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Short-Termism as Optimal Investment Policy

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  • Brusco, Sandro

Abstract

Models of managerial short-termism rely on a number of assumption, such as limited availability of capital, fixed compensation schemes and an additive impact of managerial ability on revenue. We discuss the role of these assumption in generating short-termism. We show that when managerial ability has a multiplicative impact on revenue then the first best investment policy may require the implementation of short-term projects with negative NPV in order to generate information on managerial ability that can be exploited in later periods. We also show that, when the firm is free to design the compensation scheme, the first best is attained even if only short-term contracts are allowed. Short-termism is therefore the result of an optimal experimentation policy rather than the consequence of managerial misbehavior.

Suggested Citation

  • Brusco, Sandro, 1999. "Short-Termism as Optimal Investment Policy," CEPR Discussion Papers 2103, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2103
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    References listed on IDEAS

    as
    1. Stein, Jeremy C, 1988. "Takeover Threats and Managerial Myopia," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 61-80, February.
    2. Narayanan, M P, 1985. "Managerial Incentives for Short-term Results," Journal of Finance, American Finance Association, vol. 40(5), pages 1469-1484, December.
    3. Narayanan, M. P., 1996. "Form of Compensation and Managerial Decision Horizon," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(4), pages 467-491, December.
    4. Bengt Holmstrom & Joan Ricart i Costa, 1986. "Managerial Incentives and Capital Management," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 835-860.
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    More about this item

    Keywords

    investment policy; managerial compensation;

    JEL classification:

    • G3 - Financial Economics - - Corporate Finance and Governance

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