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Robust contracting and corporate-termism

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  • Zhao, Siqi

Abstract

We build a robust contract model in which the principal is ambiguity averse regarding the distribution of transitory and permanent shocks. Short-term and long-term investments are at the discretion of the agent. We find that ambiguous transitory shocks generate pessimism concerning earnings in the short run, while ambiguous permanent shocks can lead to optimism about the long-run growth rate. Since short-run pessimism mitigates agency costs, the short-term investment rises beyond the first-best level, leading to short-termism. In contrast, long-run optimism exacerbates the cost of incentive provision and reduces the long-run investment below the first-best level. Finally, in a robust contract, a negative correlation between transitory and permanent shocks can both amplify and mitigate corporate short-termism.

Suggested Citation

  • Zhao, Siqi, 2022. "Robust contracting and corporate-termism," Economics Letters, Elsevier, vol. 213(C).
    • Handle: RePEc:eee:ecolet:v:213:y:2022:i:c:s0165176522000416
    DOI: 10.1016/j.econlet.2022.110344
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    References listed on IDEAS

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    1. Gryglewicz, Sebastian & Mayer, Simon & Morellec, Erwan, 2020. "Agency conflicts and short- versus long-termism in corporate policies," Journal of Financial Economics, Elsevier, vol. 136(3), pages 718-742.
    2. Jianjun Miao & Alejandro Rivera, 2016. "Robust Contracts in Continuous Time," Econometrica, Econometric Society, vol. 84, pages 1405-1440, July.
    3. Flor, Christian Riis & Hesel, Søren, 2015. "Uncertain dynamics, correlation effects, and robust investment decisions," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 278-298.
    4. Xin Chang & Sudipto Dasgupta & George Wong & Jiaquan Yao, 2014. "Cash-Flow Sensitivities and the Allocation of Internal Cash Flow," The Review of Financial Studies, Society for Financial Studies, vol. 27(12), pages 3628-3657.
    5. Daniel Ellsberg, 1961. "Risk, Ambiguity, and the Savage Axioms," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 75(4), pages 643-669.
    6. Pascal J. Maenhout, 2004. "Robust Portfolio Rules and Asset Pricing," The Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 951-983.
    7. Lars Peter Hansen & Thomas J Sargent, 2014. "A Quartet of Semigroups for Model Specification, Robustness, Prices of Risk, and Model Detection," World Scientific Book Chapters, in: UNCERTAINTY WITHIN ECONOMIC MODELS, chapter 4, pages 83-143, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Shilin Li & Jinqiang Yang & Siqi Zhao, 2022. "Robust leverage dynamics without commitment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 74(2), pages 643-679, September.

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    More about this item

    Keywords

    Contract; Ambiguity; Investment;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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