Human Capital Best Practices in PE-Funded Companies

On Oct. 25, 2019, Keith Giarman and Martin Pocs hosted DHR’s fifth annual conference addressing talent best practices in private equity-funded companies. This year’s conference convened at the St. Julien Hotel in Boulder, Colorado, where a group of PE leaders addressed a range of topics relevant to the proper assessment of human capital.

Keynote Address: Humans are Remarkably Predictable: Why Aren’t You Using This as a Competitive Advantage?

Presenter: Barry Conchie, Founder & President – Conchie Associates

The day started with a keynote from Barry Conchie, a noted leadership assessment guru who has training in cognitive science and is a former Leadership Scientist at Gallup. He set the stage for the day, exploring key biases we unintentionally embrace when evaluating people.

Key Findings

Mr. Conchie’s thesis was simple: Notwithstanding a plethora of data-driven tools and processes, our track record for selecting the right people is poor, at best. He cited three reasons for our shortcomings in this regard:

• Company leaders spend too much time thinking about profitability rather than strategic growth, in part, because they can’t properly assess probability and risk.
• It’s difficult to overcome our covert biases, our inclination to pick people just like ourselves and our tendency to self-replicate our dominant capabilities.
• Most leadership teams can’t identify and exploit their true strategic imperatives.

A threshold problem to overcoming these issues is that too many top-level executives have an inflated view of their success in picking the right people. Mr. Conchie cited a longitudinal study conducted on the hiring practices of 100 high-level executives:

• When asked to rate themselves on a scale of 1-5 for their ability to hire great leaders, 73% of executives gave themselves the highest possible score, while nobody scored themselves a 1 or a 2.
• While the executives considered 68% of their executive-level hires to be top performers, the reality was that only 12% of them turned out that way.
• Eleven percent of executives claim to hire top performers 100% of the time, whereas research shows 3% pick top-quartile performers just 18% of the time.

We Are Human: We Make Bad Bets

One reason for our deficiencies in making the right hiring choices is that humans are bad at assessing probability, according to Mr. Conchie. Taking the attendees through various exercises, he demonstrated how our tendency, between conflicting options, is to bet the farm on the downside but are relatively conservative on the upside. This can be a fatal error for companies because our inherent aversion to risk on the upside acts as a constraint to growth and, likewise, affects our ability to see upside potential in people.

In identifying candidates, we should be trying to predict the 9-11% of people who are more immune from this constraining influence on risk. The challenge is figuring out how to find people with a propensity to think and operate that way and who are, therefore, more likely to seize upside opportunities for their organizations.

We Don’t Like People We Don’t Like – Even When We Should

Mr. Conchie then took a deep dive into how our biases often override the supposedly objective evaluations we conduct when hiring and evaluating performance.

He discussed an extensive study on bank performance he conducted in which he compared the ratings regional managers gave their branches with the actual performance of those branches. The study revealed a surprising negative correlation between the scores and performance – the branches rated the lowest were, in fact, the highest performers.

Why? The regional managers simply did not like the branch managers at the highest-performing branches. They didn’t like them because of the very reasons behind their success:

• They were demanding;
• They asked tough questions;
• They often defended the customer against their own bank; and
• They had higher expectations for service delivery than their own bank was able to provide.

In sum, the managers based their ratings on likability and ease of management rather than results.

“This wasn’t a performance evaluation; this was American Idol on stilts,” Mr. Conchie concluded.

“If you are a really nice team player and you show up with bright eyes and a bushy tail; if you don’t create any ripples and you’re eager to do whatever your manager wants, you’re a dream to have on the team. As a result, you are going to get a higher rating than the people who are actually performing, but who could not or might not fit that mold.”

One result of these personal biases in the face of contradictory performance data is that the aggregate evaluation of performance within an organization doesn’t correlate with the growth trajectory of a company. In a study of 73 companies, Mr. Conchie found almost no variation in the overall aggregate score of employee performance; it was 4.1 on a 1-5 scale, regardless of whether the company “was hitting it out of the park or was about to close shop.”

“We’re not suffering from too much objectivity. We’re relying too much on our native wit and judgment on the assumption that humans can apply rational criteria when making refined decisions about performance. We get it systematically wrong time after time after time.”

The Problem with “Cultural Fit”

A related bias problem relates to the amorphous concept of “cultural fit” when evaluating external hires. Mr. Conchie’s concern is that we don’t have a way to define and measure “cultural fit.” Instead, we think of cultural fit in terms of the capacity to get along with our peers at work. When we use that construct as part of our selection process, it often excludes candidates who have characteristics we don’t like, even though those characteristics may be precisely what the individual leader and overall organization needs.

While personality-based tools can help in developing people, they should play no role in the hiring process. Too many companies use them for this process, believing the information helps them make “cultural fit” decisions. They don’t help and they shouldn’t be used for this purpose. Too many companies place disproportionate weighting on characteristics they believe are important – using personality assessments erroneously to justify their decisions – and thus wind up replicating the results they would reach without the use of these tools.

Mr. Conchie conducted a review of 2,681 C-suite candidates, 88% of whom the executives leading the candidate search identified as having a strong cultural fit. Of that 88%, 873 were fired or voluntarily left within three years. Only 7% became top-quartile performers.

“Cultural fit, as a filter, didn’t seem to have the returns that many people use as the reason why they interject it within the selection process. The evidence doesn’t support it very strongly as a construct.”

Bias Against Strategic Thinking

The biases we bring to the selection and evaluation processes also manifest themselves in the choices we make about who to promote internally. The result is a significant problem in terms of strategic thinking at the highest levels of companies.

Mr. Conchie discussed the differing perceptions between operational leaders and strategic leaders regarding the performance and value of their peers. Using 360 assessment data, he found that operational leaders rated strategic leaders much lower than other operational leaders. In fact, operational leaders rate strategic leaders lower than any other category of leader. 

But strategic leaders also rate other strategic leaders lower than any other category of leadership.

Part of the reason for these perceptions is that it’s easier to define and quantify operating behaviors; operational leaders get stuff done. In turn, this creates a bias against strategy, the result of which is that organizations tend to weed out strategic thinkers several levels below the leadership level. Conversely, the high value we place on operational leadership leads to individuals with such talents rising through the ranks claiming to be strategic thinkers even though they clearly are not.

The very characteristics that make effective strategists often result in their termination lower in the ranks. They’re also often the same qualities that result in negative performance evaluations, as discussed above. Executives or managers may see a strategic thinker as not playing well with others because they challenge assumptions or the way the company does things. They ask hard questions and are perceived as slowing things down. It is, therefore, no surprise we have a narrowing of the strategic talent pool toward the top of organizations. Companies that complain about their lack of strategic thinking in top executives are oblivious to their organizations weeding out these individuals well before they become visible to upper leadership roles. 

How to Overcome Our Biases

Interjecting a credible assessment into a decision-making process will help you get the decision right eight times out of 10. He described the predictive psychometric assessment his company has built and used precisely for this purpose. It is based on the largest C-suite leadership database in the world and comprises 58,000 leaders.

What’s frustrating for us is it means that two out of every 10 people that we say will be top-quartile performers will fail. But that’s still better than the four out of five the very best executives can do on intuition alone.

Mr. Conchie concluded that one of the ways to address bias and to counteract the issues of likability and cultural fit is to challenge perceptions with credible assessments.

“We’re not as rational as we think we are. We’re not gifted with special powers. My advocacy to you is to challenge the presuppositions that you’ve got around the characteristics that you look at when evaluating people and be open to the fact that you might be no better than the data output from an assessment tool.”

Panel 1: Leadership Assessment Tools & Methodologies: Best Practices & Potential Trade-Offs