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May 31, 2006


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The post is (intentionally, I presume) related to the previous one on The Prime Directive. If I can summarize your perspective it is that Boards look for good CEOs, and need to be alert as to when to unload them, and they ought to have some doubts about the importance and role of incentives. This is in part because an important incentive is the terms of the next contract, or the next set of employment opportunities. One method of offering incentives is to hire for a short period of time.

A boring reaction or add-on is that some people are good at turnarounds, at selling assets and renegotiating with employees and creditors. But the fun suggestion is that there may be much more room for short term contracts. It would be interesting if in sports we found that some positions normally generated shorter-term contracts than others.

The sports analysis you and Todd Henderson are engaging in should trouble us a bit, if we want to believe in the market. If the player does better in the final year, then the employer ought to be averse to multi-year contracts. If the answer is that risk averse players prefer long term contracts, then we ought to find more players willing to go with shorter term contracts - though note that these present risks to the employer as well.


Another angle here is the ever-shortening tenure of CEOs. Recent data shows that the average length of CEO service is around 4-5 years, way down from just a decade ago. One driver of this might be the specialization you describe. Instead of hiring a CRO after a concrete event like a bankruptcy filing, firms may opt, either explicitly or implicitly, for different skill sets to serve at different times. A good example was highlighted by Alan Murray in the Wall Street Journal on May 24th, describing the case of HP. Former CEO Carly Fiorina, who championed a merger with Compaq and was ousted because it came to pass, is finding out that her strategy--emphasis on "her"--is proving to be quite successful, especially in the hands of current CEO Mark Hurd. As Murray writes: "In the end, [HP] got eh best of both worlds--a charismatic CEO who brought a hotly contested but transformational merger, and a no-nonsense, operations-orientated CEO determined to make the combined company work." Expect this scenario to be repeated, with the consequences of increasing turnover, increasing risk, and therefore increasing compensation levels on a per year basis.


The Carly/Hurd pair is a nice illustration of how the same corporation needs a CEO with a differnet skill set at different times. The one difference between this situation and the turnaround situation may be the effect of leaving on the manager's reputation. When a turnaround person leaves a company, this is often seen as a positive development that enhances his future employment prospects. While some may now appreciate what Carly brought to the table, no one thought that her reputation was enhanced when she left HP. Of course, she got a decent payout when she left. To the extent that the reputational hit that one takes when leaving a company decreases, we would expect the payouts upon leavnig to decrease as well.

Dan Levine

I wonder if today's announced ascension of Lloyd Blankfein at Goldman Sachs--from the get-go, apparently, a fait accompli--offers an interesting caveat to this discussion. Why is it that successful companies always seem to hire new CEOs from within? One might think that it is because their success allows them to, but couldn't the causation run the other way? Might they be successful because they hire from within? Or is this a phenomenon particular to investment banks... and law firms... and consulting firms? [Compare the frictions at Morgan Stanley before and after it hired non-insider John Mack.]
Contrasting the WSJ's 5/9 article about the wealth accumulated by the CEOs of investment banks (over $1 billion for Bear Stearns' Jimmy Cayne) with its general coverage of the executive pay phenomemon in this country supports Prof. Rasumssen's first point. No one seems to mind when a long-time insider is paid excessively. There are two possibilities why: 1) years of vetting may have assured shareholders that he or she is worth the money; or 2) high executive pay, when combined with a norm of hiring from within, may create positive spillovers to other employees and reassure shareholders that the CEO is not an interloper who has captured the board (or the executive hiring firm that advised it). In either case, having the right person seems to be more important than creating the right incentives for them.


GE is better off because of Nardelli's presence, but Im not sure you can say the same thing about HD, at least at this point.

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