Research Note: CEO Locus of Control and Small Firm Performance - chief executive officer

Organization Studies, May, 2000 by Christophe Boone, Bert De Brabander, Johan Hellemans

Abstract

Boone et al. (1996) reported that Chief Executive Officer (CEO) locus of control was significantly associated with profitability in a cross-sectional study of 39 small firms. As the authors could not rule out the possibility that firm performance causes an internal locus of control rather than the other way around, a follow-up study was performed to provide us with a possible clarification of the direction of causation. We traced the life history of each of these 39 firms and analyzed the relationship between locus of control and long-run organizational survival. We found that 21 percent of the 39 firms studied in Boone et al. (1996) went bankrupt within 6 years. Among the CEOs classified as internals, only 1 company failed (1 out of 14), whereas among the external CEOs 45 percent did not survive (5 out of 11). We also found that the differences between internal and external CEOs were only observable for firms that were relatively unprofitable in 1990-1991, indicating that short-term performance shields the c ompanies from subsequent bankruptcy. We conclude that our findings suggest that CEO locus of control is an important predictor of small firm performance.

Descriptors: Chief Executive Officer, locus of control, firm performance

Introduction

Boone et al. (1996) published the results of a study into the relationship between Chief Executive Officer (CEO) locus of control and small firm performance. Among a sample of 39 small Flemish furniture firms they confirmed the robust finding that firms headed by CEOs with an internal locus of control performed better than firms with external CEOs. [1] They reported a zero-order correlation between CEO scores on the Rotter scale (Rotter 1966) and a composite measure of financial performance (i.e., the regression factor score of cash flow on assets, return on assets and gross profit margin) of 0.35 (p = 0.03, n = 39). Regression analyses revealed that this relationship was independent of other determinants of firm performance such as firm competitive strategy (low cost and differentiation), firm size, liquidity and tenure.

Unfortunately, as both variables were measured at the same time, the authors could not rule out the possibility that performance affects locus of control rather than the other way around (Boone et al. 1996; Miller and Toulouse 1986). That is, good performance might increase self-confidence and facilitate the development of an internal locus of control. To shed more light on the issue of whether locus of control causes organizational performance, we traced the life history of each of the firms from 1991, the year of data collection of the study of Boone et al. (1996), up until 1997 and analyzed the extent to which the 1991 locus-of-control scores allow us to predict long-run organizational performance. We expect that firms led by external CEOs are more likely to go bankrupt than firms headed by internal CEOs. We also investigate the role of short-term financial performance as a buffer against bankruptcy. That is, the difference between internal and external CEOs in terms of organizational survival will probably be more pronounced among firms with low profitability in 1990-1991.

Methods

The details of the data collection procedure and measurement methodology are discussed in depth in Boone et al. (1996). It suffices to mention here that the study pertains to 39 small Flemish furniture firms (average number of employees = 80, SD = 81). CEO locus of control was assessed with the well-known Rotter I-E scale (Rotter 1966). This scale contains 23 forced-choice locus-of-control items. The respondents have to choose between an internal and an external alternative. The following pair of statements is a good example of a forced-choice item: 'When I make plans, I am almost certain that I can make them work' (internal alternative), and 'It is not always wise to plan too far ahead because many things turn out to be a matter of good or bad fortune anyhow' (external alternative). A total locus of control score is obtained by counting the number of internal alternatives chosen. Cronbach alpha amounts to an acceptable value of 0.69 in the present study.

Short-run organizational performance is measured with the factor scores of a factor analysis including the following three financial performance indices: cash flow on assets, return on assets and gross profit margin. The first two ratios assess the firm's overall profitability. We included cash flow on assets to account for possible differences in depreciation accounting practices. The gross profit margin stresses the firm's operational efficiency. Each of these ratios is a standard indicator of profitability (Van Home 1983). As small firm performance can vary substantially from year to year, we computed two-year averages of each of the performance indices (years 1990-1991). Note that one factor, explaining 82.2 percent of performance variance, was extracted. In the subsequent analyses, we use the regression factor scores of this factor analysis as a composite measure of firm profitability. The financial information was collected from the company annual reports, centralized on CD-ROM by the National Bank of B elgium.