Investor horizon and managerial short-termism

Abstract

This paper shows that long-term shareholders embed horizon incentives in executive compensation contracts as a mechanism to promote long-term oriented managerial behavior. Increase in long-term institutional ownership leads to longer equity vesting periods measured by CEO pay duration. Further, CEO pay duration decreases following hedge-fund activism that is often argued to be associated with short-term investment horizon. To establish causality, we use institutional mergers as an exogenous change in institutional investor horizon, and to address reverse causality, we use the indexing behavior of institutions. We support our findings by providing evidence that long-term institutional ownership is associated with long-term oriented shareholder proposals. Overall, CEO pay duration is a potential mechanism for institutional investors to align managerial horizon with their investment horizon, and ultimately to influence corporate behavior.