Optimal Short-Termism

52 Pages Posted: 30 Oct 2017 Last revised: 3 Nov 2018

See all articles by Dirk Hackbarth

Dirk Hackbarth

Boston University - Department of Finance & Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Alejandro Rivera

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Tak-Yuen Wong

Shanghai University of Finance and Economics - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: October 29, 2018

Abstract

This paper studies incentives in a dynamic contracting framework of a levered firm. In particular, the manager selects long-term and short-term efforts, while shareholders choose initially optimal leverage and ex-post optimal default policies. Notably, a resource constraint that binds the agent's effort captures the essence of short-termism: an increase in short-term effort makes long-term effort costlier thereby undermining long-term performance. There are three results. First, shareholders trade off the benefits of short-termism (current cash flows) against the benefits of higher growth from long-term effort (future cash flows), but because shareholders only split the latter with bondholders, excessive short-termism ex-post is optimal for shareholders. Second, bright (grim) growth prospects imply lower (higher) optimal levels of short-termism. Third, the endogenous default threshold rises with the substitutability of tasks and, for a positive correlation of shocks, the endogenous default threshold is hump-shaped in the volatility of permanent shocks, but increases monotonically with the volatility of transitory shocks. Finally, we quantify agency cost of excessive short-termism, which underscores the economic significance of our results.

Keywords: Capital Structure, Contracting, Multi-Tasking

JEL Classification: D86, G13, G32, G33, J33

Suggested Citation

Hackbarth, Dirk and Rivera, Alejandro and Wong, Tak-Yuen, Optimal Short-Termism (October 29, 2018). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 546/2018; Asian Finance Association (AsianFA) 2018 Conference. Available at SSRN: https://ssrn.com/abstract=3060869 or http://dx.doi.org/10.2139/ssrn.3060869

Dirk Hackbarth

Boston University - Department of Finance & Economics ( email )

Department of Finance
595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 358-4206 (Phone)
(617) 353-6667 (Fax)

HOME PAGE: http://people.bu.edu/dhackbar/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Alejandro Rivera (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

HOME PAGE: http://jindal.utdallas.edu/faculty/alejandro-rivera

Tak-Yuen Wong

Shanghai University of Finance and Economics - Department of Finance ( email )

Shanghai, 200433
China

HOME PAGE: http://sites.google.com/site/etywong110/

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