The Short-Termism Trap: Competition for Informed Investors Under Stock-Based CEO Compensation
53 Pages Posted: 2 Nov 2021 Last revised: 14 Jan 2022
Date Written: January 14, 2022
We show that stock-based CEO compensation can create a ``race to the bottom" among firms that escalates short-termist pressure. More informative stock prices reduce the agency cost of using stock-based compensation to incentivize managers. Also, shortening a firm's project maturity improves stock price informativeness by attracting informed investors, who prefer to invest in short-term assets. However, when informed trading capital is a scarce resource, competition for informed investors creates excessive short-termism that destroys shareholder value, while in equilibrium, price informativeness stays the same. More intense competition between firms sharpens incentives to shorten project maturity, deepening the ``short-termism trap.''
Keywords: informed trading, managerial compensation, short-termism, optimal contracting, race to the bottom, strategic complementarities
JEL Classification: G14, G32, G38
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