Short-Termism of Executive Compensation
40 Pages Posted: 7 Mar 2016
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
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