Term Test 2 Flashcards
Chapters 7-9
What percentage of CEO turnover events are forced
35%
Global CEO turnover rate
17%
Cost of C-Suite succession mistakes
1.8 billion
Supply side - Successful CEO candidate characteristics
- Humble
- Feedback seeking
- Unselfish
What caused the shortage of executive talent?
Downsizing of middle management and organization flattening
Succession Planning
An effort to protect the organization’s ability to operate during a leadership transition
Benefits of succession planning
- Reduce costs
- Reduce anxiety
- Prepare for CEO retirement
- Prepare for crises
Models for CEO succession planning
- External candidate
- President and/or COO (heir apparent)
- Horse race
- Inside-outside model
External candidate model for CEO succession planning
Company recruits an external candidate. Associated with companies with weak performance
What percentage of successions involve an internal replacement?
70-80%, common in companies with strong performance
External CEO pros
- Tends to have proven CEO experience
- More free to make changes
External CEO cons
- Less familiar with company
- Operations disruption
- Board has not evaluated performance firsthand
- Leadership style may not translate
Heir Apparent
Company promotes a leading candidate to position of president and/or COO
Heir apparent pros
- Board observes performance
- Familiar with company
- Continuity
- Smooth transition
Heir apparent cons
- Adds complexity to organization
- Responsibilities need to be defined and differentiated from CEO
- Risk becoming lifetime COO
- No significant change
Horse race
Company promotes two or more internal candidates to high-level positions who compete for CEO
Horse race pros
- Board observes performance
- Board does not commit to a candidate
- Executives develop desired skills
Horse race cons
- Public
- Creates internal factions
- Creates a loss of talent when losers resign
Inside-outside model
Company develops internal talent and evaluates external talent
Inside-outside pros
- Internal candidates gain new skills
- Assures board that best candidate is selected
Inside-outside cons
- Requires lots of planning
- Can cause erosion in trust
Executive compensation
Mechanism that aligns the interests of managers and owners through incentives
Goal of compensation
- Attract and retain talent
- Motivate executive
What is the largest determinant of CEO pay?
Company size
Optimal contracting
CEO pay is awarded through market forces
Rent extraction
CEO pay levels are a result of market failure and has allowed for compensation over what should be awarded
Who might set executive compensation?
- Compensation consultants
- Compensation committees
- Board of directors
- Shareholders
What is the right amount of compensation?
Minimum amount it takes to attract and retain a qualified individual
Why is CEO pay higher among companies with compensation consultants?
Due to issues with governance quality
Ratcheting
Median compensation increases due to benchmarking pay against peer groups
Conclusions about peer groups and CEO pay
- Peer groups set competitive pay
- Peer groups are selected to inflate pay
Deferred compensation
- Stock options
- Stock plans
- Stock appreciation rights
Components of current core compensation
- Annual base pay
- Bonuses
Annual base pay
Fixed element of annual cash compensation
Bonuses
- Discretionary
- Performance contingent
- Predetermined allocation
- Target plan
Stock options
Stocks purchased at a designated price for a specific time
Stock grants
Company offers stock to employees
Exercise of stock grants
Purchase of stock
Disposition
Sale of stock
Fair market value
Average stock price on TSX
Severance
Payment given if the CEO is removed for reasons other than what is stipulated in their contract
Golden Parachutes
Provide executives pay and benefit following termination due to ownership change or takeover
Platinum parachutes
Compensation for departing executives. Awarded to avoid legal battles or critical press reports
Clawback provisions
Allow board to take back performance-based compensation when goals were not reached
Compensation risk
Compensation plans designed to get the most motivation for a given amount of risk
Theory of executive ownership
Holding equity should create incentive to build economic value because they have “skin in the game”
Target ownership plan
Require an executive to hold a minimum amount of stock
What do direct stock holdings do with risk?
Motivates executives to grow and protect value
What do stock option grants do with risk?
Motivates executives to increase firm risk
True or false: Executives facing convex payoff curves engage in more risk taking?
True
Hedging
Executives might hedge the value for equity holdings rather than selling
Hedging pros
- Diversification
- Tax advantages
- Minimizes scrutiny
Hedging cons
- Unwinds equity incentives to perform
- More costly
- Difficult to explain
True or false: Executives use hedges to opportunistically time trades.
False
Pledging
Pledging shares as collateral
What is an insider?
Individual who has access to material information that is not available to the public
Blackout window
Period in which material information is not released to the public and insiders are restricted from trading
Price sensitive infomration
Information which will affect the price of securities of a company
