Short-Termist CEO Compensation in Speculative Markets: A Controlled Experiment

Abstract

Bolton, Scheinkman, and Xiong (2006) analyze a setting where investors disagree and short-sale constraints cause pessimistic views of stock prices to be sidelined, which leads to speculative stock prices. A theoretical implication of the model is that existing shareholders can exploit the speculative stock prices by (1) designing managerial compensation contracts that encourage short-term performance and (2) subsequently selling their shares to more optimistic investors. We document empirical support for this theory by finding that an exogenous removal of short-sale constraints curbs the provision of short-term incentives, an effect reflected in longer CEO compensation duration. The effect is concentrated among stocks with high investor disagreement and short-term-oriented institutional ownership. Consistent with prior work, we also find that longer CEO compensation duration leads to longer CEO investment horizons, less over-investment, and less earnings management.

Keywords: CEO Compensation, Speculative Market, Disagreement, Institutional Ownership

JEL Classification: J33, M12, G30