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Optimal Short-Termism

Author

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  • 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
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    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).

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    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

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