Suppose you decide to elicit high CEO effort when and if bad luck occurs by paying the bonus for $1 billion outcomes only. What criticism can you see with this incentive contract plan?

The incentive contract plan you mentioned, where CEOs are eligible for a bonus payout only in the case of achieving $1 billion outcomes, may have a few potential criticisms. Here are some possible criticisms:

1. Risk-Taking Behavior: This type of contract might encourage excessive risk-taking by CEOs. Since they are only rewarded for highly successful outcomes, they may be more inclined to pursue riskier strategies in the hopes of achieving the desired $1 billion result. This could expose the company to unnecessary risks and potentially harm its long-term stability.

2. Short-Term Focus: The incentive contract with a high threshold might lead CEOs to prioritize short-term results over long-term growth and sustainability. Instead of focusing on building a solid foundation for the company's success, they may engage in short-sighted actions solely aimed at achieving the $1 billion outcome in order to receive the bonus. This could hinder the company's ability to adapt and thrive in the long run.

3. Demotivation and Moral Hazard: Setting such a high threshold for CEO bonuses could demotivate and disengage CEOs when they face unfavorable circumstances or bad luck. If they believe that achieving the $1 billion outcome is unlikely or out of their control, they may lose motivation to put in the necessary effort. Additionally, they may be more inclined to engage in moral hazard, taking less responsibility for their actions, as the outcome is largely dependent on external factors like luck.

4. Neglect of Other Value-Adding Activities: By solely focusing on the $1 billion outcomes, CEOs may neglect other value-adding activities that may not directly contribute to achieving the bonus threshold. This narrow focus could lead to missed opportunities for improvement in areas such as operational efficiency, customer satisfaction, or innovation.

It's important to note that these criticisms are not definitive conclusions, but potential concerns that could arise from the incentive contract plan you described. Evaluating the specific circumstances and understanding the dynamics of the company are crucial in determining the appropriateness and effectiveness of any incentive plan.