A Theory of Efficient Short-Termism

63 Pages Posted: 12 Aug 2016

See all articles by Richard T. Thakor

Richard T. Thakor

University of Minnesota - Carlson School of Management

Date Written: August 2016

Abstract

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

Suggested Citation

Thakor, Richard T., A Theory of Efficient Short-Termism (August 2016). Available at SSRN: https://ssrn.com/abstract=2821162 or http://dx.doi.org/10.2139/ssrn.2821162

Richard T. Thakor (Contact Author)

University of Minnesota - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

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