Optimal Short-Termism

Optimal Short-Termism

Dirk Hackbarth, Alejandro Rivera, Tak-Yuen Wong

Series number :

Serial Number: 
546/2018

Date posted :

January 22 2018

Last revised :

January 22 2018
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Keywords

  • capital structure • 
  • contracting • 
  • Multi-tasking

This paper studies incentives in a dynamic contracting framework of a levered firm. In particular, the manager selects long-term and short-term efforts, while shareholders choose initially optimal leverage and ex-post optimal default policies. There are three results.

First, shareholders trade off the benefits of short-termism (current cash flows) against the benefits of higher growth from long-term effort (future cash flows), but because shareholders only split the latter with bondholders, they find short-termism ex-post optimal. Second, bright (grim) growth prospects imply lower (higher) optimal levels of short-termism. Third, the endogenous default threshold rises with the substitutability of tasks and, for a positive correlation of shocks, the endogenous default threshold is hump-shaped in the volatility of permanent shocks, but increases monotonically with the volatility of transitory shocks. Finally, we quantify agency costs of short-term and long-term effort, cost of short-termism, effects of investor time horizons, credit spreads, and risk-shifting.

Authors

Real name:
Alejandro Rivera
Real name:
Tak-Yuen Wong