Why are Founder CEO's so Effective? Arrow and the Behaviour of Firms

The maxim in Silicon Valley is that founders make the most effective CEOs. Assuming that's true, can we understand a deeper reason for it? I think we can. To do so, let's talk about how groups make decisions.

  • Famously, Arrow's impossibility theorem shows that no voting system will be rational in the human sense.
  • A rational voting system means that:
    • If every individual prefers option A over option B, then A should win over B. (Pareto Condition)
    • If A wins out of the choice of {A,B}, then B should not win out of the choice of {A,B,C}. Either A wins or C wins. (Independence of Irrelevant Alternatives)
    • No single voter can choose the election outcome. (No Dictator)
  • Arrow's theorem says that it is impossible to have a voting system that satisfies all three of these conditions.
    • Note: The voting system is abstracted away. Arrow's theorem applies to any voting system. The only assumption is that individuals vote based on their ordinal (and not cardinal) preference.
  • Another way of describing Arrow’s theorem is: Groups of people cannot reliably make rationally decisions.
    • Or: Groups of rational agents tend to be irrational.
  • An important consequence of Arrow's theorem is that, for a group to always behave rationally, its voters must be irrational or it must be run by a rational dictator.
    • That is: Either the voters are irrational or the voting system is irrational.
  • Why does this relate to firms? Because a firm is just a collection of individuals whose daily actions (i.e. votes) determine the direction of the firm.
  • Thus, Arrow’s theorem also applies to firms: A firm will only reliably behave rationally when it is run by a dictator.
  • More loosely: Firms will behave more rationally when the power of the CEO is more concentrated.
  • This is why large bureaucratic organizations, where power is dispersed throughout the organization, will often seemingly behave irrationally, lacking clear direction and regularly making illogical decisions.
  • And hence the preference for founder CEOs who have the moral authority to wield concentrated power within the organization.

So yes there is a theoretical case to be made for founder CEOs.