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On My Mind: You're Fired!

Shareholders ought to decide whether a chief executive stays or goes. Here's how.

Robin Hanson

October 13, 2006

Forbes

Too many corporations wait too long before firing the boss. Consider Michael Eisner at Disney, Carly Fiorina at HP, Jack Stahl at Revlon and Scott McNealy at Sun. All of these chief executive officers were kept on long past the point when a rational owner of the companies in question would have told them to leave.

Why are boards so slow to fire the chief? One reason is that they don't have enough skin in the game. They own few shares and therefore don't feel obligated to protect their investment from an out-of-touch boss. Besides, most of them owe their cushy jobs to the chief executive.

I propose instead that we put investors in charge of deciding when to fire the chief. Investors, after all, already set the boss' pay in an indirect way. When investors think the chief is doing a bad job, they are more eager to sell, which bids down the price of the company's stock and in turn reduces the value of an executive's options.

My idea: Set up two new stock markets where investors would be making not outright bets on the future of a company but conditional bets. In one market the trades are consummated only if the current chief executive remains in place at the end of the current quarter. In the other market the trades are consummated only if the incumbent is bounced out by the end of the quarter. The price spread between these two markets would send a signal about whether the boss should stay or go.

Say Eisner is the current boss and you own one share of Disney you want to sell. Instead of selling on the New York Stock Exchange for, say, $30, you could do simultaneous sell orders, each for one share, on the two alternative markets. Perhaps Disney is trading in the Stays Put market at $29 and in the Early Retirement market at $31. If Eisner does keep his job, only the first trade becomes valid: You give up your share and get $29. If he gets the ax, only the second trade is valid and the buyer (probably a different buyer) gives you $31.

Just as the $30 price on the Big Board reflects the collective wisdom about the value of Disney, the $29 Stays Put and the $31 Early Retirement prices would reflect the collective wisdom about relative values under different management scenarios. Spreads would open up because sellers (or buyers) in the alternative markets would often do only one of the two trades. If you happen to think Disney is worth $30 a share overall but would be disappointed to see Eisner leave, you would sell only in the Early Retirement market. If he does get bounced, you're happy to have the $31 cash; if he stays put, you are happy to continue owning the stock. On the other side of your trade: a hedge fund that thinks Disney would be worth $32 if a new manager came in.

The directors' job would be to listen to the markets. If a wide enough spread opens up in favor of a departure--maybe 1%--get out the pink slip.

There are plenty of potential problems with my idea; there are also solutions. Worried that investors don't have access to corporate secrets, like plans to reveal a fantastic technological innovation? Make sure that insiders trade in the two markets. You could even set it up so that trades by insiders are made public. Concerned that the chief executive and his minions will try to manipulate trading? Or that trading in these markets will be too thin?

We've tested these questions in experiments. If you make sure that enough insiders and outsiders can trade in these markets, the problems go away. We used two groups of students, giving each group clues about a stock. To one group we offered an extra bonus if it could push the price up or down. We found that this situation didn't affect the stock price, because the group that wasn't offered the bonus knew that the other group included manipulators.

It's worth a trial run. A few million dollars would be enough seed money to get a real-life test going on a few dozen stocks.

Robin Hanson, Associate professor of economics at George Mason University and a scholar at the Mercatus Center.