A company’s CEO typically takes actions that affect the firm’s future performance beyond his own tenure. The CEO leaves behind a legacy. How can a firm incentivize a new CEO who inherits the legacy? How does a legacy affect the firm’s decision to dismiss a poorly performing CEO and to adopt new strategies? And what is the nature of the relationship between a CEO and the strategy he stands for? Even though these questions are at the core of company’s concerns in the face of poor performance, existing theory provides little guidance regarding the economic mechanisms that link CEOs to strategies or that link successive CEOs intertemporally. This paper is aimed at addressing these questions.
The starting point of this paper is the observation that there is an intertemporal link between a new CEO’s incentives and the actions taken by his predecessor. The fact that such a link exists is probably more recognized in the accounting literature than in economics. Pourciau (1993) for example provides evidence that the successor of a CEO who has left the firm for non-routine reasons, tends to depress accounting earnings during their first year in office. Pourciau interprets this as an attempt ‘to take a bath while still being able to blame the predecessor.’ In addition, there is rich anecdotal evidence that illustrates the prevalence of the blame game in which CEO successors often engage, with the corresponding challenge for outsiders to attribute responsibility fairly. For example, when Mike Parton, former CEO of Marconi, was asked “How much blame do you accept for Marconi’s [...] troubles?” he replied that “You can’t be part of management and just wash your hands of it. However, I was not a board member when the key strategic decisions were made, and it’s difficult to say what my view might have been had I been on the board at the time.”
The market for convertible bonds has been expanding rapidly. In the U.S., over $105 billion of new convertibles were issued in 2001, as compared with just over $60 billion in 2000. As of early in 2002, there were about $270 billion of convertibles outstanding, more than double the level of five years previously, and the global market for convertibles exceeded $500 billion.1 Moreover, in the past couple of decades there has been considerable innovation in the contractual features of convertibles. Examples include liquid yield option notes (McConnell and Schwartz, 1986), mandatory convertibles (Arzac, 1997), “death spiral” convertibles (Hillion and Vermaelen, 2001), and cross currency convertibles (Yigitbasioglu, 2001). It is now common for convertibles to feature exotic and complicated features, such as trigger prices and “soft call” provisions. These preclude the issuer from exercising its call option unless the firm’s stock price is either above some specified level, has remained above a level for a specified period of time (e.g. 30 days), or has been above a level for some specified fraction of time (e.g. 20 out of the last 30 days).
The modern academic literature on the valuation of convertibles began with the papers of Ingersoll (1977) and Brennan and Schwartz (1977, 1980). These authors build on the “structural” approach for valuing risky non-convertible debt (e.g. Merton, 1974; Black and Cox, 1976; Longstaff and Schwartz, 1995). In this approach, the basic underlying state variable is the value of the issuing firm. The firm’s debt and equity are claims contingent on the firm’s value, and options on its debt and equity are compound options on this variable. In general terms, default occurs when the firm’s value becomes sufficiently low that it is unable to meet its financial obligations.2 An overview of this type of model is provided in Nyborg (1996). While in principle this is an attractive framework, it is subject to the same criticisms that have been applied to the valuation of risky debt by Jarrow and Turnbull (1995). In particular, because the value of the firm is not a traded asset, parameter estimation is difficult. Also, any other liabilities which are more senior than the convertible must be simultaneously valued.
The prospect of a substantial scaling-up of external aid flows offers much promise for low-income countries’ efforts to realize higher growth rates and realize the Millennium Development Goals. To make good use of these resources, development partners will need to address a number of important issues, including the potential impact of higher aid flows on the competitiveness of low-income countries in international markets (the so-called “Dutch disease issue”); the more complex task of managing fiscal and monetary policy in an environment of greater aid derived from multiple, external sources associated with different degrees of uncertainty; the budgetary management issues for both
ministries of finance and sectoral ministries of delivering public services which are largely financed by external donors; and the various and complex behavioral incentive effects arising from a high dependency on external funding sources. Beyond new approaches to macroeconomic policy management, other issues that will become important to consider include the appropriate sequencing of aid-financed investments; the balancing among alternative expenditure priorities; considering the implications for fiscal and budget sustainability; and strategizing for the ultimate graduation from reliance on donor funding. For the donors and international financial institutions, greater efforts will be required in ensuring higher long-term predictability of aid and lesser short-term volatility in the provision of aid, as well as more intensive guidance on macroeconomic, fiscal, and budgetary management, in addition to the existing policy agenda of greater harmonization and alignment of aid practices and policies. The paper also offers some suggestions on the ways in which the IFIs--IMF, World Bank, and regional development banks--can strengthen their efforts in helping countries to address the various scaling-up issues.
These are remarkable times. The global community appears increasingly energized to confront long-standing issues of persistent poverty in Africa and parts of Latin America and Asia. Major industrial countries have begun to respond to the challenge of mobilizing additional resources for development. Several countries have pledged to reach the 0.7 percent target for ODA within the next decade and others, including the United States have begun to significantly increase their commitments for development assistance. Combined with the possibility of new global financing initiatives, there is the possibility of a dramatic scaling up of aid resources far beyond the levels of past experience (for some countries at least). This is all to the good and a sign for hope that the enormous and inexcusable gaps in living standards between rich and poor countries can be narrowed.
