Short Termism of Executive Compensation

I present an optimal contracting theory of short term contracts. Short term contracts arise as shareholders’ response to conflicting intergenerational managerial incentives. High return projects may be longer lived than the tenure of managers who implement them. Consequently, long term contracts must align incentives across multiple managers, which comes at greater costs than providing incentives for a single manager. Short term bias is amplified further when shareholders can only observe the returns of accepted projects. Managers choose short term projects and earn all information rents and avoid long term projects, in which these rents accrue to future managers.