DP12588 Optimal Short-Termism
|Author(s):||Dirk Hackbarth, Alejandro Rivera, Tak-Yuen Wong|
|Publication Date:||January 2018|
|Keyword(s):||Capital Structure, Contracting, Multi-tasking|
|JEL(s):||D86, G13, G32, G33, J33|
|Programme Areas:||Financial Economics|
|Link to this Page:||www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12588|
This paper studies incentives in a dynamic contracting framework of a levered firm. In particular, the manager selects long-term and short-term efforts, while shareholders choose initially optimal leverage and ex-post optimal default policies. There are three results. First, shareholders trade off the benefits of short-termism (current cash flows) against the benefits of higher growth from long-term effort (future cash flows), but because shareholders only split the latter with bondholders, they find short-termism ex-post optimal. Second, bright (grim) growth prospects imply lower (higher) optimal levels of short-termism. Third, the endogenous default threshold rises with the substitutability of tasks and, for a positive correlation of shocks, the endogenous default threshold is hump-shaped in the volatility of permanent shocks, but increases monotonically with the volatility of transitory shocks. Finally, we quantify agency costs of short-term and long-term effort, cost of short-termism, effects of investor time horizons, credit spreads, and risk-shifting.