Executive contracts and investment - Business Works
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Executive contracts and investment

Adi Gaskell, CMI T he English Premier League season began in earnest again this weekend and it seems only a matter of time before rumours will begin over which manager is set for the chop. Of course, football enjoys a rarefied position in this sense in that the lifecycle of managers tends to be incredibly short.

In the real world however, the length of contract offered to a manager is something of concern to HR departments across the land. For instance, if you award a manager a short contract, will that detract from long-term thinking? Likewise, if a contract is up for renewal, will it encourage undue focus on short-term earnings or on vanity projects?

New research from Insead looks into this issue. CEO Contract Horizon and Investment suggests that the length of contract awarded to an executive has a marked impact on their behaviour.

The paper investigated 20 years of data from more than 3700 CEOs and found that investment typically declines as an executives contract nears renewal. What's interesting, however, is that if these executives are shifting resources from the long-term to the short-term, it is not working. They report no better short-term earnings than their peers.

The researchers provide evidence of what they refer to as the contract horizon effect, whereby investment peaks at the beginning of their contracts and declines the nearer they get to the end. Investment was found to be 20% lower in the final year of a 5 year contract than it was in the first year. The speed of decline in investment increases as the contract nears its end.

Therefore the implication is that if you wish your executives to remain focused on the long-term health of your organisation, you should begin negotiations on a new contract a significant period before they are due for renewal. This will increase their sense of security and keep their focus where it belongs.

Rolling your way to oblivion

These findings were particularly pronounced when executives were deprived the security of a fixed=term contract and had to make do with a rolling, at-will contract. Executives in such circumstances were shown to invest significantly less throughout their tenure, with lower earnings as a result.

Interestingly, the software industry demanded most flexibility in arrangements with executives, with the banking industry providing mostly fixed term contracts. The research found that those in fixed-term contracts stayed in post two years more on average than those on flexible contracts.

Key takeaway

So, if you want your executive to remain focused on the long-term success of your organisation, this research shows the following things to be key:

  • Provide them with a fixed-term contract;
  • Don't let that contract enter its final two years before re-negotiating

Adi Gaskell is from the Chartered Manaagement Institute (CMI): www.managers.org.uk

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