group s performance depends in part on the extent to which leaders share or retain their decision-making authority, is one way to begin to assess leadership effectiveness. Early conceptualizations categorized leadership styles as autocratic, democratic, or laissez-faire (White and Lippitt, 1960). Assessing leadership styles is challenging. We know that leaders influence their groups, but the question remains of why some groups prosper when guided by good leaders (Bass, 1990). Vanguard decided to explore this question by examining whether leadership style can dramatically alter the effectiveness of investment committee decision-making. In 2010, we conducted a survey titled Investment Committees: The Dynamics of Leadership Styles to determine the effects of a leader s participation in decision-making. We received 213 responses, from a range of client types (defined benefit [DB], 40; defined contribution [DC], 71; and endowment and foundations [E&F], 102) and portfolio asset levels (the largest asset level being $250 million). (See the appendix for further details on the survey sample.) Leadership style: Democratic most prevalent Vanguard s survey asked respondents to characterize their leadership climate as autocratic, democratic, or laissez-faire; hereafter, their responses are referred to as the stated leadership style. We then asked respondents which style they would have preferred, if given the choice. We also asked several derived (i.e., with embedded assumptions) leadership style questions to verify the authenticity of the stated leadership style (discussed more in next section). The shaded text box on page 3 provides an overview of the three leadership styles and also shows the breakdown of the 213 responding committees by stated and preferred types. 2

3 Identifying the style of committee leadership In Vanguard s Leadership Styles survey, investment committees were given the following definitions of three leadership styles. Autocratic Leader seeks to have the most authority and control in decisionmaking. Leader seeks to retain responsibility rather than use complete delegation. Democratic Leader seeks consultation and welcomes feedback on all major issues and decisions. Leader effectively assigns tasks to committee members and gives them full control and responsibility. Laissez-faire (hands-off) Leader provides minimal direction. All authority is given to committee members, and they must determine goals, make decisions, and resolve problems on their own. Respondents were asked to characterize their current leadership climate ( stated ) and were then asked which style they would have preferred: Each box represents a respondent, and color denotes a preference: Autocratic Democratic Laissez-faire Stated autocratic 12 survey respondents (6%) Stated democratic 171 survey respondents (80%) Stated laissez-faire 30 survey respondents (14%) Some potential advantages and disadvantages of each leadership style: Autocratic Democratic Laissez-faire Potential advantages Faster decision-making. Increased productivity. Reduced stress, because of increased control. Potential disadvantages Deskilled, demotivated, and less confident group. Micro-management. Less-creative decision-making. Creative thinking. Fewer grave mistakes. Cohesive team. Lengthy decision-making. Certain individuals may dominate. Creative thinking. Flexibility. Originality. Allows for an emergent leader. Frustration. Poor quality of outcomes. Disorganization. Limited personal growth. 3

4 By far the most common stated leadership style was democratic (80%), followed by laissez-faire (14%) and autocratic (6%), with responses showing little difference by client type (DB, DC, or E&F). The data for preferred styles showed a more revealing story, however. The majority of committees, no matter which stated leadership style, would have preferred a democratic leadership style (see blue boxes on page 3). A closer look at the laissez-faire committees preferring democratic leadership revealed that this group did have a worse impression of their committees behavior. For instance, as discussed later in this paper, respondents reported using fewer investment committee best practices as identified in the survey; at the same time, they perceived group behavioral bias to be higher. These findings were revealing, since a primary function of a committee leader is to ensure that the decision-making processes are outlined and that rules are established and enforced. Therefore, leaders particularly those that are hands-off should be aware that a lack of structure can actually be disruptive. (Note that these results should be interpreted with caution, given the small sample sizes of the autocratic and laissez-faire committees in the survey.) As described earlier, to check the legitimacy of the stated leadership style, we queried respondents about their leader s behavior. As expected, within each style the answers to the derived questions were closely aligned with the stated style, no matter whether the respondent was the chairperson or a committee member. Figure 1 highlights this, as shown by the fact that the derived mean leadership style bars were generally highest within each stated style. The results were statistically significant for the stated democratic responses. For example, the derived democratic mean was 3.5 for respondents who stated they were democratic, compared with the derived autocratic mean of 1.7 and derived laissez-faire mean of 2.8. Figure 1. Respondents stated and derived leadership styles were closely aligned The survey asked respondents how often the committee leader displayed a series of behaviors. We assigned 1 point for an often or always response; 0 points for occasionally ; and 1 for seldom or never. We totaled the points for each leadership style (for a maximum of 4 points per style) per respondent. The average mean for each derived style is represented by the height of the bars; the higher the bar, the higher the relationship between stated and derived styles. Mean of responses Stated autocratic Derived autocratic Derived democratic Derived laissez-faire 1.6 Stated democratic Stated laissez-faire The laissez-faire derived leadership style was less clear. Respondents who indicated that their stated leadership style was laissez-faire gave the same answers for the derived laissez-faire and democratic questions (see Figure 1). This could indicate that the leadership style of the stated laissez-faire Notes: An example of a derived autocratic description posed to respondents was closely monitors member s participation. A derived democratic description was seeks to create an environment where the members take ownership of an issue. A derived laissez-faire description was allows members to determine what needs to be done and how to do it. 4

5 respondents was actually more democratic than they believed. Finally, the derived autocratic mean of the stated autocratic groups was low (see the figure), suggesting that respondents answered occasionally or seldom or never to the autocratic derived question. It is also noteworthy for this group that the derived democratic and laissez-faire means were low, suggesting that the leaders may use a mixture of leadership styles. In groups, there can either be designated or emergent leaders. When there is no designated leader, an opportunity can present itself for a natural leader to emerge. Research has shown that there is more leadership behavior when there is a designated leader as opposed to an emergent leader (Borg, 1957). In our survey, 87% of committees polled had a designated leader. As expected, the greater the leader s level of participation, the more likely it was that there was a designated leader. All of the autocratic leadership styles had a designated leader, compared with 88% of the democratic styles and 73% of the laissez-faire leadership structures. We also found that E&F clients had the most designated leaders (95%), compared with DB (83%) and DC (77%). The higher rate of designated E&F leaders could relate to the fact that 95% were also volunteers. In our survey, the stated designated democratic leaders received statistically significant higher rates of satisfaction from committee members (see Figure 2): 99% of democratic committees reported being often or always satisfied, compared with laissez-faire (84%) and autocratic (78%) styles. To what degree are members satisfied with the leader s performance? Percentage of respondents Figure % % Satisfaction ratings of stated leadership style by committee member respondents 1% 16% Seldom/ occasionally Autocratic Democratic Laissez-faire 67% 53% 58% Often 11% 46% Always 26% The next three sections of this paper addressing best practices, selection and evaluation of managers, and group decision-making, respectively point to the fact that leaders of investment committees can achieve similar results no matter the level of participation in committee processes. Surprisingly, whether a leader employed an autocratic, democratic, or laissez-faire style did not significantly alter the results. 5

6 Figure 3. Percentage of respondents whose committees used best practices Encourages additional education or training for members on relevant investment topics Regularly assesses whether portfolio fees are reasonable relative to performance expectations Reviews the investment policy statement at least annually 35% 77% 82% Assesses portfolio risk at least annually Ensures that the process used to operate the portfolio conforms to committee documents such as the investment policy statement Conducts regular meetings on all aspects of the portfolio, both administrative and investment-related Documents meeting minutes, attendance, member contributions, reasons for manager changes Reviews asset allocation at least annually 88% 90% 91% 92% 97% Often Always Investment committee best practices We recommend that by following a series of Vanguard best practices, investment committees can improve their productivity and effectiveness. We surveyed respondents on how frequently they adhered to certain best practices and found that the results did not vary significantly by leadership style or portfolio asset size. Also, best practices were used most of the time. For instance, more than 90% of the time, on average, committees reviewed the asset allocation at least annually, followed proper documentation procedures, conducted regular meetings, and used processes that were in line with their policy statements. Two areas of opportunity for improvement included encouraging continuing education relevant to investments (respondents reported engaging in this activity just 35% of the time, on average) and regularly assessing fees (reportedly done 77% of the time) (see Figure 3). The one area in which there was statistical significance across leadership styles pertained to reviewing the asset allocation. Just 76% of committees with a laissez-faire leadership style always reviewed the asset allocations, compared with 92% for committees with a democratic style. Selecting and evaluating a fund manager Investment committees tend to hire at least one outside advisor to manage their assets, with a majority hiring multiple managers. In our survey, the average number of managers per investment committee was ten. We asked respondents to rank the following seven factors in order of importance: integrity of the firm, portfolio performance, depth and skill of managers, investment philosophy, portfolio construction consistency/conviction, investment process, and cost (see Figure 4). Generally, there was little difference in respondents ranking of criteria when comparing leadership style, client type, or whether the respondent was a chairperson or member. 6

7 Figure 4. Respondents ranking of criteria for selecting/evaluating manager(s) Figure 5. Committee leaders reported level of expertise Percentage ranked first and second in importance Leaders level of expertise Cost 2% 15% 100% Investment process Portfolio construction consistency/conviction Investment philosophy 4% 8% 8% 7% 11% 17% % 52% 72% Depth and skill of manager(s) Performance Integrity of the firm First 12% 16% 23% 25% 18% Second 33% % 15% Investment experience 35% 12% Finance experience 22% 5% Business experience Note: Some percentages may not sum to 100 because of rounding. High Medium None/low Note: Some percentages may not sum to 100 because of rounding. The survey s results reinforced that there is an opportunity to educate investment committees on the importance of reducing costs and the ineffective reliance on past performance when evaluating managers. On average, as Figure 4 shows, just 2% of respondents ranked cost as the most important criterion, and 15% ranked it as second. In particular, DC clients (22%) placed more emphasis on cost (ranking it first or second) than DB (12%) or E&F (14%) clients. Over time, in Vanguard s view, the inability to control manager fees and expenses can impair a committee s, or participant s, ability to meet a portfolio s goals. Our survey results differed slightly from those of a previous Vanguard survey that evaluated managers, in which performance was rated first out of five key factors influencing investment manager turnover (e.g., LaBarge, 2010). In the LaBarge study, cost was rated the third most important factor. Surprisingly, in our survey, respondents reported that fees were a relatively less important factor (see Figure 4). Of note, the level of expertise of the leader (Figure 5) did affect respondents ranking of criteria for evaluating/selecting managers. In particular, a lower level of expertise in all of the fields whether investment, finance, or business meant that performance was rated more important. On the other hand, higher levels of a particular type of experience did affect which factor was dominantly ranked. For example, higher investment experience correlated with greater emphasis on the depth and skill of the managers, but less focus on a firm s integrity. Higher general finance experience ranked investment philosophy higher, but cost became less so. More general business experience was aligned with more importance given to the firm s integrity, but less emphasis on the investment process. 7

8 Group decision-making behavior Groups, by their nature, make decisions that are susceptible to behavioral and psychological biases. These biases can undermine their decisions and have negative consequences for committees (Mottola and Utkus, 2009). Conventional wisdom might suggest that when members are more satisfied with the leadership, their committees may exhibit less bias. This was not the case with our survey results, however. Although we found that democratic leaders enjoyed higher levels of satisfaction, there was not a statistically significant relationship between this leadership style and a lower level of bias in group decision-making. 1 Our results indicated that the level of bias was generally low (see Figure 6), as was the case in Vanguard s previous research (Stockton, 2009). To gauge the level of bias such as overconfidence or group think we asked survey participants to respond to several statements (see the figure). The greatest amount of reported bias was that of shared-information bias (the tendency to discuss only the information currently available to the team), at 30%. Of particular interest was the difference in the level of bias reported by the chairperson versus committee members. In all cases, members reported approximately 10% more bias occurring often or always. Aside from querying about bias, we also asked if the leader inspired extra effort among members. This was the only area in which leaders indicated the performance occurred more frequently than did members; chairpersons reported that the leader often or always (53%) inspired extra effort, compared with 39% for members. Figure 6. Overconfidence Group decision-making Group think Confirmation bias Social loafing Shared-information bias 6% 10% 10% 16% 30% Notes: To gauge the degree of bias, we asked survey participants to respond to several statements: 1. There is a tendency to develop unduly optimistic forecasts of the future. (Indicator of overconfidence bias.) 2. Members are more interested in avoiding conflict and maintaining unanimity than realistically appraising the various courses of action. (Group think.) 3. There is a tendency for a group to acquire information that confirms the group s views and to disregard information that conflicts with the group s views. (Confirmation bias.) 4. The committee contains members who do not make meaningful contributions. (Social loafing.) 5. There is a tendency to discuss only the information that is available to all of the group s members before discussion. (Shared-information bias.) The level of assets had a significant impact on the amount of social loafing. For committees with more than $250 million in assets, more social loafing was reported (24% reporting often or always ), compared with committees with less than $50 million (just 10% reporting social loafing often or always ). 1 The small sample size of autocratic and laissez-faire style respondents affected the statistical significance of our findings. 8

9 Figure 7. Use of external consultants Respondents use of external consultants and their involvement level Level of involvement Caution should be used in drawing conclusions, however, given both the small number of aggregate autocratic respondents (12) and all respondents subjective interpretation of low, medium, and high levels of involvement (see Figure 7). Not surprisingly, committees with less than $50 million in assets were less likely to employ a consultant (69%). Conclusions 78% 22% Yes No 41% 25% 8% 4% High Medium Low None Conventional wisdom suggests that leadership style could dramatically alter the effectiveness of investment committee decision-making. Our research found otherwise, reinforcing the presumption that the leader, the committee members, and the group situation are all important considerations. Consequently, we suggest that most successful leaders are able to adjust their behavior as circumstances dictate to effect positive outcomes. Use of external consultants Consultants can be a key source of information for investment committees focused on portfolio construction, investment management, research, fiduciary and compliance matters, and data analysis. In this study, nearly 80% 2 of the investment committees surveyed employed an external consultant, and 41% of those indicated that the consultant had a high degree of involvement (see Figure 7). We did find that consultant use was dependent upon the leadership style and asset size, but that it did not vary by client type. Surprisingly, consultant use did not dramatically affect the degree to which best practices were followed. Committees with democratic and laissez-faire leadership styles were more inclined to hire a consultant (80% and 77%, respectively), versus 50% of committees with autocratic leadership styles. We did find that a democratic leadership style was the most popular and successful of the three types, if measured by satisfaction of the committee members. However, there was little indication that committees with democratic leaders achieved increased productivity or superior behavior among their members. We do caution committees with laissez-faire leaders to remain aware of the risk that a lack of structure can actually be disruptive. We found that failure of a leader to fulfill his or her roles and responsibilities was likely to undermine the committee s confidence and ability to make decisions. Finally, we recommend that investment committees remain focused on addressing concerns within their control, such as implementing best practices for investment committees, promoting a cohesive and unified team, determining specific roles and responsibilities for members, adhering to the agreed-upon decision-making process, and regularly assessing fees. 2 See also Vanguard research by Stockton (2009), who reported that many institutions hire consultants to assist with investment decisions: 81% of respondents for nonprofits, 75% of respondents for defined benefit, and 51% for defined contribution reported using an external consultant. 9

10 References Bass, Bernard M., From Transactional to Transformational Leadership: Learning to Share the Vision. Organizational Dynamics 19(3): Borg, Walter R., The Behavior of Emergent and Designated Leaders in Situational Tests. Sociometry (American Sociological Association) 20(2, June): Forsyth, Donelson R., Group Dynamics. Belmont, Calif.: Wadsworth Publishing Co. Gordon, Catherine D., and Karin Peterson LaBarge, Investment Committees: Vanguard s View of Best Practices. Valley Forge, Pa.: The Vanguard Group. LaBarge, Karin Peterson, What Matters Most? An Analysis of Hire/Fire Decisions. Valley Forge, Pa.: The Vanguard Group. Moore, Lori L., and Rick D. Rudd, Leadership Styles of Current Extension Leaders. Journal of Agricultural Education 47(1): 6 7. Mottola, Gary, and Stephen P. Utkus, Group Decision-Making: Implications for Investment Committees. Valley Forge, Pa.: The Vanguard Group. Stockton, Kimberly A., Investment Committee Decision-Maker Study. Valley Forge, Pa.: The Vanguard Group. Vroom, Victor H., Some Personality Determinants of the Effects of Participation. Journal of Abnormal and Social Psychology 59(3, Nov.): White, R.K., and R. Lippitt, Autocracy and Democracy: An Experimental Inquiry. New York: Harper & Row. Lewin, K., R. Lippitt, and R.K. White Patterns of Aggressive Behavior in Experimentally Created Social Climates. Journal of Social Psychology 10:

11 Appendix. Details for Investment Committees: The Dynamics of Leadership Styles survey Percentage of respondents, by client type and size of portfolio assets $50M Client type <$50M $250M >$250M Total DB 10% 38% 52% 100% DC E&F Total Note: M = million. Number of committee members reported by respondents % Tenure of respondents on the investment committee 0 1 year 3% 2 3 years years years 57 Respondents role on the committee Chairperson 24% Member 76 Responses to the question Is the committee leader volunteering? Yes 79% No 21 Method of choosing committee leader Selected by senior management 44% Elected by other committee members 30 Other 26 Portfolio composition Active 60% Index 31 Alternatives (private equity, hedge funds, commodities) 9 Age of respondents 40 years or less 7% years years years 27 11

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