A Theory of Efficient Short-Termism
63 Pages Posted: 12 Aug 2016
Date Written: August 2016
This paper develops a theory in which the owners of firms pursue short-termism in project choice to limit managerial rent-seeking behavior. Unlike in previous theories, a short-term bias in investment horizons maximizes firm value in the second-best case, whereas managers themselves prefer long-horizon projects. Short-termism benefits the firm in two ways: it limits managerial rent extraction by preventing investments in bad projects that delay information revelation about project quality and managerial ability, and it enables faster learning about managerial ability which allows more efficient subsequent decisions. This result does not depend on any stock mispricing or managerial desire to manipulate stock prices. The likelihood of short-termism is higher when corporate governance is stronger, and at lower levels of the corporate hierarchy. Numerous testable predictions of the analysis are discussed.
Keywords: Short-termism, Internal Governance, Payback, Capital Budgeting, Project Choice
JEL Classification: C72, D82, G31, G32, J31
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