Robust contracting and corporate-termism

Abstract

We build a robust contract model in which the principal is ambiguity averse regarding the distribution of transitory and permanent shocks. Short-term and long-term investments are at the discretion of the agent. We find that ambiguous transitory shocks generate pessimism concerning earnings in the short run, while ambiguous permanent shocks can lead to optimism about the long-run growth rate. Since short-run pessimism mitigates agency costs, the short-term investment rises beyond the first-best level, leading to short-termism. In contrast, long-run optimism exacerbates the cost of incentive provision and reduces the long-run investment below the first-best level. Finally, in a robust contract, a negative correlation between transitory and permanent shocks can both amplify and mitigate corporate short-termism.