The Executive Turnover Risk Premium

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THE EXECUTIVE TURNOVER RISK PREMIUM

Summary

Volatile company conditions may cause the chief executive officers to lose their jobs. At the same time, risks within a firm has a lower association with the compensation awarded to the CEO’s but can result in their dismissal (Peter & Wagner, 2014). Thus, this report unveils the consideration that turnover risk is factored in the executive heads’ compensation. This corresponds with the pay discussion with the United States corporations and beyond to establish the relationship between the two concepts; hence, creating an understanding. A constructive association between the risk of dismissal and pay awarded to CEOs is fundamental within the competitive labor market. This report affirms that the executive heads subjected to higher job-associated risks earn more than their counterparts, who enjoy job security. The nexus point between the risk of being dismissed and compensation is anchored on time factor.

Earlier reports confirmed that CEOs incur considerable costs when getting fired; thus, the existence of turnover risk premium in their pay is not a new phenomenon. After dismissal, their job-hunting period may be prolonged, and acquiring new jobs may subject them to lower pay than their earnings (Peter & Wagner, 2014). Hence, in most cases, executive tenets associated with turnover risks within organizations are linked to compensation. The executive heads, in most instances, lose their jobs based on poor performance and the board’s decision to dismiss them in instances where there is a change in the industry conditions.

The relevance of the paper and lesson learned from it.

The paper is instrumental in literature because it provides a connection between the turnover risks and rewards accorded to the executive heads of a company. It shows that the chief executive officers are at higher risk within their jobs due to the volatility of the work conditions they are subjected to (Peter & Wagner, 2014). Thus, it provides a basis for understanding the compensational rewards to senior officials and the risks associated with their earnings. The lesson learned from this paper is that executive heads are like other employees, although their roles are fragile based on the goals set by the boards. As a result, they can be dismissed if their tenure fails to deliver the organizational goals, and changes within the firm can also render them jobless. Thus, the CEOs in uninsured jobs require higher pay because of the uncertainties of their job conditions compared to their colleagues with job security.

 

Empirical methods

The discussion on why chief executive officers at risk of dismissal should get higher rewards is because the loss of their jobs affects their earning in subsequent years due to unemployment. As a result, dynamics within the highly competitive labor market, such risks require higher pay (Peter & Wagner, 2014). The following empirical methods have been utilized in this research;

Instrumental variables

The uncertain industrial conditions and risks depict a genuine instrumental variable for a forced turnover. The motivation is that board directors can dismiss the executive heads of a company based on failure to achieve the set goals (Peter & Wagner, 2014). In some instances, a company can experience a shock in its operations, causing a change in its external choice; hence, the management teams considering it necessary for the boards to terminate the services of the chief executive officer. Volatile conditions within an industry when a mismatch is experienced between the CEO’s skills and the competency demand by the company can weaken; hence, resulting in dismissal.

The authors have utilized two positions for changing business conditions. The first approach is the stock return volatility in which volatile equity prices show a dynamic environment. Within an industrial framework, this reflects broader foreign technology, production, and shocks in demand (Peter & Wagner, 2014). Secondly, the authors utilized prolonged ratings on credit, focusing on default risks.

Accounting covariates

Existence of risks within an industry associate to levels of rewards through the compensational structure. It is established that hazardous environments offer more equity-based compensation to their CEO’s. Prevailing market compensational values entail rewarding based on the risks associated with stock (Peter & Wagner, 2014). Thus, higher market compensational value asserts higher volatility leading to differences in the pay structure. The authors used completed cash equivalents that CEO’s willingly accept instead of compensational rewards.

Effectiveness of the strategy in addressing empirical concerns

Payment is a reward and serves as a motivation for employees at senior and junior levels to work harder in helping an organization to realize its set goals. In reality, senior ranks within a firm demand higher pay because of the job demands and the associated risks. However, this study asserts that higher pay to CEOs is due to the risks associated with dismissal risks attached to their services within a corporation. The assertion is true; however, it cannot be generalized to apply to every situation because of the variations within the labor markets. Service to a company has a legal basis; hence, the boards cannot unilaterally fire the serving chief executive officers without evaluating the terms of employment and performance contract because the dismissed official can seek legal assistance. Thus, the findings should focus on generalizable tenets resulting in CEO’s higher-earning and dismissal risks because some executive heads enjoy job security while earning significantly higher salaries and compensations.

Secondly, risks are not an ultimate means to an end because the business environment demands calculative moves to turn the associated risks into growth opportunities. As a result, subjective evaluation enables the CEO to take early precautions in addressing risk exposures. The chief executive officer can invest in safer assets and reduce frequent exposure to risks; thus, minimizing their dismissal chances. The executive heads are like other employees who require motivation through a favorable work environment and policies to support their services in an organization. However, when the employer focuses on minor failures by the executive heads to terminate their contracts, it creates an environment of fear inhibiting the confidence of the serving CEO to deliver on the set goals. Thus, the boards should provide a favorable environment for the executive heads through an avenue to evaluate performance, identification of areas of weaknesses, and recommendations on improvement to give them time since human beings can make mistakes. Termination should be considered as the last resort when all other avenues have proven unproductive.

 

 

 

 

 

 

 

Reference

Peters, F. & Wagner, A. (2014). The executive turnover risk premium