Are managers too myopic, relative to what shareholders would want? In a forthcoming RCFS paper, “Short-termism, Managerial Talent, and Firm Value,” Richard Thakor provides a theoretical model in which the answer is “no,” with a surprising twist: In the model, managers prefer long-term projects, because it allows talented managers to earn higher rents. However, to reduce managerial rents, the firm may induce a manager to invest in a short-term project, even though the long-term project has a higher NPV. In equilibrium, therefore, the firm may have a short-term orientation despite rather than because of the manager’s preferences. An interesting empirical implication is that short-termism will be observed in well-governed firms. The paper also considers competition for managers. Here, the results depend crucially on whether managerial skill is observable to the market. When skill is unobserved, one way for talented managers to reveal their type is by succeeding in a short-term project. Thus, in the initial period, firms that incentivize short-term projects attract talented managers. These tend to be small- and medium-sized firms. Once talent has been revealed, the best managers are hired away by large firms, which also invest in long-term projects.
Spotlight by Uday Rajan
Photo courtesy of Richard Thakor