Does Longer Duration of Executive Compensation Foster Investment Efficiency?

Abstract

In this paper, I examine whether longer duration of executive compensation influences investment decisions. I exploit a regulation designed to foster long-term orientation in executive compensation as an exogenous trigger to lengthen executives' incentive duration. I find that treated firms reduce their abnormal investment relative to control firms, implying an increase in investment efficiency. These results are robust to different measures of investment, several models of expected investment, and different plausible control groups. The treatment effect is economically significant, as the reduction in abnormal investment amounts to about 10% of mean investment. It appears that a mandated longer duration has the greatest effect on investment efficiency in firms that had a low degree of compensation committee independence before the shock. Further, it seems that the lower abnormal investment stems to a greater extent from reductions in over-investment.

Keywords: Executive compensation, Incentive duration, Investment, Investment efficiency, Regulation

JEL Classification: J33, M12, M48, M52, G31