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

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: (1) designing managerial compensation contracts that encourage short-term performance, and (2) 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 over-investment, 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