The Inevitable Tension between Long-Term and Short-Term Managerial and Investor Incentives

Abstract

The paper considers a model in which (1) managers allocate effort to both short- and long-term projects, and (2) there is feedback between the managerial incentive contract and the number of speculators collecting information on each type of project. More weight placed on near-term price results in more speculation based on information about the short-term project, which induces further increases in the weight placed on near-term price. This feedback effect can result in short-term speculation crowding out the collection of long-term information, which in turn results in the withdrawal of incentives aimed at inducing effort in more profitable long-term projects. The paper shows that the equilibrium that obtains depends upon adjustment costs and initial conditions and will, in general, not be efficient. Such outcomes are consistent with concerns about managerial and investor short-termism recently expressed by public policy makers and market participants (e.g., the Aspen Institute). The paper considers the efficacy of various corporate and public policy remedies.