It is an issue of agency and moral hazard. A CEO is an agent for the company's owners - shareholders. For the purposes of this post, publicly traded companies are the focus as closely held companies complicate issues of agency. The CEO is supposed to act in a manner that is in the best interests of the company's owners. To ensure that the CEO acts in this manner, companies seek to align the interests of the company and CEO. A common method for interest alignment is compensating a CEO with stock options. By tapping into the natural tendency of a CEO to act in his or her own best interests, a company can benefit alongside a CEO pursuing personal wealth creation. The tie up of company interests with CEO interests is also meant to keep at bay the issue of moral hazard. Moral hazard is related to risk. The less personal risk a CEO has when making company decisions, the less likely a CEO will act in a conservative, careful or thorough manner.
Consider the rental car versus the driver owned car scenario. A rental car requires less care or concern because the renter does not have long term consequences or replacement responsibility (unless negligence /recklessness). A renter is generally going to be harder on the rental car than one in which the renter owns. The hardship is a matter of degrees - higher speeds or harder turns otherwise opportunities for culpability increases. And culpability indicates responsibility so the risks are taken in such a way as to be disguised by continued use not an individual renter's use. The matter of degrees also applies to how a CEO directs the day to day operations of a company. Consequences of takings risks that can be assigned to externalities - stock market forces, competitive threats - effectively covers one's tracks and blur issues of moral hazard.
Risk temperance and the aligning of interests fail to control for intrinsic motivation. Wealth creation is an external representation of success. Intrinsic motivation is sourced internally and functions off psychological needs and desires. Extrinsic motivation is limited in its effectiveness and experiences diminishing returns, however it can be argued that intrinsic motivation never experiences that. The drive and ambition that created a CEO does not diminish once the CEO attains the position. It is channeled into a surrogate - the company. The company then takes on the personality of the CEO and depending upon how much self awareness a CEO possesses, the result could be devastating to the company. MF Global and its CEO Jon Corzine is a current example of how a risk seeking personality without a strong counterbalance is dangerous.
Jon Corzine was motivated by the potential reputation capital (mastery) had he pulled off the European sovereign bond gamble a la George Soros. George Soros' reputation or persona was created by shorting the pound in September 1992. The billion or so dollars that was made on the gamble is impressive, but not what people remember - it is that George Soros was innately aware of something that others were not - timing. This elevated the mystique of George Soros. Jon Corzine has, in the end, made a name for himself just not the name he intended. By focusing on the money as the overriding or sole motivation, companies will labor under the impression that Jon Corzine could have been more effectively managed had his compensation package not been what it was. Pure fairy tale. The management of Jon Corzine required strong gatekeepers capable of challenging his intrinsic motivation.
Instead, like many companies, MF Global relied on extrinsic motivation without understanding the diminishing returns of CEO compensation thereby making MF Global vulnerable to unmitigated risk. As long as companies believe in fairy tales, CEOs will continue to make risky decisions with greater and greater consequences as the global market becomes smaller and smaller. The ending, however will not be a Disney movie
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