IDEAS home Printed from https://ideas.repec.org/a/inm/ormnsc/v68y2022i9p6477-6505.html
   My bibliography  Save this article

Optimal Short-Termism

Author

Listed:
  • Dirk Hackbarth

    (Questrom School of Business, Boston University, Boston, Massachusetts 02215; Centre for Economic and Policy Research (CEPR), London EC1V 0DX, United Kingdom; European Corporate Governance Institute (ECGI), 1000 Brussels, Belgium)

  • Alejandro Rivera

    (Naveen Jindal School of Management, University of Texas at Dallas, Richardson, Texas 75083)

  • Tak-Yuen Wong

    (Department of Quantitative Finance, National Tsing Hua University, Hsinchu 300044, Taiwan)

Abstract

This paper develops a dynamic contracting (multitasking) model of a levered firm. In particular, the manager selects long-term and short-term efforts, and shareholders choose optimal debt and default policies. Excessive short-termism ex post is optimal for shareholders because debt has an asymmetric effect: shareholders receive all gains from short-term effort but share gains from long-term effort. We find that grim growth prospects and shareholder impatience imply higher optimal levels of short-termism. Also, an incentive cost effect and a real option effect create nontrivial patterns for the endogenous default threshold. Finally, we quantify agency costs of excessive short-termism, which underscore the economic significance of our results.

Suggested Citation

  • Dirk Hackbarth & Alejandro Rivera & Tak-Yuen Wong, 2022. "Optimal Short-Termism," Management Science, INFORMS, vol. 68(9), pages 6477-6505, September.
  • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:9:p:6477-6505
    DOI: 10.1287/mnsc.2021.4139
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1287/mnsc.2021.4139
    Download Restriction: no

    File URL: https://libkey.io/10.1287/mnsc.2021.4139?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Kenneth A. Froot & Andre F. Perold & Jeremy C. Stein, 1992. "Shareholder Trading Practices And Corporate Investment Horizons," Journal of Applied Corporate Finance, Morgan Stanley, vol. 5(2), pages 42-58, June.
    2. Stein, Jeremy C, 1988. "Takeover Threats and Managerial Myopia," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 61-80, February.
    3. Dirk Hackbarth & David C. Mauer, 2012. "Optimal Priority Structure, Capital Structure, and Investment," The Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 747-796.
    4. Mariassunta Giannetti & Xiaoyun Yu, 2021. "Adapting to Radical Change: The Benefits of Short-Horizon Investors," Management Science, INFORMS, vol. 67(7), pages 4032-4055, July.
    5. Douglas W. Diamond & Zhiguo He, 2014. "A Theory of Debt Maturity: The Long and Short of Debt Overhang," Journal of Finance, American Finance Association, vol. 69(2), pages 719-762, April.
    6. Bruno Biais & Thomas Mariotti & Jean-Charles Rochet & StÈphane Villeneuve, 2010. "Large Risks, Limited Liability, and Dynamic Moral Hazard," Econometrica, Econometric Society, vol. 78(1), pages 73-118, January.
    7. Peter M. Demarzo & Michael J. Fishman & Zhiguo He & Neng Wang, 2012. "Dynamic Agency and the q Theory of Investment," Journal of Finance, American Finance Association, vol. 67(6), pages 2295-2340, December.
    8. Alex Edmans & Xavier Gabaix & Tomasz Sadzik & Yuliy Sannikov, 2012. "Dynamic CEO Compensation," Journal of Finance, American Finance Association, vol. 67(5), pages 1603-1647, October.
    9. Bruno Biais & Thomas Mariotti & Guillaume Plantin & Jean-Charles Rochet, 2007. "Dynamic Security Design: Convergence to Continuous Time and Asset Pricing Implications," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 74(2), pages 345-390.
    10. Hackbarth, Dirk & Miao, Jianjun & Morellec, Erwan, 2006. "Capital structure, credit risk, and macroeconomic conditions," Journal of Financial Economics, Elsevier, vol. 82(3), pages 519-550, December.
    11. Goldstein, Robert & Ju, Nengjiu & Leland, Hayne, 2001. "An EBIT-Based Model of Dynamic Capital Structure," The Journal of Business, University of Chicago Press, vol. 74(4), pages 483-512, October.
    12. Jianjun Miao & Alejandro Rivera, 2016. "Robust Contracts in Continuous Time," Econometrica, Econometric Society, vol. 84, pages 1405-1440, July.
    13. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    14. Erik P. Gilje, 2016. "Do Firms Engage in Risk-Shifting? Empirical Evidence," The Review of Financial Studies, Society for Financial Studies, vol. 29(11), pages 2925-2954.
    15. Richard T Thakor, 2021. "Short-termism, Managerial Talent, and Firm Value [Seeking alpha: Excess risk taking and competition for managerial talent]," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 10(3), pages 473-512.
    16. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous‐Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
    17. Patrick Bolton & José Scheinkman & Wei Xiong, 2006. "Executive Compensation and Short-Termist Behaviour in Speculative Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(3), pages 577-610.
    18. Graham, John R. & Harvey, Campbell R. & Rajgopal, Shiva, 2005. "The economic implications of corporate financial reporting," Journal of Accounting and Economics, Elsevier, vol. 40(1-3), pages 3-73, December.
    19. Gustavo Manso, 2008. "Investment Reversibility and Agency Cost of Debt," Econometrica, Econometric Society, vol. 76(2), pages 437-442, March.
    20. Alexander S. Gorbenko, 2010. "Temporary versus Permanent Shocks: Explaining Corporate Financial Policies," The Review of Financial Studies, Society for Financial Studies, vol. 23(7), pages 2591-2647, July.
    21. Sebastian Gryglewicz & Barney Hartman-Glaser, 2020. "Investment Timing and Incentive Costs," The Review of Financial Studies, Society for Financial Studies, vol. 33(1), pages 309-357.
    22. Strebulaev, Ilya A. & Whited, Toni M., 2012. "Dynamic Models and Structural Estimation in Corporate Finance," Foundations and Trends(R) in Finance, now publishers, vol. 6(1–2), pages 1-163, November.
    23. Chaigneau, Pierre & Edmans, Alex & Gottlieb, Daniel, 2018. "Does improved information improve incentives?," Journal of Financial Economics, Elsevier, vol. 130(2), pages 291-307.
    24. Szydlowski, Martin, 2019. "Incentives, project choice, and dynamic multitasking," Theoretical Economics, Econometric Society, vol. 14(3), July.
    25. Tak-Yuen Wong, 2019. "Dynamic Agency and Endogenous Risk-Taking," Management Science, INFORMS, vol. 65(9), pages 4032-4048, September.
    26. Rangarajan K. Sundaram & David L. Yermack, 2007. "Pay Me Later: Inside Debt and Its Role in Managerial Compensation," Journal of Finance, American Finance Association, vol. 62(4), pages 1551-1588, August.
    27. Décamps, Jean Paul & Morellec, Erwan & Villeneuve, Stéphane & Gryglewicz, Sebastian, 2015. "Corporate policies with permanent and temporary shocks," CEPR Discussion Papers 10420, C.E.P.R. Discussion Papers.
    28. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    29. Narayana Kocherlakota, 2004. "Figuring out the Impact of Hidden Savings on Optimal Unemployment Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 541-554, July.
    30. Jeremy C. Stein, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(4), pages 655-669.
    31. Assaf Eisdorfer, 2008. "Empirical Evidence of Risk Shifting in Financially Distressed Firms," Journal of Finance, American Finance Association, vol. 63(2), pages 609-637, April.
    32. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
    33. Antonio E. Bernardo, 2004. "Capital Budgeting in Multidivision Firms: Information, Agency, and Incentives," The Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 739-767.
    34. Morellec, Erwan & Gryglewicz, Sebastian & Mayer, Simon, 2018. "Agency Conflicts over the Short and Long Run: Short-termism, Long-termism, and Pay-for-Luck," CEPR Discussion Papers 12720, C.E.P.R. Discussion Papers.
    35. Mello, Antonio S & Parsons, John E, 1992. "Measuring the Agency Cost of Debt," Journal of Finance, American Finance Association, vol. 47(5), pages 1887-1904, December.
    36. DeMarzo, Peter M. & Livdan, Dmitry & Tchistyi, Alexei, 2014. "Risking Other People's Money: Gambling, Limited Liability, and Optimal Incentives," Research Papers 3149, Stanford University, Graduate School of Business.
    37. Strulovici, Bruno & Szydlowski, Martin, 2015. "On the smoothness of value functions and the existence of optimal strategies in diffusion models," Journal of Economic Theory, Elsevier, vol. 159(PB), pages 1016-1055.
    38. Ilya A. Strebulaev, 2007. "Do Tests of Capital Structure Theory Mean What They Say?," Journal of Finance, American Finance Association, vol. 62(4), pages 1747-1787, August.
    39. Emmanuelle Auriol & Guido Friebel & Lambros Pechlivanos, 2002. "Career Concerns in Teams," Journal of Labor Economics, University of Chicago Press, vol. 20(2), pages 289-307, Part.
    40. He, Zhiguo, 2011. "A model of dynamic compensation and capital structure," Journal of Financial Economics, Elsevier, vol. 100(2), pages 351-366, May.
    41. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    42. Mikkelson, Wayne H. & Partch, M. Megan, 1986. "Valuation effects of security offerings and the issuance process," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 31-60.
    43. Young Ho Eom, 2004. "Structural Models of Corporate Bond Pricing: An Empirical Analysis," The Review of Financial Studies, Society for Financial Studies, vol. 17(2), pages 499-544.
    44. John Asker & Joan Farre-Mensa & Alexander Ljungqvist, 2015. "Corporate Investment and Stock Market Listing: A Puzzle?," The Review of Financial Studies, Society for Financial Studies, vol. 28(2), pages 342-390.
    45. Shleifer, Andrei & Vishny, Robert W, 1990. "Equilibrium Short Horizons of Investors and Firms," American Economic Review, American Economic Association, vol. 80(2), pages 148-153, May.
    46. Jesse Edgerton & Naomi E. Feldman & Laura Kawano & Elena Patel & Nirupama Rao & Michael Stevens, 2018. "The Long and Short of It : Do Public and Private Firms Invest Differently?," Finance and Economics Discussion Series 2018-068, Board of Governors of the Federal Reserve System (U.S.).
    47. Sebastian Gryglewicz & Loriano Mancini & Erwan Morellec & Enrique J. Schroth & Philip Valta, 2018. "Transitory versus Permanent Shocks: Explaining Corporate Savings and Investment," Swiss Finance Institute Research Paper Series 18-21, Swiss Finance Institute.
    48. Jean-Paul Decamps & Sebastian Gryglewicz & Erwan Morellec & Stephane Villeneuve, 2016. "Corporate Policies with Permanent and Transitory Shocks," Swiss Finance Institute Research Paper Series 16-18, Swiss Finance Institute.
    49. Jean‐Paul Décamps & Thomas Mariotti & Jean‐Charles Rochet & Stéphane Villeneuve, 2011. "Free Cash Flow, Issuance Costs, and Stock Prices," Journal of Finance, American Finance Association, vol. 66(5), pages 1501-1544, October.
    50. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(3), pages 957-984.
    51. Morellec, Erwan, 2001. "Asset liquidity, capital structure, and secured debt," Journal of Financial Economics, Elsevier, vol. 61(2), pages 173-206, August.
    52. Rivera, Alejandro, 2020. "Dynamic Moral Hazard and Risk-Shifting Incentives in a Leveraged Firm," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 55(4), pages 1333-1367, June.
    53. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Małgorzata Janicka & Aleksandra Pieloch-Babiarz & Artur Sajnóg, 2020. "Does Short-Termism Influence the Market Value of Companies? Evidence from EU Countries," JRFM, MDPI, vol. 13(11), pages 1-22, November.
    2. Hoffmann, Florian & Pfeil, Sebastian, 2021. "Dynamic multitasking and managerial investment incentives," Journal of Financial Economics, Elsevier, vol. 142(2), pages 954-974.
    3. Alain Bensoussan & Benoit Chevalier-Roignant & Alejandro Rivera, 2021. "Does Performance-Sensitive Debt mitigate Debt Overhang?," Post-Print hal-03364891, HAL.
    4. Bedendo, Mascia & Garcia-Appendini, Emilia & Siming, Linus, 2023. "Managers' cultural origin and corporate response to an economic shock," Journal of Corporate Finance, Elsevier, vol. 80(C).
    5. Morellec, Erwan & Gryglewicz, Sebastian & Mayer, Simon, 2018. "Agency Conflicts over the Short and Long Run: Short-termism, Long-termism, and Pay-for-Luck," CEPR Discussion Papers 12720, C.E.P.R. Discussion Papers.
    6. Gryglewicz, Sebastian & Mayer, Simon & Morellec, Erwan, 2020. "Agency conflicts and short- versus long-termism in corporate policies," Journal of Financial Economics, Elsevier, vol. 136(3), pages 718-742.
    7. Bensoussan, Alain & Chevalier-Roignant, Benoît & Rivera, Alejandro, 2021. "Does performance-sensitive debt mitigate debt overhang?," Journal of Economic Dynamics and Control, Elsevier, vol. 131(C).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Morellec, Erwan & Gryglewicz, Sebastian & Mayer, Simon, 2018. "Agency Conflicts over the Short and Long Run: Short-termism, Long-termism, and Pay-for-Luck," CEPR Discussion Papers 12720, C.E.P.R. Discussion Papers.
    2. Gryglewicz, Sebastian & Mayer, Simon & Morellec, Erwan, 2020. "Agency conflicts and short- versus long-termism in corporate policies," Journal of Financial Economics, Elsevier, vol. 136(3), pages 718-742.
    3. Feng, Felix Zhiyu & Westerfield, Mark M., 2021. "Dynamic resource allocation with hidden volatility," Journal of Financial Economics, Elsevier, vol. 140(2), pages 560-581.
    4. Décamps, Jean-Paul & Gryglewicz, S. & Morellec, E. & Villeneuve, Stéphane, 2015. "Corporate Policies with Temporary and Permanent Shocks," TSE Working Papers 15-552, Toulouse School of Economics (TSE), revised 15 Jun 2016.
    5. Décamps, Jean Paul & Morellec, Erwan & Villeneuve, Stéphane & Gryglewicz, Sebastian, 2015. "Corporate policies with permanent and temporary shocks," CEPR Discussion Papers 10420, C.E.P.R. Discussion Papers.
    6. Bolton, Patrick & Li, Ye & Wang, Neng & Yang, Jinqiang, 2020. "Dynamic Banking and the Value of Deposits," Working Paper Series 2020-13, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    7. Bolton, Patrick & Wang, Neng & Yang, Jinqiang, 2019. "Investment under uncertainty with financial constraints," Journal of Economic Theory, Elsevier, vol. 184(C).
    8. Hugonnier, Julien & Malamud, Semyon & Morellec, Erwan, 2015. "Credit market frictions and capital structure dynamics," Journal of Economic Theory, Elsevier, vol. 157(C), pages 1130-1158.
    9. Alex Edmans & Xavier Gabaix, 2016. "Executive Compensation: A Modern Primer," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1232-1287, December.
    10. Driss, Hamdi & Drobetz, Wolfgang & El Ghoul, Sadok & Guedhami, Omrane, 2021. "Institutional investment horizons, corporate governance, and credit ratings: International evidence," Journal of Corporate Finance, Elsevier, vol. 67(C).
    11. Niu, Huawei & Hua, Wei, 2019. "An endogenous structural credit risk model incorporating with moral hazard and rollover risk," Economic Modelling, Elsevier, vol. 78(C), pages 47-59.
    12. Rampini, Adriano A. & Viswanathan, S., 2013. "Collateral and capital structure," Journal of Financial Economics, Elsevier, vol. 109(2), pages 466-492.
    13. Mu, Congming & Wang, Anxing & Yang, Jinqiang, 2017. "Optimal capital structure with moral hazard," International Review of Economics & Finance, Elsevier, vol. 48(C), pages 326-338.
    14. Jianjun Miao & Alejandro Rivera, 2016. "Robust Contracts in Continuous Time," Econometrica, Econometric Society, vol. 84, pages 1405-1440, July.
    15. Ramona Westermann, 2018. "Measuring Agency Costs over the Business Cycle," Management Science, INFORMS, vol. 64(12), pages 5748-5768, December.
    16. Cetemen, Doruk & Feng, Felix Zhiyu & Urgun, Can, 2023. "Renegotiation and dynamic inconsistency: Contracting with non-exponential discounting," Journal of Economic Theory, Elsevier, vol. 208(C).
    17. Lambrecht, Bart M., 2017. "Real options in finance," Journal of Banking & Finance, Elsevier, vol. 81(C), pages 166-171.
    18. Tak-Yuen Wong, 2019. "Dynamic Agency and Endogenous Risk-Taking," Management Science, INFORMS, vol. 65(9), pages 4032-4048, September.
    19. Suresh Sundaresan & Neng Wang & Jinqiang Yang, 2015. "Dynamic Investment, Capital Structure, and Debt Overhang," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 4(1), pages 1-42.
    20. Felix Feng, 2018. "Dynamic Compensation under Uncertainty Shocks and Limited Commitment," 2018 Meeting Papers 159, Society for Economic Dynamics.

    More about this item

    Keywords

    capital structure; contracting; multitasking;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:68:y:2022:i:9:p:6477-6505. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Asher (email available below). General contact details of provider: https://edirc.repec.org/data/inforea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.