Working Paper: CEPR ID: DP2103
Authors: Sandro Brusco
Abstract: Models of managerial short-termism rely on a number of assumption, such as limited availability of capital, fixed compensation schemes and an additive impact of managerial ability on revenue. We discuss the role of these assumption in generating short-termism.We show that when managerial ability has a multiplicative impact on revenue then the first best investment policy may require the implementation of short-term projects with negative NPV in order to generate information on managerial ability that can be exploited in later periods. We also show that, when the firm is free to design the compensation scheme, the first best is attained even if only short-term contracts are allowed. Short-termism is therefore the result of an optimal experimentation policy rather than the consequence of managerial misbehavior.
Keywords: managerial compensation; investment policy
JEL Codes: G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| managerial ability + project size (L25) | optimal experimentation policy (C90) |
| short-term projects with negative NPV (G31) | generate timely information about managerial ability (M51) |
| generate timely information about managerial ability (M51) | leverage in future investment decisions (G11) |
| short-term projects (O22) | perceived short-termism (D25) |
| managerial short-termism (D25) | perceived short-termism (D25) |
| optimal investment decisions (G11) | enhance firm value (G32) |