Review for Quiz 2 Dasha Notes Flashcards
Why might a CEO leave (4 reasons stated)
- M&A (failed mergers and acquisitions like HP CEO)
- Underperformance
- Misconduct
- Retirement
how do ceo’s most often depart
their departure is planned
what is a rough percentage on CEO termination
3-6%
what is a interim CEO and what is their main purpose
a ceo that is there temporarily
- used to navigate through the succession and transition to a new ceo
- used in emergency situations
- used to audition new ceo
- used to groom potential candidates
what is a director CEO and what does it signify
a director turned CEO
it is a sign of poor planning
what are the two types of internal hires
heir apparent and horse race
what is the heir apparent model
it is when you promote the leading candidate to president or COO in order to groom them into the CEO position
what are positives of the heir apparent model
- known leadership style
- little to no onboarding because there it familirity with company
- can observe their perfromance before promoting
- custom to company’s needs
- gained exp through interacting with board, shareholders, analysts
- continuity and retention of private knowledge
what are some negatives of the heir apparent model
- adds complexity to decision
- must CREATE CLEAR distinctions between tasks of CEO and heir apparent
- might be there for too long and stuck in role
- no change in company mentality and its just more of the same
what is the horse race model
the idea of promoting 2 or more candidates and having them “battle it out” on who gets promoted to CEO
what are positives of the horse race model
- do not have to commit to one candidate
- observe performance before selection
- candidates develop specific skills
what are negatives of the horse race model?
- a lot of unwanted media attention
- internal fraction for favored candidates
- losers most likely resign and there is a brain drain
define a moral hazard
the risk that someone or something will be more likely to take a risk when they know that an insurer will cover the cost of any damages
why is succession planning important (4 points)
- reduces costs due to loss business or desperate spending on new ceo
- reduces fear of internal or external shareholders
- prepared if there is a lawsuit, retirement, or transition of new CEO into role
- prepared in emergency situations such as CEO death/termination/departure
what are consultants helping with
- external party fairness in decision making
- provide external expertise
- provide external objectivity
- enhance board credibility
- takes away power and influence from CEO
what are the two conflicts of interests from consultants
- if they have interest and allow the CEO to exert power and influence over them
- they have have conflict of interest because they provide other services to the company
what are the 3 main goals of CEO compensation
- attract
- retain
- motivate
companies with weaker governance pay the CEO ___
more
companies with weaker governance have a ________ chance of hiring consultants
higher
why are companies with weaker governance more likely to spend more on a CEO
because they would need to spend more in order to get them on board in difficult situations
weaker governance means there is a ______ chance of agency problems and _______ performance
higher and lower
what is the biggest determinant of CEO pay and why
company size, often because of benchmarking to peers
what are the considerations in benchmarking pay
- company size
- industry
- geography
what is the ratcheting affect
raising median pay due to benchmarking to 50th percentile
what are the pros of hiring an internal ceo (4)
- lower first year compensation
- already understand the company - little to no onboarding
- can groom them into the position
- have observed their performance
what sort of performance does a company have if it is hiring and internal ceo
higher perfromance
what is teh negative of an internal ceo
- no change in philosophy
_______ performing companies are more likely to higher an external ceo
lower
positives of hiring an external CEO
- more ceo experience
- more free in decision making because they have a blank slate with the company
- e.g. cultural, operating, strategic
negatives of hiring an external ceo
- cannot gauge capabilities during an interview
- less familiar with company
- may disrupt staff and operations
- leadership style may not work for the company
what are the three categories of CEO pay and state if they are short or long term
- salary s-t
- bonus s-t
- stock options l-t
what is a bonus and what are some types (5)
cash for meeting or exceeding certain targets
- guaranteed bonus
- min/max bonus
- based on financial targets
- based on non-financial targets (e.g. environmental)
- discretionary bonus
what are stock options
- right to buy shares at a certain price before expiration in the future
what is vesting and what does it encourage
the process of the stock being earned over time.
encourages long term focus
what is restricted stock and its purpose
stock that cannot be be sold, transferred, hedged or pledged. the stock will be transferred to you if you have met certain conditions or targets
encourages long term focus
what are the two schedules for restricted stock
time based
performance based
what is a severance payment
a payment that is awarded once the CEO is terminated
what is a golden parachute
severance payment that is made if the company changes ownership or there is a takeover
what are perquisites
other perks like personal use of corporation car, plane, club membership, home
what is the concept of say on pay and has it been influential?
shareholders have a say on exec pay during annual meetings.
has not helped much or had influecen
what are the two theories on compensation
optimal contracting
rent extraction
what is optimal contracting
efficient process of pay, driven by market forces.
Value that is created by the CEO is shared amongst share/stake holders and CEO
what is rent extraction
not an efficient process and CEO exerts influence over the BofD
typicall receives higher compensation than they should
what are 4 contractual restrictions
- target stock ownership plan
- hedging restrictions
- pledging restrictions
- clawback + deferred payouts
what is the target stock ownership plan
it is the minimum amount of stock that a CEO must have in the company and it is usually expressed as a multiple of their salary
what does the targeted stock ownership plan encourage
long term approach and risk taking
the targeted stock ownership plan is non-_____
linear
what is hedging
it is a risk management strategy that is used to offset losses in an investment by taking the opposite position in a related asset
what are hedging restrictions
the idea that the company can chose to limit the CEO hedging their equity
what are your choices when it comes to hedging and how much can you hedge
- can chose to hedge equity rather than sell the equity
- cannot hedge everything
what are benefits of hedging
minimizes public scrutiny when dealing with shares
allows diversification
what is the negative of hedging
diminishes incentive to perform
what is pledging
the use of shares as collateral for a loan or margin act.
can pledge your shares and purchase more
what is a pledging restriction
some companies allow you to use equity as collateral and some do not
what is the main positive of pledging
- can diversify portfolio while maintaining high equity in your company
which structure does pledging change for management
the incentive structure
what are clawback and deferred payments
the company can reclaim compensation in future years if it has become clear that there was unethical practices involved. These two concepts are related because deferred payout arrangements can include clawback provisions to align executive pay with long-term company performance and compliance with ethical standards.
what happens the clawback clause is triggered
must surrender back all your gains
what do clawbacks reduce and what might trigger a clawback
clawbacks reduce agency costs
- ethical misconduct
- manipulation of earnings
- violation of non-compete
what is the main purpose of equity ownership (5)
- align interest
- minimize agency costs
- incentivize to increase value of company
- incentivized to run company more efficiently
- increases risk taking
what does equity ownership have to do with risk
encourages risk taking, especially with stock options as riskier projects are more likely to increase the value of the company
what is manipulative accountaing
changing of numbers in order for the CEO to meet objectives and receive bonus or inflate stock price, or manipulate the timing of the granting of the stocks
what incentivizes manipulative accounting
equity ownership in the company
what is the definition of an insider trader
a corp officer, employee, director that has access to material confidential information before the general public and uses this knowledge to trade
how can family be part of inside trading
letting them know about material confidential information not known to the public and shares being traded based on it would make it insider trading
how can government officials be inside traders and give an example
they can get information from their day to day tasks
e.g. knowing that a certain law will be passed which will benefit a company and buying its stock
what professionals might be able to inside trade
those who would have access to insider information such as bankers, lawyers, paralegals, auditors
what is insider trading a negative of?
equity ownership in a company
what does the SEC rule
that you may trade only if you are not in posession of material confidential information not available to the public
what are the consequesnces for insider trading
jail time and financial penalties (3x gains)
what are blackout trading periods
period presceeding the earinigns announcement and release of material information such as
- earnings
- acquisitions
- major product release
what is teh typical range of blackout periods
50 days
what sort of trading happens when there is market outperfromance
purchasing
what sort of trading happens when there is market underperfromance
selling
why do the ceo and chairman have the most amount of power
because they have the most amount of information
what is tipping
the act of providing material non-public information about a publicly traded company or a security to a person who is not authorized to have the information with the intent to gain some sort of benefit
can executives/CEO buy put options
yes.
put options are having the right to sell something at a specific price during a specific time - can be done as hedging
can executives/CEO short sell
no selling borrowed assets in anticipation of a price drop
