Long-Term Bias

An emerging consensus in certain legal, business, and scholarly communities maintains that corporate managers are pressured unduly into chasing short-term gains at the expense of superior long-term prospects. The forces inducing manage- rial myopia are easy to spot, typically embodied by activist hedge funds and Wall Street gadflies with outsized appetites for current quarterly earnings. Warnings about the dangers of “short termism” have become so well established, in fact, that they are now driving changes to mainstream practice as courts, regulators and practitioners fashion legal and transactional constraints designed to insulate firms and managers from the influence of investor short-termism. This Article draws on ac- ademic research and a series of case studies to advance the the- sis that the emergent folk wisdom about short-termism is in- complete. A growing literature in behavioral finance and psychology now provides sound reasons to conclude that corpo- rate managers often fall prey to long-term bias—excessive op- timism about their own long-term projects. We illustrate sev- eral plausible instantiations of such biases using case studies from three prominent companies where managers have argua- bly succumbed to a form of “long-termism” in their own corpo- rate stewardship. Unchecked, long-termism can impose sub- stantial costs on investors that are every bit as damaging as short-termism. Moreover, we argue that long-term managerial bias sheds considerable light on the paradox of why short- termism evidently persists among supposedly sophisticated fi- nancial market participants: shareholder activism—even if unambiguously myopic—can provide a symbiotic counter-bal- last against managerial long-termism. Without a more defini- tive understanding of the interaction between short- and long- term biases, then, policymakers should be cautious about em- bracing reforms that focus solely on half of the problem.

Do Peer Warnings Affect CEO Compensation?

SYNOPSIS In this study, focusing on the period 1996–2010, we conduct an empirical investigation of how warnings by industry peer firms about future earnings affect CEO compensation structure. These warnings contain information about the industry, signaling dim industry prospects and possibly triggering negative spillovers on stock prices. We predict that firms respond to industry-wide negative information by changing the compensation mix to make it more future oriented and by reducing pay-performance sensitivity to shield CEOs from negative factors beyond their control. We find that (1) for firms that issue warnings, peer warnings are associated with a reduction in pay-performance sensitivity; and (2) for firms that do not issue warnings, peer warnings are associated with a modification in compensation mix, such that it becomes more equity based and future oriented, similar to the adjustment made to CEO compensation in the wake of self-warnings. Our results are robust to different definitions of warnings and to the exclusion of annual earnings warnings. However, the results do not hold after 2005, which may be due to factors such as a decline in the use of option compensation, a decrease in the issuance of warnings outside of the announcement window, and changing patterns in management guidance behavior.