When you use the very last of your Monopoly money to buy up Boardwalk, odds are decent that you’ll lose the game. That kind of risk is no big deal, though, because it’s just play money.
But what if the money’s real?
A recent study from Tulane University’s Freeman School of Business has found that CEOs with generous severance contracts are more inclined to take inordinate risks—and the results aren’t pretty.
In fact, their companies “underperformed in the markets by 1.6% on average in the ensuing three-year period, when compared with firms that did not” hand out fat severance deals, according to The Wall Street Journal.
“With a severance contract, a company is basically saying that even if a CEO fails, there will be no penalty,” said Peggy Huang, an assistant professor of finance at Tulane, who analyzed more than 2,000 CEO severance agreements from S&P 500 companies between 1993 and 2007.
Peter Drucker disliked companies that were overly risk-averse. “Safe mediocrity” can destroy a company, Drucker warned in The Practice of Management. “It breeds bureaucrats and penalizes what every business needs the most: entrepreneurs.
“Nobody learns except by making mistakes,” Drucker added. “The better a man is the more mistakes will he make—for the more new things he will try.”
More]But just as people can respond to incentives for mediocrity, they can also respond to invitations to cast aside all caution. Drucker called stock options “an open invitation to mismanagement,” for instance, since they tempt executives into exaggerating short-term profits at the cost of long-term health.
“A management decision is irresponsible if it risks disaster this year for the sake of a grandiose future,” Drucker wrote. “The all too common case of the great man in management who produced startling economic results as long as he runs the company but leaves behind nothing but a sinking hulk is an example of irresponsible managerial action and of failure to balance present and future.”
What do you think: How do you incentivize executives to take smart risks, but avoid recklessly betting the house?