Short-Termist CEO Compensation in Speculative Markets: A Controlled Experiment

Abstract

Bolton, Scheinkman, and Xiong (2006) model a setting where investors disagree and short-sales constraints cause pessimistic views of stock prices to be less influential, which leads to speculative stock prices. A theoretical implication of the model is that existing shareholders can exploit the speculative stock prices by (i) designing managerial compensation contracts that encourage short-term performance, and (ii) subsequently selling their shares to more optimistic investors. We document empirical support for this theory by finding that an exogenous removal (Regulation SHO) of short-sales constraints curbs the provision of short-term incentives, an effect reflected in longer CEO compensation duration. The effect is concentrated among stocks with high investor disagreement and short-term-oriented institutional ownership. Consistent with prior work, we also find that longer CEO compensation duration leads to longer CEO investment horizons, less overinvestment, and less earnings management. Collectively, our results speak to the contributing role of speculative stock prices in corporate short-termism. Finally, our study implies that effective policies to curb corporate short-termism should address stock market speculation and promote mechanisms that tie executive compensation to longer-term stock price performance.