Jensen, Michael C. →

Putting Integrity into Finance: A Purely Positive Approach

Behavior that lacks integrity leads to value destruction. This paper analyzes some common beliefs, actions, and activities in finance that are inconsistent with being a person or a firm of integrity. Each of these beliefs leads to a system that lacks integrity, i.e., one that is not whole and complete and therefore creates unworkability and destroys value. Focusing on these phenomena from the integrity viewpoint, the authors argue, makes it possible for managers to focus on the value that can be created by putting the system back in integrity and correcting the non-value maximizing equilibrium that exists in capital markets. Overall, this paper summarizes a purely positive theory of integrity that has no normative elements whatsoever, and demonstrates how it applies to both individuals and organizations. In effect, integrity is a factor of production just like knowledge, technology, labor, and capital, but it is undistinguished—and its affect (by its presence or absence) is huge. Key concepts include: Integrity matters. Not because it is virtuous, but because it creates workability. Workability increases the opportunity for performance, and maximum workability is necessary for realizing maximum value. Integrity thus becomes a necessary (but not sufficient) condition for value maximization-a proposition that should become an important element in every finance course in every business school. Closed for comment; 0 Comments.

CEO Bonus Plans: And How to Fix Them

Discussions about incentives for CEOs in the United States begin, and often end, with equity-based compensation. After all, stock options and (more recently) grants of restricted stock have comprised the bulk of CEO pay since the mid-1990s, and the changes in CEO wealth due to changes in company stock prices dwarf wealth changes from any other source. Too often overlooked in the discussion, however, is the role of annual and multiyear bonus plans—based on accounting or other non-equity-based performance measures—in rewarding and directing the activities of CEOs and other executives. In this paper, Kevin J. Murphy and Michael C. Jensen describe many of the problems associated with traditional executive bonus plans, and offer suggestions for how these plans can be vastly improved. The paper includes recommendations and guidelines for improving both the governance and design of executive bonus plans and, more broadly, executive compensation policies, processes, and practices. The paper is a draft of a chapter in Jensen, Murphy, and Wruck (2012), CEO Pay and What to Do About it: Restoring Integrity to both Executive Compensation and Capital-Market Relations, forthcoming from Harvard Business School Press. Key concepts include: While compensation committees know how much they pay in bonuses and are generally aware of performance measures used in CEO bonus plans, relatively little attention is paid to the design of the bonus plan or the unintended consequences associated with common design flaws. These recommendations for improving executive bonus plans focus on choosing the right performance measure; determining how performance thresholds, targets, or benchmarks are set; and defining the pay-performance relation and how the relation changes over time. In the absence of "clawback" provisions, boards are rewarding and therefore providing incentives for CEOs and other executives to lie and game the system. Any compensation committee and board that fails to provide for the recovery of ill-gained rewards to its CEO and executives is breaching another of its important fiduciary duties to the firm. Closed for comment; 0 Comments.

The Three Foundations of a Great Life, Great Leadership, and a Great Organization

This is the commencement speech that HBS professor Michael Jensen delivered to the 2011 graduates of the McDonough School of Business at Georgetown University. Drawing from his own experiences, he discusses the three foundations of a great personal life, great leadership, and a great organization. Those three foundations are integrity, authenticity, and being committed to something bigger than oneself. Key concepts include: As integrity declines, workability declines. As workability declines, value (or more generally, the opportunity for performance) declines. The actionable pathway to authenticity is to be authentic about your inauthenticities. Being committed to something bigger than oneself is the source of both personal and corporate passion and energy. Closed for comment; 0 Comments.

Creating Leaders: An Ontological Model

HBS professor emeritus Michael C. Jensen and coauthors have created an ontological approach to creating leaders in which leadership emerges through spontaneous and intuitive natural self-expression. Key concepts include: The ontological model of leader and leadership opens up and reveals the actual nature of being when one is being a leader. It also opens up and reveals the source of one's actions when exercising leadership. Ontology's associated phenomenological methodology provides actionable access to what has been opened up. Students do not need to study ontology or phenomenology. Closed for comment; 0 Comments.

Just Say No to Wall Street: Putting A Stop to the Earnings Game

Over the last decade, companies have struggled to meet analysts' expectations. Analysts have challenged the companies they covered to reach for unprecedented earnings growth, and executives have often acquiesced to analysts' increasingly unrealistic projections, adopting them as a basis for setting goals for their organizations. As Monitor Group cofounder Joseph Fuller and HBS professor emeritus Michael C. Jensen write, improving future relations between Main Street and Wall Street and putting an end to the destructive "earnings game" between analysts and executives will require a new approach to disclosure based on a few simple rules of engagement. (This article originally appeared in the Journal of Applied Corporate Finance in the Winter 2002 issue.) Key concepts include: Managers must confront the capital markets with courage and conviction. Managers must be forthright and promise only those results they have a legitimate prospect of delivering, and they must be clear about the risks and uncertainties involved. Managers must recognize that an overvalued stock can be damaging to the long-run health of the company, particularly when it serves as a pretext for overpriced acquisitions. Managers must work to make their organizations more transparent to investors and to the markets. To limit wishful thinking, managers must reconcile their own company's projections to those of the industry and their rivals. While recent history may have obscured the analyst role, managers should not simply presume that analysts are wrong when disagreement occurs. In fact, analysts have a vital monitoring role to play in a market economy. Closed for comment; 0 Comments.

Introductory Reading For Being a Leader and The Effective Exercise of Leadership: An Ontological Model

Effective leadership does not come from mere knowledge about what successful leaders do; or from trying to emulate the characteristics or styles of noteworthy leaders; or from trying to remember and follow the steps, tips, or techniques from books or coaching on leadership. And it certainly does not come from merely being in a leadership position or in a position of authority or having decision rights. This paper, the sixth of six pre-course reading assignments for an experimental leadership course developed by HBS professor emeritus Michael C. Jensen and coauthors, accompanies a course specifically designed to provide actionable access to being a leader and the effective exercise of leadership as one's natural self-expression. Key concepts include: One of the conditions for realizing the promise of the leadership course is that students must be open to examine, question, and then transform their worldviews (models of reality) and frames of reference (mindsets). Students create for themselves a powerful 4-part contextual framework that calls them into being as a leader. Having done this what remains is to confront one's own Ontological Perceptual and Functional constraints so as: 1) to relax their ability to restrict one's perceptions of what must be dealt with in any leadership situation, and 2) to relax their ability to restrict one's freedom of choice for action in any leadership situation. Students cannot master that which they do not create for themselves. This is especially true of anything that is at first counterintuitive. Closed for comment; 0 Comments.

Integrity: Without It Nothing Works

"An individual is whole and complete when their word is whole and complete, and their word is whole and complete when they honor their word," says HBS professor Michael C. Jensen in this interview that appeared in Rotman: The Magazine of the Rotman School of Management, Fall 2009. Jensen (and his coauthors, Werner Erhard and Steve Zaffron) define and discuss integrity ("a state or condition of being whole, complete, unbroken, unimpaired, sound, in perfect condition"); the workability that integrity creates for individuals, groups, organizations, and society; and its translation into organizational performance. He also discusses the costs of lacking integrity and the fallacy of using a cost/benefit analysis when deciding whether to honor your word. Key concepts include: The personal and organizational benefits of honoring one's word are huge—both for individuals and for organizations—and generally unappreciated. We can honor our word in one of two ways: by keeping it on time and as promised, or if that becomes impossible, by owning up to the parties counting on us to keep our word in advance and cleaning up the mess our failure to keep our word creates in their lives. By failing to honor our word to ourselves, we undermine ourselves as persons of integrity, and create "unworkability" in our lives. Integrity is a necessary but not sufficient condition for maximum performance. There are unrecognized but significant costs to associating with people and organizations that lack integrity. Closed for comment; 0 Comments.

Specific Knowledge and Divisional Performance Measurement

Performance measurement is one of the critical factors that determine how individuals in an organization behave. It includes subjective as well as objective assessments of the performance of both individuals and subunits of an organization such as divisions or departments. Besides the choice of the performance measures themselves, performance evaluation involves the process of attaching value weights to the different measures to represent the importance of achievement on each dimension. This paper examines five common divisional performance measurement methods: cost centers, revenue centers, profit centers, investment centers, and expense centers. The authors furnish the outlines of a theory that attempts to explain when each of these five methods is likely to be the most efficient. Key concepts include: Each of these methods can be seen as providing an alternative way of aligning corporate decision-making authority with valuable "specific knowledge" inside the organization. Jensen and Meckling's theory suggests that cost and revenue centers work best in cases where headquarters has (or can readily obtain) good information about cost and demand functions, product quality, and investment opportunities. Decentralized profit and investment centers tend to supplant revenue and cost centers when managers of business units have a significant informational advantage over headquarters. Closed for comment; 0 Comments.