volatility, or value. Smart beta advocates often employ historical back tests demonstrating advantages over a specific period of time, promoting logical arguments as justification. 9 In this article, we utilize a founder-CEO factor as an enhancement to a U.S. large-cap growth index. We apply this variable coinciding with developing aca- demic and anecdotal evidence, along with emerging investment strategies, purporting benefits of investing alongside founder CEOs. 10 Legendary founder CEOs, such as Steve Jobs, Sam Walton, and Jeff Bezos, built extraordinary organizations that continue to generate exceptional personal and stakeholder wealth. 11 In their companies’ early formative years, these founder CEOs were known to eschew corporate bureaucracy, subscribe to a vision consisting of long-term leadership, cultivate organic company growth, and align executive compen- sation. Founder CEOs often assemble tight management teams with manageable debt levels and ensure that key expansion projects are held within reach. As stewards of the firm, founder CEOs appear driven by both eco- nomic and noneconomic incentives. Their entrepre- neurial culture keeps costs lean, enabling margins to expand, and retains key people. We presume that these unique governance attributes might contribute to better economic performance for the organization and superior stock results for shareholders. Academic arguments favoring a founder-CEO grouping attribute success to their long-term orienta- tion, longer tenure, higher ownership, younger firm age, higher relative expenditures on capital expenditures, and larger relative investments in research and development. 12 Founder CEOs may also be more likely to view the company as their life’s achievement, providing additional noneconomic motivation to help drive the organization to succeed. 13 Furthermore, founder-CEO firms might be more productive compared to professional coun- terparts due to reduced agency costs, continuity with leadership, greater reliance on founder reputation, and higher degree of firm-specific skills compared to non– founder CEOs. 14 Importantly, this research makes a distinction between the broader term “entrepreneur” and the spe- cific factor in this research, “founder CEO.” 15 There are likely many more factors involved in being labeled an entrepreneur than simply the term founder CEO. 16 Moreover, it would be an overstatement to presume that all founder CEOs provide an entrepreneurial outlook
or to assume that all entrepreneurs are founder CEOs. Many cases exist of well-recognized entrepreneurs who are not founder CEOs or of founder CEOs who are not entrepreneurs. 17 Founder CEOs who overcome early obstacles and persist after IPO often reward shareholders with strong stock returns. 18 We note the academic evidence that describes the benef its of investing in founder CEOs over non–founder CEOs and provide a carefully constructed methodology to implement this trading rule. 19 The model factor that we employ is based, in part, on these publications and the compelling evidence that suggests this factor may be beneficial to investors over an extended time period. 20 We incorporate our founder-CEO factor into a smart beta strategy using one of two basic approaches: We either 1) start with a U.S. large-cap growth index (benchmark index) and overweight the founder-CEO constituents or 2) simply buy a benchmark index or benchmark ETF and buy the desired founder-CEO index or individual securities within the basket of founder CEOs. 21 Given the risk–return exposure the investment manager desires, he or she can calibrate the overweighting levels in the benchmark index basket or relative amount of weighting in the benchmark index/ ETF versus the founder-CEO index. 22 Smart beta enthusiasts hope to offer better risk- adjusted returns than standard indexes by employing a passive investment strategy that targets rewarded risk premiums through alternative weighting schemes. 23 In our case, we attempt to enhance the returns of a U.S. large-cap growth index by targeting two com- bined management factors that we believe can enhance investment performance: company founders who are also CEOs. 24 The effectiveness of a smart beta index with a founder-CEO factor hinges on two basic criteria: 1) the ability to correctly identify founder-CEO compa- nies and 2) the likelihood that founder-CEO tenden- cies help improve shareholder performance. If the first criterion is difficult to detect on a consistent, reliable basis and/or the second factor becomes insignificant, then the exercise of creating a smart beta index with DOES SMART BETA WORK WITH FOUNDER CEO S ?
L EADERSHIP M ATTERS : C RAFTING A S MART B ETA P ORTFOLIO WITH A F OUNDER -CEO T WIST
W INTER 2017
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