Eric Rasmusen’s Weblog

It is widely recognized that CEO’s, being rich, are expensive to motivate with money. What do they have in more limited quantities? The esteem of their peers. “Money is just a way to keep score”. This has at least two big implications:

1. Past and present CEO’s make good directors. If a CEO knows he will be scrutinized by them, he will be ashamed to do badly and eager to do well. A professor or a politician’s opinion matters less, partly because they are too easy to fool.

2. Formulaic pay and options are worse incentives than bonuses and increases in base salary. If the CEO gets high pay just because the Return on Equity is high this year, where is the glory? He’ll get the high pay even if the directors don’t notice the great job he did. If the CEO has high income just because the stock price rose and he could cash in his options for millions, where’s the glory? He could do that even if the directors thought he had done a bad job and just got lucky. A subjective bonus, on the other hand, freely given, shows appreciation. Moreover, a bonus can be based on something subtle, like the hiring of a new marketing head or the decision to pursue a new project, that has no current effect on profits and that is unappreciated by the market analysts.

This entry was posted on Thursday, May 3rd, 2007 at 1:14 am and is filed under Economics, Thoughts-New, Social Reg. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.