Compensation Duration, Shareholder Governance, and Managerial Short-Termism

Abstract

In this paper, I investigate the interaction between the duration of executive compensation and shareholder governance. I show that short-term compensation can elicit shareholder intervention and thus enhance firm value. The central mechanism is that the use of short-term incentives enables informed incumbent shareholders to commit to using their private information to intervene (voice) instead of selling their shares (exit). Without a commitment to voice, incumbent shareholders might find, ex post, that exit is more appealing than voice if they privately observe that a firm's type is bad. Short-term incentives encourage a good firm to take actions that reveal its type early on, which reduces the information advantage of the incumbent shareholders and their ability to profit from exit. Effectively, short-term compensation serves as a commitment device for value-enhancing intervention.