The Short-Termism Trap: Catering to Informed Investors under Stock-Based CEO Compensation

Department: Finance

Speaker: James Dow (LBS)

Room: T015

Abstract

The combination of stock-based CEO compensation and limited informed trading capital
creates a “race to the bottom” among firms resulting in myopic project choice. More
informative stock prices reduce the agency cost of incentivizing managers. Also, shortening
project maturity improves stock price informativeness by catering to informed investors,
who prefer short-term assets. However, since informed trading capital is a scarce resource,
attracting informed investors cannot increase an individual firm’s price informativeness in
equilibrium: it simply destroys shareholder value. The “short-termism trap” can destroy
large amounts of shareholder value, potentially up to 100% of the benefits of stock market
listing.