European Corporate Governance Institute (ECGI) - Finance Working Paper No. 546/2018
58 Pages Posted: 30 Oct 2017 Last revised: 22 Jun 2021
There are 2 versions of this paper
Date Written: June 10, 2021
This paper develops a dynamic contracting (multi-tasking) 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 non-trivial patterns for the endogenous default threshold. Finally, we quantify agency costs of excessive short-termism, which underscore the economic significance of our results.
Keywords: Capital Structure, Contracting, Multi-Tasking
JEL Classification: D86, G13, G32, G33, J33
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