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

Suppose you decide to elicit high CEO effort when and if bad luck occurs by paying the bonus for $500 million outcomes. What criticism can you see with this incentive contract plan?

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?

The incentive contract plan you mentioned, where a $1 billion bonus is paid only for $1 billion outcomes, may have some criticisms associated with it. Here are a few potential criticisms:

1. Risk Aversion: The plan might result in risk-averse behavior from the CEO. Since the CEO's bonus is contingent on achieving a $1 billion outcome, they might become overly cautious and avoid taking risks that could potentially lead to higher returns. This could limit their innovation and decision-making, as they prioritize minimizing the risk of failure over maximizing potential gains.

2. Short-Term Focus: Placing such a high emphasis on achieving a $1 billion outcome might lead to a short-term focus by the CEO. They may prioritize actions that provide immediate gains, even if these actions are not sustainable in the long run. Long-term strategic planning and investments might be overlooked, potentially compromising the company's future success.

3. Neglecting Non-financial Goals: By solely focusing on financial outcomes, the incentive plan may disregard other important objectives, such as corporate social responsibility, building sustainable relationships, or fostering a positive work culture. This narrow focus could have negative effects on the company's overall performance and reputation.

4. Potential Misalignment: The incentive plan might create a misalignment between the CEO's goals and the interests of other stakeholders, such as employees, customers, or shareholders. This misalignment could disrupt teamwork, create conflicts of interest, and ultimately harm the organization's overall performance and long-term growth.

When considering these criticisms, it is important to strike a balance between incentivizing desired outcomes and considering the potential unintended consequences of the incentive structure.