Chief Executive Officers are often driven more by their short-term per

5. The passage supports each of the following statements EXCEPT

Difficulty Level: 700

Explanation

We are looking for the one statement that is NOT supported by the passage.

Let us analyze the options one by one.

A. This option is correct. It is NOT supported by the passage. The passage only suggests that the performance targets of most CEOs are such that they can be – and are – manipulated by the CEOs. This, the passage suggests, may not be in the long-term interests of the company. However, the passage does not indicate that these targets are not aligned to the company's mission and values.

B. This option is incorrect. It is supported by the passage. The first line of the passage states that a CEO is likely to act in his own self-interest even if it hurts the interests of his company. So, if his bonus depends on EPS, he will strive to maximize EPS even if this hurts other vital metrics of the company (such as revenue growth).

C. This option is incorrect. It is supported by the passage. The passage provides many examples of how the CEOs even manipulate their performance so as to hit the targets that are linked to their compensation. The research finding quoted in the first paragraph also states that most CEOs hit their performance targets.

D. This option is incorrect. It is supported by the passage. The second paragraph mentions that the performance targets of CEOs are often based on a single metric.

E. This option is incorrect. It is supported by the passage. The third paragraph explains how the executive payouts are zero below the minimum threshold, then increase rapidly till the set target, and taper off above the target. So, the payouts do not increase steadily with the performance.

Answer: A

1. The author of the passage would be most likely to attribute the research finding mentioned in the first paragraph to which of the following causes?

Difficulty Level: 650

Explanation

The 'research finding' mentioned in the first paragraph is this:

"In actual practice, CEOs meet their targets far often than they miss them."

By contrasting this with the note made in Passage Analysis:

(A target that cannot be gamed by the CEO) = (A target that the CEO would be as likely to meet as to miss)

the Research finding can be simplified as:

"In actual practice, most CEOs game their targets."

So, we need to think: how is the author most likely to complete this sentence:

"In actual practice, most CEOs game their targets and this happens because __________."

Now, the author mentions clearly that it is the board's critical duty to set such targets for the CEOs that cannot be gamed.

"In actual practice, most CEOs game their targets and this happens because most boards fail to do their duty well."

Let us analyze the options one by one.

A. This option is incorrect. The author mentions the CEOs as being self-interested (even at the cost of their organization's long-term well-being). He says nothing in the passage about the self-interest, or selflessness, of the boards.

B. This option is correct. It is in accordance with the analysis done above before starting with the options.

C. This option is incorrect. It mentions (multiple) 'closely correlated' performance metrics whereas the second paragraph of the passage states that most boards in fact use a single performance metric to measure executive performance.

D. This option is incorrect. The question of whether the boards accept 'without debate' or 'after debate' the forecasts presented to them by the CEOs is outside the scope of the passage. Also, the boards accepting the CEOs' inputs when setting the performance targets is only one of the two ways mentioned in the passage for how the CEOs are able to game the targets. The other way is that the boards set only one performance metric for their CEOs instead of multiple – not closely correlated – metrics. So, the author is likely to explain the research finding by saying that the boards err by using only a single metric and by using the CEO's forecasts in setting the performance targets. Both these errors are responsible for the CEOs gaming the metrics. It would be wrong to attribute the phenomenon of gaming of metrics to only one of these errors (which is what you would be doing if you choose Option D).

E. This option is incorrect. While it explains why CEOs would strive to achieve the set performance targets, it fails to explain why most CEOs game their targets.

Answer: B

4. Which of the following rationale to taper off CEO rewards for performance beyond the set targets can be inferred from the passage?

Difficulty Level: 700

Explanation

In the third paragraph, the author of the passage suggests that tapering off executive rewards for performance beyond the set targets is bad practice because it provides little incentive for the CEOs to do better than the set targets, and so is detrimental to the interests of the company.

This question however asks for the option that:

• provides a reason why tapering off the rewards in such a manner is good, and
• is supported by the passage.

Let us analyze the options one by one.

A. This option is incorrect. That boards want executive compensation to seem reasonable to the shareholders does not explain why it is good to taper off the rewards for performing better than the targets. Also, since the passage does not mention this concern of the boards at all, this option is not supported by the passage.

B. This option is incorrect. The unlikelihood of an event does not explain why it is good to not reward that event, if it takes place. Also, the passage mentions only that CEOs usually have little motivation to strive beyond their set targets. But if some executive did decide to strive beyond his set targets, would he succeed or not? The passage gives us no clue about the odds. So, the phrase 'it is highly unlikely' is not supported by the passage.

C. This option is incorrect. That CEOs are interested in A more than B does not explain why not rewarding them with A for B is good.

D. This option is incorrect. The passage clearly states that good performance targets are those that cannot be gamed by the CEOs. So, if not capping the rewards around the set targets leads to gaming of the performance, then it is good to cap the rewards. So, this option does explain why it is good to taper off the rewards beyond the set targets. However, this explanation is not supported by the passage: we find no indication if or how capping of rewards is related to gaming of executive performance.

E. This option is correct. If payouts increase at a constant rate relative to performance, there would be no tapering off of rewards for performance beyond the set targets. So, the higher the performance, the more the rewards (and hence, the more the personal gains of the CEOs). The first line of the passage states that executives are likely to act in their self-interest even at the cost of their company. Therefore, the passage does support the explanation that the prospect of higher payouts is likely to make CEOs take excessive risks. Such rash risk-taking may harm the long-term interests of the company. So, to avoid such a possibility, it is good to taper off executive rewards for performance beyond the set standards. Thus, this option both explains why the tapering off is good and is supported by the passage.

Answer: E

6. The author is primarily concerned with

Difficulty Level: 700

Explanation

The organization of the passage is this:

• Paragraph 1: Explains why it is critical for the boards to link CEO compensation with "good" performance targets. Mentions a research finding that suggests the boards are not setting good targets.
• Paragraph 2: Lists a problem in most performance targets
• Paragraph 3: Lists a problem in the procedure boards follow to set performance targets. Then, lists a problem in the way CEO compensation is linked with performance targets.

Since all the answer choices use abstract words, let us make a more general version of the above organization summary:

• Paragraph 1: Explains why a particular duty of an entity is critical. A research finding suggests that this entity is not doing its duty well.
• Paragraph 2: Lists one problem in the way this entity executes its duty
• Paragraph 3: Lists two more problems in the way this entity executes its duty

Let us analyze the options one by one.

A. This option is incorrect. The entity whose behavior is discussed in the passage is the CEO. But, as the above summary shows, the author is not primarily concerned with analyzing the consequences of the selfish behavior of the CEOs. Had the author done so, the passage would probably have been organized as:

a. Paragraph 1: Introduce and explain the selfish behavior of CEOs
b. Paragraph 2: Consequence 1 of this selfishness
c. Paragraph 3: Consequence 2 of this selfishness

B. This option is correct. It is in accordance with the discussion done above.

C. This option is incorrect. The author makes a claim of selfishness about the CEOs. Then, he gives examples for, and not counter-examples against, such selfishness.

D. This option is incorrect. Only two entities are mentioned in the passage – the CEOs and the boards. The author enumerates the responsibilities of neither.

E. This option is incorrect. The author lists ways in which an entity (the boards) fail to execute a particular task (setting performance targets) well. From this discussion, better ways to execute this task can certainly be inferred but that is not the primary purpose of the author.

Answer: B

3. According to the passage, which of the following is not a feature of good performance targets set by a board for its CEO?

Difficulty Level: 650

Explanation

According to the passage, a good performance target is one that:

• cannot be gamed
• can only be met (by the CEO) by actually creating long-term (sustainable) value for the company.
• For our answer, we are looking for the option that is NOT a feature of a good performance target.

Let us analyze the options one by one.

A. This option is incorrect. A target that involves multiple metrics is good because it will be difficult to game.

B. This option is incorrect. The third paragraph says that targets that are easily achievable are not in the long-term interest of the company. Therefore, targets that are challenging (not easy) to achieve are good.

C. This option is incorrect. Targets that cannot be easily gamed by the CEO are in fact good targets.

D. This option is correct. 'Targets' do not reward the CEO for superlative performance; 'Compensation/Incentive Structure' does.

E. This option is incorrect. Targets that are aligned to the long-term good of the company are good targets.

Answer: D