CEO Horizon, Optimal Pay Duration, and the Escalation of Short‐Termism

Abstract

This paper studies optimal contracts when managers manipulate their performance measure at the expense of firm value. Optimal contracts defer compensation. The manager's incentives vest over time at an increasing rate, and compensation becomes very sensitive to short‐term performance. This generates an endogenous horizon problem whereby managers intensify performance manipulation in their final years in office. Contracts are designed to encourage effort while minimizing the adverse effects of manipulation. We characterize the optimal mix of short‐ and long‐term compensation along the manager's tenure, the optimal vesting period of incentive pay, and the dynamics of short‐termism over the CEO's tenure.

Financial Misreporting: Hiding in the Shadows or in Plain Sight?

“…A growing theory literature analyzes the motivations for misreporting. For example, Peng and Roell (2014), Marinovic and Varas (2016), Marinovic and Povel (2017) examine how misreporting relates to the structure of compensation contracts. Guttman and Marinovic (2018) examine how misreporting relates to debt contracts.…”

Distributional differences in the time horizon of executive compensation

“…15 Theory suggests multiple mechanisms to deal with the concerns about shorttermism. An optimal contract with concerns about stock price manipulation after vesting relates current pay to all past performance dates of firm performance, conditions vesting on performance, and not on a fixed date, and can also shift some vesting into retirement (Edmans et al 2012;Marinovic and Varas 2019). Lengthening the vesting period into retirement is costly for the executive near career end, as this exposes the executive to more risk.…”

“…The literature hitherto has identified short-termism as a problem (Narayanan 1985;Bebchuk and Stole 1993;Edmans et al 2019;Marinovic and Varas 2019), but not systematically assessed distributional differences in the time horizon of executive compensation. I find significant distributional heterogeneity of short-term and long-term performance-pay relations.…”

Executive Incentives Matter for Corporate Social Responsibility under Earnings Pressure and Institutional Investors Supervision

“…According to Finkelstein and Hambrick [18], executive incentives provide an effective way to measure the convergence of the interests of executives and shareholders. Specifically, compared with executives with short-incentives, these with long-incentives are more likely to converge with the interests of shareholders and pay more attention to capital investment [19], and are less sensitive to short-term financial performance [20]. Some evidence also supports that executive incentives could affect the CSR strategy.…”

“…Antia et al [25] also show that short-term executive incentives are an essential indicator of investment to chase faster returns. Marinovic and Varas [20] note that executives who are more sensitive to short-term performance are more likely to engage in performance manipulation.…”