Agency Conflicts and Short- vs Long-Termism in Corporate Policies

We develop a dynamic agency model in which the agent controls both current earnings via short-term effort and firm growth via long-term effort. Under the optimal contract, agency conflicts can induce both over- and underinvestment in short- and long-term efforts, leading to short- or long-termism in corporate policies. The paper shows how firm characteristics shape the optimal contract and the horizon of corporate policies, thereby generating a number of novel empirical predictions on the optimality of short- vs. long-termism. It also demonstrates that combining short- and long-term agency conflicts naturally leads to asymmetric pay-for-performance in managerial contracts, rationalizing the asymmetric benchmarking observed in the data.