Do Short-Term Managerial Objectives Lead to Under- or Over-Investment in Long-Term Projects
Lucian A. Bebchuk
Harvard Law School; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR) and European Corporate Governance Institute (ECGI)
University of Chicago - Booth School of Business
NBER Working Paper No. t0098
This paper studies managerial decisions about investment in long-run projects in the presence of imperfect information (the market knows less about such investments than the firm's managers) and short-term managerial objectives (the managers are concerned about the short-term stock price as well as the long-term stock price). Prior work has suggested that imperfect information and short-term managerial objectives induce managers to underinvest in long-run projects. We show that either underinvestment or overinvestment is possible, and we identify the connection between the type of informational imperfection present and the direction of the distortion. When investors cannot observe the level of investment in long-run projects, suboptimal investment will be induced. When investors can observe investment but not its productivity, however, an excessive level of investment will be induced.
Number of Pages in PDF File: 17
Date posted: January 5, 2007