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Optimal Short-Termism

Author

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  • Dirk Hackbarth

    (Questrom School of Business, Boston University, Boston, Massachusetts 02215; Centre for Economic and Policy Research (CEPR), London EC1V 0DX, United Kingdom; European Corporate Governance Institute (ECGI), 1000 Brussels, Belgium)

  • Alejandro Rivera

    (Naveen Jindal School of Management, University of Texas at Dallas, Richardson, Texas 75083)

  • Tak-Yuen Wong

    (Department of Quantitative Finance, National Tsing Hua University, Hsinchu 300044, Taiwan)

Abstract

This paper develops a dynamic contracting (multitasking) model of a levered firm. In particular, the manager selects long-term and short-term efforts, and shareholders choose optimal debt and default policies. Excessive short-termism ex post is optimal for shareholders because debt has an asymmetric effect: shareholders receive all gains from short-term effort but share gains from long-term effort. We find that grim growth prospects and shareholder impatience imply higher optimal levels of short-termism. Also, an incentive cost effect and a real option effect create nontrivial patterns for the endogenous default threshold. Finally, we quantify agency costs of excessive short-termism, which underscore the economic significance of our results.

Suggested Citation

  • Dirk Hackbarth & Alejandro Rivera & Tak-Yuen Wong, 2022. "Optimal Short-Termism," Management Science, INFORMS, vol. 68(9), pages 6477-6505, September.
    • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:9:p:6477-6505
    DOI: 10.1287/mnsc.2021.4139
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    References listed on IDEAS

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