What is the maximum amount it would be worth to shareholders to elicit high CEO effort all the time rather low CEO effort all the time?
If you decide to pay 1% of this amount (in Question 1) as a cash bonus, what performance level (what share price or shareholder value) in the table should trigger the bonus? Suppose you decide to elicit high CEO effort when and if medium luck occurs by paying the bonus for $800 million outcomes. What criticism can you see with this incentive contract plan?
To determine the maximum amount it would be worth to shareholders in order to elicit high CEO effort compared to low CEO effort, we need to consider the factors involved in CEO effort and its impact on company performance.
1. Define the value of high CEO effort: Calculate the potential increase in company performance associated with high CEO effort. This can be done through various metrics such as revenue growth, profitability, market share, or stock price appreciation.
2. Determine the value of low CEO effort: Estimate the potential negative impact on company performance due to low CEO effort. Consider the potential decline in key metrics mentioned earlier.
3. Assess the probability of high and low CEO effort: Evaluate the likelihood of a CEO consistently providing high effort or low effort over time. This assessment can be based on previous performance, track record, motivation, and alignment with company goals.
4. Quantify the impact on shareholder value: Calculate the difference in potential shareholder value between high and low CEO effort scenarios. This can be done by comparing projected financial outcomes, market valuations, or investor expectations.
5. Consider the time horizon: Determine the time period over which these scenarios would play out. Short-term impacts may differ from long-term impacts, as CEO effort can have compounding effects over time.
By following these steps, a comprehensive analysis can be conducted to estimate the maximum amount it would be worth to shareholders to elicit high CEO effort compared to low CEO effort. It is important to note that this evaluation is subjective and dependent on various assumptions and factors specific to each company and situation.