Do Risk Prone CEOs Really Promote Innovation?RESEARCH BY DOVEV LAVIE AND PATRICIA KLARNER REVEALS THAT A CEO'S RISK PROPENSITY PROMOTES EXPLORATION IN PRODUCT DEVELOPMENT ONLY WHEN THE CEO IS POWERFUL, COMPETITIVE PRESSURE IS STRONG AND, SURPRISINGLY, THE FIRM'S ACCUMULATED EXPLORATION EXPERIENCE IS NOT TOO HIGH
As intuitive as it may seem, the association between CEOs’ risk propensity (a behavioral tendency to take risk) and the prevalence of exploration (i.e., developing new knowledge) over exploitation (i.e., refining and leveraging existing knowledge) in their firms’ product development is not straightforward. New research by Dovev Lavie (Bocconi Department of Management and Technology) and Patricia Klarner (Vienna University of Economics and Business) revisited this relationship.
Previous studies had observed a simple positive association between actual risk taking and exploration in small- to medium-sized firms. Professors Lavie and Klarner studied public firms operating in a dynamic industry and use content analysis to introduce a novel approach for capturing a CEO’s risk propensity and to examine how such propensity drives a firm’s transition from exploitation to exploration in product development. They also identified the conditions under which this association holds.
“A CEO’s risk propensity drives exploration only when certain conditions are met,” Professor Lavie summarized. “It depends on the CEO’s personal power, on the organizational support for such risky decisions in the firm, and on external pressures originating from the industry that influence risk taking within the company.”
The authors analyzed 229 U.S.-based publicly traded firms in the prepackaged software industry from1990 to2001. In this period, the firms in the sample engaged in substantial innovation, introducing 5,046 new products (a measure of exploration) and 7,027 versions of existing products (a measure of exploitation).
In order to measure a CEO’s risk propensity, the authors developed a dictionary of relevant words representing risk proneness and risk aversion in the specific context of software industry CEOs in the 1990s and applied content analysis to a corpus of 26,138 press items for the 418 CEOs in their sample.
Their findings suggest that the extent to which the CEO’s risk propensity translates to exploration in product development depends on the CEO’s ability to influence risk taking in the firm by exerting power. This power – they find – derives from three sources:
|• A CEO’s tenure, i.e., the amount of time that the individual has spent in the firm’s CEO position since being appointed as the CEO.
|• CEO duality, i.e., whether the CEO also holds the position of Chairperson of the Board of Directors.
|• A CEO’s origin, referring to CEOs coming from inside that are capable of mobilizing their established corporate network to promote exploration.
In addition to personal power, the authors found that competitive pressure, measured as the number of competitors that the firm encounters in its product markets, creates urgency to seek new knowledge, to experiment with product prototypes, and to introduce new products to the market and, thus, reinforces the CEO’s call for exploration.
Finally, the firm’s accumulated exploration experience enters the picture in a surprising way. Counter to expectations, the firm’s accumulated exploration experience does not reinforce, but rather weakens the effect of the CEO’s risk propensity on exploration. “This unexpected result may suggest that a firm that reaches an excessive exploration level following past exploration efforts is inclined to restrict its exploration tendency in a search for a balance between exploration and exploitation,” explained the authors.
The paper offers rich managerial implications both for CEOs and for Boards: “A CEO who is more risk-prone cannot strive for exploration if he lacks power, if there is no competitive pressure, or if the firm has over-explored,” Prof. Lavie said.
“Specifically, a CEO who lacks tenure, insider status, or duality needs to build internal coalitions and garner organizational support for exploration. Even a CEO who enjoys discretion needs to assess the firm’s particular balance point and to avoid drifting away from it,” added Prof. Klarner.
Boards, in turn, need to carefully assess CEOs’ risk profiles to determine whether their behavioral inclinations are in line with company traditions of exploration and exploitation and its desired balance between the two inclinations.
Dovev Lavie, Patricia Klarner, “When Does a CEO’s Risk Propensity Drive Exploration in Product Development?”, Strategy Science, Articles in Advance, DOI: https://doi.org/10.1287/stsc.2022.0160.
by Fabio Todesco