Optimal Short-Termism
Dirk Hackbarth, Alejandro Rivera, Tak-Yuen Wong
Management Science · 2022 · Volume 68 · Issue 9
Abstract
This paper develops a dynamic contracting (multitasking) model of a levered firm. In particular, the manager selects long-term and short-term efforts, and shareholders choose optimal debt and default policies. Excessive short-termism ex post is optimal for shareholders because debt has an asymmetric effect: shareholders receive all gains from short-term effort but share gains from long-term effort. We find that grim growth prospects and shareholder impatience imply higher optimal levels of short-termism. Also, an incentive cost effect and a real option effect create nontrivial patterns for the endogenous default threshold. Finally, we quantify agency costs of excessive short-termism, which underscore the economic significance of our results. This paper was accepted by Gustavo Manso, finance.
Keywords
capital structure, contracting, multitasking
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