Effective Leadership Response to a Crisis

According to Helio Fred Garcia of Logos Consulting, effective crisis response is a competitive advantage; ineffective crisis response causes a competitive disadvantage, and can even put an enterprise’s existence in jeopardy. But many leaders who are otherwise given credit for vision, strategic focus, and discipline preside over undisciplined crisis responses, often at great risk to their career and their company’s future.

Whether an organization survives a crisis with its reputation, operations, and financial condition intact is determined less by the severity of the crisis than by the timeliness and effectiveness of the response.

Effective leaders demonstrate situational awareness in a crisis, grasping the significance of the underlying event and its likely impact on the company and its stakeholders. They also demonstrate self-awareness, and the ability to redirect their attention and energy to mobilize a quick response and thereby protect the company’s enterprise value. More than 2,500 years ago the Chinese philosopher-warrior Sun Tzu identified the need for both self-awareness and situational awareness in navigating through perilous times. He wrote:

If you know others and know yourself, you will not be imperiled in a hundred battles; if you do not know others but know yourself, you win one and you lose one; if you do not know others and do not know yourself, you will be imperiled in every single battle[11].

Leadership ability and enterprise value

Effective crisis response isn’t just a matter of protecting reputation. It also allows a company to get on with business faster and more effectively than if it delays its response. More important, effective crisis response has direct impact on a company’s productivity, demand for its product, stock price, and other quantitative measures of success.

Two Oxford University researchers have demonstrated the extent to which effective and ineffective crisis response affects a company’s enterprise value. Rory F. Knight and Deborah J. Pretty studied the stock price performance of prominent publicly-traded corporations that had suffered significant crises. They calculated each company’s stock price performance attributable to the crisis – stripping out market movements and other factors unrelated to the crisis that might have affected the stock price, and calculating what they called the ‘‘cumulative abnormal returns’’ for each company[9].

Knight and Pretty found that companies that mishandled crises saw their stock price (calculated as cumulative abnormal returns) plummet an average of ten percent in the first weeks after a crisis, and continue to slide for a year, ending the year after the crisis an average of 15 percent below their pre-crisis prices.

Companies with effective crisis response, on the other hand, saw their stock fall an average (cumulative abnormal returns) of just five percent in the weeks following a crisis, about half the initial decline of companies that mis-handled the crisis. More significant, companies with effective crisis response saw their stock price recover quickly, and remain above their pre-crisis price thereafter, closing an average of 7 percent above their pre-crisis price one year after the crisis (Exhibit 1).

In other words, the tangible difference between effective and ineffective crisis response was, on average, 22 percent of a company’s market capitalization. Knight and Pretty assess the reasons for this disparity, and conclude that the most significant factors are not the scope of financial damage or reduction in cash flows caused by the crisis. Rather, the most important determinant of a company’s ability to recover and increase its market capitalization after a crisis is the management team’s response. Knight and Pretty conclude that positive stock performance:

. . . springs from what catastrophes reveal about management skills not hitherto reflected in value. A re-evaluation of management by the stock market is likely to result in a re-assessment of the firm’s future cash flows in terms of both magnitude and confidence. This in turn will have potentially large implications for shareholder value. Management is placed in the spotlight and has an opportunity to demonstrate its skill or otherwise in an extreme situation.

The government’s initial response to the New Orleans flood and Exxon’s early response to the Exxon Valdez spill demonstrated lack of both situational awareness and self-awareness. They also demonstrated a lack of leadership discipline and command focus. In both cases leaders fell into one of the common perils in a crisis: denial. Former General Electric CEO Jack Welch describes the need to get past denial quickly. In a Wall Street Journal Op-Ed piece soon after the flood, Welch said:

One of the marks of good leadership is the ability to dispense with denial quickly and face into the hard stuff with eyes open and fists raised. With particularly bad crises facing them, good leaders also define reality, set direction, and inspire people to move forward. Just think of Guiliani after 9/11 or Churchill during World War II. Denial doesn’t exactly come to mind – a forthright, calm, fierce boldness does[12].

Effective leaders demonstrate this forthright, calm, and fierce boldness early. They see crisis response not as an interruption in their stewardship of a company, but as the test of that stewardship.

And as the exodus of CEOs in 2004 and 2005 showed, ignoring a crisis won’t make it go away, but it may result in the CEO going away.

Thank you to Helio Fred Garcia for his great article.