Short-Termism of Executive Compensation

40 Pages Posted: 7 Mar 2016

See all articles by Jonathan Pogach

Jonathan Pogach

FDIC, Division of Insurance and Research

Date Written: December 1, 2015

Abstract

This paper presents an optimal contracting theory of short-term firm behavior. Contracts inducing short-sighted managerial behavior arise as shareholders’ response to conflicting intergenerational managerial incentives. High-return projects may last longer than the tenure of managers who implement them. Consequently, inducing managers to act in the long-term interests of the firms requires the alignment of incentives across multiple managers. Such action comes at greater costs than providing incentives for a single manager and, as a result, leads to contracts that favor short-term behavior. Long-term firm value maximization is further impeded when only the quality of accepted projects–but not those of declined projects–is public. In that case, shareholders find it costly to induce long-term project selection among managers who can earn all information rents from short-term projects but must sacrifice information rents from long-term projects to future managers.

Keywords: Executive Compensation, Short-Termism

Suggested Citation

Pogach, Jonathan, Short-Termism of Executive Compensation (December 1, 2015). FDIC Center for Financial Research Paper No. 2016-01, Available at SSRN: https://ssrn.com/abstract=2743210 or http://dx.doi.org/10.2139/ssrn.2743210

Jonathan Pogach (Contact Author)

FDIC, Division of Insurance and Research ( email )

550 17th Street NW
Washington, DC 20429
United States

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