Working Paper Series
Short-Termism of Executive
Compensation
Jonathan Pogach
Federal Deposit Insurance Corporation
Current Version: December 2015
FDIC CFR WP 2016-01
fdic.gov/cfr
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do
not necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications
to this paper (other than acknowledgment) should be cleared with the author(s) to protect the tentative
character of these papers.
Short-Termism of Executive
Compensation
Jonathan Pogach
Federal Deposit Insurance Corporation
Current Version: December 2015
FDIC CFR WP 2016-01
fdic.gov/cfr
NOTE: Staff working papers are preliminary materials circulated to stimulate discussion and critical
comment. The analysis, conclusions, and opinions set forth here are those of the author(s) alone and do
not necessarily reflect the views of the Federal Deposit Insurance Corporation. References in publications
to this paper (other than acknowledgment) should be cleared with the author(s) to protect the tentative
character of these papers.
Short-Termism of Executive Compensation ∗†
Jonathan Pogach‡
December 23, 2015
Abstract
This paper presents an optimal contracting theory of short-term firm behavior.
Contracts inducing short-sighted managerial behavior arise as shareholders’ response
to conflicting intergenerational managerial incentives. High-return projects may last
longer than the tenure of managers who implement them. Consequently, inducing man-
agers to act in the long-term interests of the firms requires the alignment of incentives
across multiple managers. Such action comes at greater costs than providing incentives
for a single manager and, as a result, leads to contracts that favor short-term behavior.
Long-term firm value maximization is further impeded when only the quality of ac-
cepted projects–but not those of declined projects–is public. In that case, shareholders
find it costly to induce long-term project selection among managers who can earn all
information rents from short-term projects but must sacrifice information rents from
long-term projects to future managers.
Keywords and phrases Executive Compensation, Short-Termism
∗This document is a draft. Please do not cite or distribute.
†Contact: jpogach@fdic.gov. The author thanks Indraneel Chakraborty, Antonio Falato, Levent G ̈untay,
Troy Kravitz, Paul Kupiec, Haluk ̈Unal, and Jun Yang for their valuable comments and suggestions. Any
remaining errors are solely the author’s.
‡Federal Deposit Insurance Corporation; the views and opinions expressed here are those of the authors
and do not necessarily reflect the views of the FDIC.
1
Jonathan Pogach‡
December 23, 2015
Abstract
This paper presents an optimal contracting theory of short-term firm behavior.
Contracts inducing short-sighted managerial behavior arise as shareholders’ response
to conflicting intergenerational managerial incentives. High-return projects may last
longer than the tenure of managers who implement them. Consequently, inducing man-
agers to act in the long-term interests of the firms requires the alignment of incentives
across multiple managers. Such action comes at greater costs than providing incentives
for a single manager and, as a result, leads to contracts that favor short-term behavior.
Long-term firm value maximization is further impeded when only the quality of ac-
cepted projects–but not those of declined projects–is public. In that case, shareholders
find it costly to induce long-term project selection among managers who can earn all
information rents from short-term projects but must sacrifice information rents from
long-term projects to future managers.
Keywords and phrases Executive Compensation, Short-Termism
∗This document is a draft. Please do not cite or distribute.
†Contact: jpogach@fdic.gov. The author thanks Indraneel Chakraborty, Antonio Falato, Levent G ̈untay,
Troy Kravitz, Paul Kupiec, Haluk ̈Unal, and Jun Yang for their valuable comments and suggestions. Any
remaining errors are solely the author’s.
‡Federal Deposit Insurance Corporation; the views and opinions expressed here are those of the authors
and do not necessarily reflect the views of the FDIC.
1