Lancaster University Management School - 54 Degrees Issue 12

H ow do you incentivise your company leader to make decisions that bene fi t shareholders? For a long time, a typical method has been to pay them, in large part, in stock options. Chief Executive O ffi cers (CEOs) are habitually given share-based payments to align their interests with those of shareholders – often as much as 80%of the CEO’s pay packet is made up of share- based payments. Shareholders’ investments in a company are such that they can take advantage of any bene fi ts of success – the share price is theoretically unlimited, so the upside is unlimited. Contrarily, their downside is limited by the amount of their investment, all they can lose is what they invested – and we have all seen provisos on stock advertisements warning you to only invest what you can a ff ord, as prices can go down as well as up. Shareholders bene fi t from a higher level of risk-taking in a company. If you are giving these stock options to the CEO, you are telling them they will bene fi t if they take more risks. Typically, there is a positive relation between risk and return, so the greater the risk, the greater the return. Data shows that, on average, a one per cent change in stock price volatility – the potential for it to go up or down – results in a $138,720 increase in the value of CEO stock options, and thus wealth. The bene fi ts are clear – both for shareholders and for the CEOs themselves as they try to maximise a fi rm’s value – but there is a dark side to this rewarding of risk-taking. To generate acceptable returns, you need to take acceptable risks. But di ff erentiating between acceptable and unacceptable risk is a very fi ne line. Stock options incentives can in fl uence investment and fi nancial decision- making, and can incentivise CEOs to invest in more risky projects and undertake more risky fi nancing choices, but they can also encourage managers to engage in other risky practices, such as accounting manipulation and fraud. Managers who are under pressure to perform often engage in practices intended to boost fi rm pro fi tability, but these same practices can compromise workforce safety and wellbeing to meet performance expectations. Previous research has shown that fi rms that just meet or beat analysts’ forecasts have higher injury rates than those that miss or beat them comfortably, and that local managers will violate rules and regulations when under pressure, a time during which there is also an increase in misconduct. Our research looked at the relation between these CEO incentives and workplace misconduct in the USA – where data is more readily available and accessible. Workplace misconduct includes health and safety violations, non-compliance with labour laws, and other violations broadly related to labour exploitation, and 16 |