Long Term Bias, Incentives, and Agency Costs

Abstract

The problem of managerial short-termism has long preoccupied policymakers, researchers, and practitioners. These groups have given much less attention, however, to the converse problem of managerial long-termism. Michal Barzuza and Eric Talley fill this gap in their pioneering article, Long-Term Bias. Relying on the behavioral finance and psychology literatures, the authors provide a novel and thought-provoking analysis of managerial long-term bias, which may be just as detrimental as the more widely condemned short-term bias. This invited Comment to Barzuza and Talley’s article advances three claims. First, it argues that proper incentives—created by executive compensation, heightened risk of early termination, market responses and shareholder pressures—are likely to turn most managers more realistic and thus to mitigate their long-term biases. Second, it explains how, in reality, it could be almost impossible to distinguish between long-term bias and traditional agency theories of empire building and pet projects. Ultimately, both long-termist and self-interested managers systematically harm shareholders; both choose to ignore shareholder interests and waste free cash flow on inferior business investments. This also explains why the cure to both long-term bias and agency costs is similar: reducing the relative insulation of the board from shareholders’ disciplinary power. Finally, this Comment expresses strong support for most of Barzuza and Talley’s normative conclusions, with one important exception: their acceptance of the use of dual-class stock. With a perpetual lock on control and a limited equity stake, corporate leaders will be immune to any “institutional brake” on all forms of long-termist overinvestment. If anything, the analysis of Barzuza and Talley provides an additional strong justification to oppose the use of perpetual dual-class stock.