The Swiss Cheese Model for Picking Great CEOs

In this episode of 5 Minutes in the Lower Middle Market, we explore a simple idea: great operators are often the people who have already passed through many hard filters.

The lesson: when hiring a GM, backing a CEO, or evaluating management, don’t just look at titles and credentials. Look for people who have been tested under pressure, adapted across environments, and kept moving up when the path was not easy.

Timestamps:
0:00 The idea behind Indian-origin CEOs outperforming
0:32 The CEO portfolio vs. the S&P 500
1:11 The Swiss cheese model explained
2:26 Why immigrants may face even more filters
3:07 Applying this to lower middle market operators
3:59 Bet on people who have been stress tested

Transcript

SPEAKER_00 0:00

Welcome to five minutes in the lower middle market, where I break down best ideas about buying, building, and owning small businesses. In five minutes or less, uh, today's idea starts with a line from Michael Milken called as uh Chunk Bond King. And he joked that if a US company replaces a US-born CEO with a CEO born in India, he's buying the stock. And while he said he never actually back tested it, someone did. So, according to the chart, over the last 15 years, a portfolio of US listed companies led by Indian origin CEOs would have turned$1 into$58 versus about$7.7 for the SP 500. That's about 30.3% gagger for the portfolio versus 14.2% for the SP 500. Now, for people in the lower middle market, um I do not think the lesson is simply about nationality. I think the deeper lesson is about selection. And one way to think about this is what is called Swiss cheese model. And this comes from aviation and risk management. The idea is that every layer of defense has weaknesses like holes in slices of Swiss cheese. No single layer is perfect. But when you stack enough layers together, the holes usually do not line up, and that makes failure much less likely. In aviation, those layers might be pilot training, checklists, maintenance, air traffic control, simulator testing, co-pilot verification, and regulatory oversight. A major failure usually happens only when the holes in multiple layers line up at the same time. I think something similar can apply to leadership selection. When someone rises to the top of a massive company, they have usually passed through a huge number of filters: educational filter, recruiting filters, performance reviews, team leadership tests, internal politics, capital allocation decisions, sports scrutiny, crisis situations, and market competition. None of those filters is perfect on its own. But when someone keeps passing through many of them over a long period of time, the probability that they are usually capable starts to go up. And in many cases, someone coming from another country may have had to pass through even more filters. Could be language, could be cultural adaptation, weaker starting networks, institutional skepticism, less inherited advantage. So the broader lesson is not buy stocks run by people from one country, the broader lesson is when someone rises to the top after surviving a very long chain of hard filters, there is a decent chance you're looking at the exceptional operator. And I think that is very useful in the lower middle market as well. That's why I wanted to brought up this uh thought from uh Michael Milken. Because when you are hiring a GM, picking a CEO, backing an operator, or evaluating management, you are really asking has this person already been tested? Have they operated under pressure? Have they earned trust in hard environments? Have they adapted across different systems? Have they proven they can keep moving up when the path was not easy? That doesn't guarantee success, of course, but it can be very useful signal. In small and medium-sized businesses, people often spend a lot of time looking at resumes, titles, credentials. Again, those things matter. But sometimes the better question is how many real filters has this person already survived? Because great operators are often not just smart, they're stress tested. If I had to pull one lesson from this, I would be to back people who have already passed many hard filters. In the lower middle market, ordinary businesses can produce extraordinary outcomes when they are run by unusually capable people. That's it for today's five minutes in the lower middle market, and see you in the next episode.