Capital allocation starts with governance—and should be led by the CEO

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It’s easy to go along to get along: give lots of managers an equal say and allot each division its “fair share” of capital. Usually, however, a laissez-faire approach underserves a corporation’s most promising opportunities for growth. Companies typically provide lump sums to division heads, often in proportion to current revenue; choices about funding get pushed across the organization and down its hierarchies, with the result that historic performance repeats itself—and forward-looking strategy goes unfulfilled. High-growth initiatives often don’t receive the resources they urgently need.

But in our experience, highly effective companies manage capital allocation differently. That starts with corporate governance—in other words, the processes of informing good decisions, as well as the power to make them. The “who” of decision making is the subject of this article, the first in our Strategy to Action series on practical steps for effective capital allocation. We believe the CEO should be the decision-maker-in-chief.

Governance achieves the greatest impact in this area when it is marked by a meaningful investment of CEO time; is driven by a mindset ardently focused on growth; has a clear set of strategic priorities; maintains an appropriate level of granularity; and is empowered by a capable, insightful, and organizationally influential support team. While not every element will necessarily be optimal for every organization—there are nuances in each case, and companies should focus on what is most effective in their specific set of circumstances—these prescriptions help to ensure that businesses and initiatives with a high potential for massive, profitable growth won’t be starved for resources. Business lines or projects that don’t fit the company’s strategy, for their part, can receive a lower proportion of capital or be divested entirely. That’s easier said than done, but all the more reason why CEOs should take the lead—and why a failure to decide leads to stagnation.

Investing significant CEO time

Strategy won’t translate into a positive outcome unless it’s based on a clear set of implications and business priorities. No one can simply intuit what the most value-creating opportunities are or how future scenarios will unfold. The groundwork for an informed decision—and the follow-through to make additional funding or no-go decisions thereafter—requires a significant investment in CEO time.

The groundwork for an informed decision—and the follow-through to make additional funding or no-go decisions thereafter—requires a significant investment in CEO time.

How much of a CEO’s already full calendar should be reserved for capital allocation? While no single answer is right for every company, a good rule of thumb is at least 10 percent of a CEO’s time. Often, the time requirement is even higher. One effective CEO commits 20 percent of his time; he makes sure to review at least one strategic initiative each week. At the Dutch publishing company Wolters Kluwer, CEO Nancy McKinstry devotes an outsize number of hours to resource allocation, both organic and through M&A. Under her direction, Wolters Kluwer discontinued funding or divested about $1.0 billion in lower-growth initiatives and acquired $1.5 billion worth of companies that advanced its digital strategy.

Many CEOs believe, understandably, that the bulk of their time should be spent as the face or voice of the company. No one disputes that a CEO has an enormous amount to do. Yet if a company doesn’t deliver profitable growth, it won’t attract sufficient capital, and will disappoint stakeholders across constituencies. We recently surveyed a broad, global group of chief investment officers from large funds. By a huge margin, these seasoned investors favored CEOs who dynamically reallocate resources for sustainable long-term value creation (exhibit).

There is no such thing as a “fair share” in capital allocation. Fair is a judgment call; someone’s got to make that decision, and only the CEO can ensure—as Winston Churchill would mark urgent memoranda—“action this day.” When CEOs fail to decisively reallocate capital, huge growth opportunities can go unrealized. Imagine, for example, if Satya Nadella, the CEO of Microsoft, had not forcefully championed Intelligent Cloud, which is currently the company’s most profitable and fastest-growing division? Or if Morgan Stanley CEO James Gorman had not allocated billions of dollars to wealth and asset management, honing a growth engine? These were courageous decisions—but also utterly rational. Companies that keep allocating capital to the same core businesses will inevitably be surpassed by more committed innovators. Eventually, these once-great corporations will likely be acquired—or simply cease to exist.

Moreover, even the boldest decisions on capital allocation should not be “one and done.” Instead, the CEO can ensure that key strategic initiatives are followed through in regular reviews. Funding can also be timed to—and conditioned on—achieving necessary benchmarks and conditions, such as proof of concept and receiving regulatory approvals. Ideally, capital allocation anticipates a range of different outcomes; projects will almost certainly need more or less funding than initially determined. But likely scenarios can be reasonably planned for and bounded.

Assembling and leading an effective committee

Subject only to guidance and approval from the company’s board of directors, the CEO should be the ultimate decision maker on capital allocation. Even so, informed decisions can’t be made by fiat. Companies that are most effective at capital allocation vet their decisions through a committee, sometimes referred to as the “investment committee”—though a more accurate designation would be the “strategic resource allocation committee.” Most companies don’t use that longer title, and many don’t use investment committee either. By any name, however, this is the forum where strategically critical capital allocation decisions are made.

“Investment committee”—though a more accurate designation would be the “strategic resource allocation committee.” Most companies don’t use that longer title, and many don’t use investment committee either.

The process of making decisions does not mean that all committee members are afforded a vote on capital allocation or that the majority vote wins. Voting, especially by secret ballot, is a helpful means to gauge what members really believe, but the final call should belong to the CEO alone. Committee members serve as recommenders, advisers, and sounding boards to the CEO. But their role is not to insulate hard decisions in consensus. Capital allocation decisions should be decisive, transparent, and stark.

It’s the CEO’s role, as well, to select the members, lead the committee, and establish core principles on committee size, meeting frequency, and membership. The latter should be limited solely to the company’s most senior leaders, who have a holistic, enterprise-wide perspective. The most effective strategic resource-allocation committees are small—ideally with three to five voting members, and fewer than ten persons (including any nonvoting members) in total. The CFO should always be among the voting members; additional voting members should similarly have organization-wide authority.

While official titles differ, particularly by industry, examples of additional voting members could be a COO, chief strategy officer, chief technology officer, or head of R&D. Not every company has these roles. A nonvoting member must, in all cases, be a knowledgeable senior executive who is at the ready to provide more information and perspective for a more informed decision—someone whose contribution is additive but should not be decisive. The most important point is that committee membership is a decision-shaping role; these are the principals who, when the door is closed and hard choices have to be made, have the authority to weigh in by vote—with the CEO always having the final say.

One principle that can trip up even outstanding leaders is the distinction between decisions and debate. Decisions are the province of the voting members, with the CEO always making the final call. Debate, on the other hand, helps inform those decisions, and a robust, meaningful debate often encompasses a wider and well-informed circle.1The limits of RACI—and a better way to make decisions,” blog entry by Aaron De Smet, Caitlin Hewes, and Mengwei Luo, July 25, 2022. Indeed, our research shows that while successful big-bet decisions are marked (as one would expect) by meaningful analyses of robust data, what matters even more is the quality of team dynamics, in particular the diversity of people and perspectives needed to encourage pushback and avoid groupthink.

Healthy debate about capital allocation enables decision makers to understand different implications of an investment and ensures that committee members fully comprehend the “for” and “against” arguments. The mark of a good debate is that participants understand both sides of the decision of whether to allocate—presenting the strongest form of each position, ideally to the point where one can articulate the opposing argument as well as or even better than those who hold a contrary view. If the debate starts to sound perfunctory—or worse, like an echo chamber—CEOs should actively seek out individuals with a different view. Business managers and outside experts with demonstrated operational, technology, risk, or country- or demographic-specific knowledge can offer valuable perspectives, especially when uncertainty is high.

One question we often encounter is whether division heads should have a voting say—or, for that matter, be a nonvoting participant. In our experience working with large corporations, division heads typically wield enormous power. That makes sense; these talented individuals are charged with delivering division performance, and they likely reached their role because they achieve distinctive results. Yet for all of their insight, division heads often lack the holistic perspective needed to make optimal capital allocation decisions on an organization-wide basis. Moreover, they are typically incentivized based on the results that their own businesses deliver during their tenure—which doesn’t necessarily match the long-term performance of the enterprise.

Those misalignments can doubly affect their opinions: more capital for their division, and more resources for operating results right now. If their division contributes an outsize share of revenues, it makes sense to have them in the room, and perhaps even grant them a vote. They’ll pound the table for more capital. Let them pound and listen carefully to what they say, but don’t cede decision making for company-wide capital allocation. Most important, don’t settle for a compromise allocation that gives every business an equal or proportional amount based on historical revenues. By definition, that’s precisely the wrong way to place outsize bets. To be effective, capital allocation needs to be unfairlow-growth, nonstrategic businesses should receive fewer resources than the company’s future growth engines.

Shifting the mission from gatekeeper to growth champion

CEOs and their supporting team should strive relentlessly to invest for growth. Yet all too often, those who are most involved in capital allocation find themselves adopting the role of gatekeeper. It’s their duty, as these leaders see it, to protect and safeguard the company’s scarce resources. This is a growth-destroying approach, and it’s up to the CEO to shake leaders free from that model and shift the mindset from gatekeepers who steward capital to growth champions who relentlessly seek out opportunities for value creation. Nor does the role of growth champion stop with writing a check. Effective resource allocation means ensuring, consistently and proactively, that strategically important businesses receive and keep receiving the capital, talent, and management attention they need—so long as the growth thesis remains robust.

Achieving the proper cadence of capital allocation decisions to keep up with current developments and get ahead of new ones will differ across industries. A fast-growing tech company with many rapidly advancing initiatives may need to hold meetings more frequently than a mature industrial company. But even in the most capital-intensive sectors, the committee shouldn’t wait too long between formal meetings. The CEO of one leading retailer, for example, supplements committee sessions with weekly meetings among the CFO and the head of FP&A (financial planning and analysis) to ensure that the company is consistently meeting its goals of identifying, analyzing, and funding its long-term, high-growth strategic priorities.

Getting clear—and granular—about resource allocation

To make sure that the right businesses are receiving sufficient resources, the CEO-led committee should be very clear about the company’s strategic priorities. This means understanding the divisions’ businesses at the appropriate level of granularity, which is definitely not a “30,000-foot view.”

To make sure that the right businesses are receiving sufficient resources, the CEO-led committee should be very clear about the company’s strategic priorities.

Getting to good decisions requires committees to rank the ten to 30 most important initiatives across the corporation. These are the initiatives that simply must have the resources they need. Practically, it’s impossible for investment committees to rank more than about 30 top initiatives: doing so can not only present a false sense of specificity but can also demoralize business unit heads by limiting their discretion to fund their individual business lines.

Second, the committee should make sure that it has insight into, and funding authority over, capital allocation at a level of about 20 to 50 business cells, regardless of the formal organizational structure. In large corporations, the major divisions likely comprise businesses and individual product lines that can have very different economics and potential. Sometimes, the highest-potential initiatives, particularly for innovative products or services, may be housed (rightly) outside a formal line; these “skunkworks” can mature into major breakthroughs—or, conversely, shrivel away if they fail to receive sufficient capital and management attention. Transparency is therefore essential. Of course, micromanagement is neither realistic nor without consequences, chiefly information overload for the decision makers and demotivation for the talented executives below the C-suite. But often, the most compelling cells within a division can get lost when they are aggregated into broader groups. When committees are presented with too few businesses or initiatives per division, they lose the opportunity to make decisions at a meaningful level of granularity.

For an example of what not to do, consider one of the world’s largest corporations, organized into three divisions; each division has about 20 product lines. For years, the corporation has allocated a lump sum of R&D and sales and marketing funding to each of the three divisions, letting the division leaders decide how to allocate that capital among their managed businesses. Privately, the CEO admits that he is essentially allocating division leaders the capital and praying that they do the right thing. Those prayers often go unanswered. Too frequently, the division heads spend the money in ways that perpetuate historic results but don’t align with strategic, forward-looking corporate priorities. Their decisions can also be affected by the division heads’ short-term compensation incentives, based on meeting their short-term numbers. Even worse, when one of the division businesses is suffering, division heads may ask the other business managers under their charge to reduce the funding of longer-term investments and direct the “saved” capital toward shoring up the underperforming, less strategically important businesses.

Empowering a capable, influential support team

A strong support team is essential to effective governance. Just as the CEO requires a senior capital allocation committee, so too do committee members need a seasoned, fact-based, and influential support team to help set the decision agenda, keep the decisions on track, and get the decision makers the most insightful, nonbiased, and actionable information.

Any employee with a strong analytical background can crunch numbers, and an effective support team can crunch with the best of them. But number-crunching for the sake of complex analyses isn’t the objective. The goal, instead, is to enable decision making. A strong support team should always include a leader with major influence inside the company, as well as team members with extensive experience beyond just financial modeling. That means members with CEO backing and demonstrated capabilities—managing upward and downward in the organization—to present the committee with the matters it needs to decide on, and the detailed supporting information its members will draw from.

While the support team doesn’t do the deciding, its members shouldn’t be gofers or wallflowers. On the contrary, they must do the rigorous prework of digging into capital allocation requests, pushing for higher-quality data, and presenting the information in a usable way. Committee time is precious; every meeting should be action-oriented. The ideal is that every committee meeting will end with a decision, rather than “deciding to decide”—that is, only figuring out what’s missing or promising to circle back later.

Often, this support team is the company’s FP&A function; sometimes it takes the form of the corporate-strategy team. Some organizations have both functions, and some have neither. The company’s capital allocation committee, though, requires critical support: senior staff need to work and set agendas, working closely with those in financial planning and analysis. Despite FP&A’s importance, it is, ironically, too often among the first functions to have its resources cut in times of broader, company-wide cost reductions. While no corporate group should be immune from scrutiny, scaling back on FP&A is usually pound-foolish; the function must have the personnel and tools it needs to deliver actionable insight, and the senior heft to speak up when committees start to meander or become perfunctory. Without quality FP&A support, challenges to business unit plans are typically left to the CEO or CFO, who often lack detail beyond consolidated reports and incomplete observations.

One automobile manufacturer is instructive. Its FP&A team is composed of 15 highly experienced leaders with diverse capabilities, including finance, procurement, marketing, and country management. The team sets strategic targets for each country and product area; business units are then responsible for achieving these targets. In another example, a leading industrial company expanded the authority of its FP&A group, giving it the remit to have blunt discussions with business unit leaders as well as executive-level management. This helps to keep the enterprise aligned throughout the resource allocation process.

Dynamic resource allocation is a choice; governance comes down to who is deciding. The CEO—the company’s most important decision maker—should take the lead. Making effective decisions requires a serious time investment, a relentless commitment to profitable growth, a capital allocation investment committee with an enterprise-wide perspective and a granular level of scrutiny, a commitment to understand the “why” and “why not” bases for investment decisions, and the experience of a seasoned, influential support team.

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