When Myopic Managers Must Mark Down to Market

Abstract

We use the subprime crisis as a laboratory to test whether managerial focus on near-term earnings (or "myopia") is a mechanism by which strict fair value-based impairment rules induce banks to sell undervalued securities into negative liquidity shocks. While prior research finds some evidence liquidity feedback trading can result from strict impairment rules, the mechanism behind this relation has not been empirically established. We present new evidence that myopia is a mechanism, consistent with a prominent yet little tested theory in the accounting literature. We find that the longer the time CEOs must wait to cash out stock and options holdings (CEO equity duration, our measure of myopia), the less their banks tend to sell mortgage-backed securities into negative liquidity shocks during the part of the crisis under the stricter impairment regime. Longer durations are also associated with larger impairments following price-reducing liquidity shocks. Finally, stock prices of banks with short CEO equity durations react more positively to news of impairment rule relaxation. We infer managerial myopia is a mechanism by which strict, fair-value-based impairment rules induce banks to sell into negative liquidity shocks.

Keywords: Financial Crisis, Securities Accounting, Other-Than-Temporary Impairments, CEO Incentives, CEO Pay Duration, Capital Regulation

JEL Classification: G21, G28, G34, G38, M41, M43, M44