A new study conducted by researchers at the Mendoza College of Business at Notre Dame suggests there is a noteworthy correlation between offering substantial stock options to the CEO and future product recalls.
Published in the Strategic Management Journal, the findings indicate that these stock options, which are often used by boards of directors as a way to encourage CEOs to go after high-risk initiatives, can quite often result in a higher percentage of safety problems.
From the board’s standpoint, they want higher-risk initiatives that have the possibility of earning their shareholders more money. But CEOs tend to naturally be naturally more reticent to take chances. Stock option pay is one way boards try to balance this tendency.
However, researchers found there is also a positive relationship between the percentage of CEO pay that is derived from stock options in one year and then the number of product recalls the following year.
The theory is that when CEOs take these opportunities and choose aggression and risk over caution and completeness, mistakes get made at all levels of service – from design to manufacturing and production to distribution.
Interestingly, it seemed as if the correlation was highest among CEOs that were relatively new to that title or position. Meanwhile, those who had more experience under their belts were less likely to fall prey to that temptation. When the researchers looked at founding CEOs, they discovered those individuals were “virtually immune” to taking the high-risk carrot. They were more interested in trying to protect the company than wrangling a larger payout.
At least some boards seem to recognize this as a potential issue, which is probably why we are seeing it become less common. Whereas in the early 2000s, it was on the table in about 50 percent of all CEO pay plans, it’s now only used in about 15 to 20 percent total.
This isn’t to say that this is stock option pay for the CEO the be-all-end-all deciding factor in whether a company will produce harmful, defective products. However, it’s certainly one worth exploring when we consider the huge number of product recalls made every year.
Every year, hundreds of companies issue thousands of recalls, and some of those only happen following a serious adverse reaction, such as a death.
Some recent recalls, as reported by the Food and Drug Administration (FDA) include:
- Certain soft cheeses, for listeria risk
- “Miracle” diet drug, for the fact it was never approved
- Insulin pods, for high rates of failure
There were more than 20 recalls just in the first 15 days of September – and that was solely for the FDA. That doesn’t even include figures from the CPSC or NHTSA.
The Notre Dame researchers say that while they did not examine the recall figure effect of restricting those stock options for CEOs, it’s likely to give them a more balanced view of the cost-risk benefit of certain actions that pertain to worker and consumer safety.
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New study found correlation between executive stock options and product safety, Sept. 14, 2015, By Michael Addady, Fortune.com
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