The Short-Termism Trap: Competition for Informed Investors Under Stock-Based CEO Compensation

53 Pages Posted: 2 Nov 2021 Last revised: 14 Jan 2022

See all articles by James Dow

James Dow

London Business School - Institute of Finance and Accounting

Jungsuk Han

Seoul National University - College of Business Administration; Swedish House of Finance

Francesco Sangiorgi

Frankfurt School of Finance & Management

Date Written: January 14, 2022

Abstract

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

Suggested Citation

Dow, James and Han, Jungsuk and Sangiorgi, Francesco, The Short-Termism Trap: Competition for Informed Investors Under Stock-Based CEO Compensation (January 14, 2022). Swedish House of Finance Research Paper No. 21-24, Available at SSRN: https://ssrn.com/abstract=3953799 or http://dx.doi.org/10.2139/ssrn.3953799

James Dow

London Business School - Institute of Finance and Accounting ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
+44 20 7262 5050 (Phone)
+44 20 7724 3317 (Fax)

Jungsuk Han (Contact Author)

Seoul National University - College of Business Administration ( email )

Seoul, 151-742
Korea, Republic of (South Korea)

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Francesco Sangiorgi

Frankfurt School of Finance & Management ( email )

Adickesallee 34
Frankfurt am Main, 60322
Germany

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