The stock market is widely believed to pressure executives to deliver short-term earnings at the expense of long-term value. This paper develops a model of the interaction between executive compensation and stock market prices, analyzing its implications for corporate short-termism. I show that inefficient short-termism can arise in equilibrium as a self-fulfilling prophecy, due to strategic complementarities between the firm's investment horizon and investors' decision to acquire information about short-term performance or long-term value. However, the severity of the underlying agency problem between the manager and shareholders fully determines whether short-termism is an equilibrium outcome. This implies both that the stock-market cannot be identified as the cause of corporate short-termism and that it actually has the potential to alleviate the problem. The model helps us assess evidence presented in the "myopia" debate and yields novel implications regarding ownership structure, executive compensation, and managerial horizon.
The Economic Theory Lunchtime Workshops are convened by Meg Meyer.