Lecture 3 Flashcards
(41 cards)
Duties of CEOs include
Manage the day to day business
Control the free cash flow
Implement the long term strategies of the firm
The managers have fiduciary duty towards shareholders
Duty of loyalty
business ethics
The managers have fiduciary duty towards shareholders
Duty of loyalty
business ethics
How to measure the impact of a CEO
Historians and economists use natural experiments
To study the events of national leader or CEO sudden death
Random evens of natural cause serve as exogeneous shocks
Findings
Jones and olken found that leaders do affect national economic growth, for better or for worse
–> Newman 1985: company shares rise upon CEO sudden death
Information transparency
independent board of directors (monitoring cost)
Independent and well functioning media (monitoring costs)
Truthful disclosure of information (binding cost by the agend)
Strong enforcement of law
Accountability (harsh punishment for bad behaviors)
Challenge: asymmetric compensation: reward for profits, no punish for huge losses
Increase monitor
Challenge: it may increase overhead cost enourmously
How to incentivize CEO
Making them partial owner would help to align the interests of managers and investors
Principles of compensation: transparency, accountability, fairness
CEO compensation package
Base salary
Cash bonuses
Stock options
Stocks
Long term incentive plan
Retirement plan
Performance based bonus
Performance threshold (minimum pay)
If performed better –> additional bonus up until bonus cap –> no additional bonus for better performance
Most of the performance based bonuses are dependent on the accounting performance
Sales growth
Earnings per share
Return on assets
Advantages of using accounting performance are:
Verifiable
Widely understood
There are several drawbacks to accounting performance:
Backward looking
Short term focus
Incentives for earnings management
Strategically set lower targets
Performance driven compensation
It may heavily affect the inecntives of executives/employees:
Short term focus (forgo long term growth opportunities)
Excessive risk-taking (stock options is the main driver)
Less cooperative behavior (within an organization)
Forgo the interest of other stakeholders (clients, employees, creditors and society)
ESG metrices in CEO compensation
Key findings
ESG contract ties CEO attention to a subset of stakeholder welfare
ESG linked contract increase over the years
Esg metricts have little transperency, impossible for outsiders to monitor, verify therefore worsens the agency problem
ESG metric in general does not significantly reduce CO2 emissions, Carbon specific metric does significantly reduce CO2 emission
Relative performance compensation
To pay for effort or pay for luck? how to distinguis the two?
Relative performance helps differentiate effort of manager in the same industry
The art/challenges of choosing industry peers
How to peer conglomerates
Tendency to cherry pick weaker peers
Would bonus cap work?
European Capital Requirement Directive III and IV (Basel III compliant requirement)
caps bonus to 100-200% (subject to shareholder approval) of the base salary,
effective from 1 Jan. 2014.
The Dutch Act on Remuneration policies Financial undertakings caps bonus to 20%,
effective from 7 Feb. 2015.
The UK government has openly fought against this bonus cap but failed.
* How effective could it be?
* What are the implications for the financial sector?
* How would regulatory discrepancies affect the international labor market?
22 Corporate
Governance
Understanding Society
Claw back clause
A contractual provision that requires an employee to return money already paid by an employer, sometimes with a penalty
Vesting period
The time an emplyoee must work for an employer in order to own outright employee stock options, shares of company stock or employer contributions to a tax-advantage retirement plan
Who determines CEO compensation
A compensation committe of independent directions
Most of the independent directors are CEOs of other firms and have personal ties with the CEO
Sometimes even worse, CEOs themselves are also active in the compensation committees
CEO compensation is higher when the board has the following characteristics
The CEO is also the chairman of the board (CEO duality)
Size of the board gets larger
Large percentage of outside directors being appointed by the CEO
The ouside directors are older
The ouside directors also serve on more than three other boards
CEO compensation is a decreasing function of
THE CEOs ownership stake
The existence of an external big shareholder that owns at least 5% of the equity
The existence of a non-CEO internal board member owns at least 5% of the shares
Board of directors - Why?
market solution
agency problem exist in all organizations
BOard of directors are there to monitor management
Board of directors -
Regulations
Minimum board size
Minimum percentage of independent directors
Various committees
Minimum female and minority directors
Board of directors - general information
Responsibility
To represent the owners or shareholders
To monitor and advise the management and mitigate agency problem
To hire and fire management
To provide strategic guidance
