DP12720 Agency Conflicts over the Short and Long Run: Short-termism, Long-termism, and Pay-for-Luck

Author(s): Sebastian Gryglewicz, Simon Mayer, Erwan Morellec
Publication Date: February 2018
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12720

We develop a dynamic agency model in which the agent controls current earnings via short-term effort and firm growth via long-term effort and the firm is subject to both short- and long-run shocks. Under the optimal contract, agency conflicts can induce both over- and underinvestment in short- and long-term efforts compared to first best, leading to short- or long-termism in corporate policies. Exposure to long-run shocks introduces pay-for-luck in incentive compensation but only after sufficiently good performance due to incentive compatibility, thereby rationalizing the asymmetric benchmarking observed in the data. Correlated short- and long-run shocks to earnings and firm size lead to externalities in incentive provision over different time horizons.