When Transparency Meets Short-termism: Optimal Contract with Short-Horizon Shareholders

This project investigates how shareholder investment horizons shape the design of executive compensation contracts and whether transparency in compensation contracts can mitigate or exacerbate the distortion arising from shareholder short-term orientation. While short-termism is often attributed to managerial myopic behavior (e.g.,earnings manipulation or underinvestment in long-term projects), such behavior may be a rational response to the incentives designed by shareholders themselves. When shareholders prioritize short-term gains, they embed their temporal preferences into managerial contracts that encourage CEOs to inflate performance metrics and boost stock prices.To explore the interaction between shareholder investment horizons and contract transparency, we develop a theoretical model in which the incumbent shareholder signsa contract with the CEO to run the business and subsequently sells a fraction of the firm’s shares to outside investors. The model predicts that a moderate investment horizon enhances firm value through disciplined oversight, while an excessive short-term orientation increases risk premiums and reduces efficiency. Furthermore, we predict that contract transparency alters shareholder incentives by exposing contract terms to outside investors, who respond by adjusting their level of scrutiny. Thisdynamic leads to a non-monotonic relation between shareholder investment horizon and pay-performance sensitivity. Contract transparency can enable shareholders to sell larger stakes at favorable prices, thereby amplifying short-term pressures. Yet, it also enhances investor scrutiny, which can curb managerial opportunism. Our project highlights a previously unexplored effect of transparency in corporate governance.The study contributes to the literature on corporate governance by analyzing the optimal incentive contract under shareholder short-term orientation. Shareholders sometimes face a strategic challenge. For instance, while they may be motivated by short-term stock price appreciation—such as during planned equity sales—they still rely on CEOs to maintain firm value beyond the immediate horizon. By endogenizing the contract design in such a strategic tension, this study offers a new framework for understanding how transparency interacts with incentive structures. Empirically, this project generates testable predictions about the relation among shareholder investment horizon, contract transparency, pay-performance sensitivity, and earnings manipulation that can be validated using compensation and litigation data.From a regulatory perspective, the findings challenge the conventional wisdom that transparency is always beneficial. Instead, our research suggests that the effectivenessof transparency depends critically on the level of investor protection and the nature of shareholder investment horizons. The study thus offers nuanced guidance for policymakers considering reforms to executive pay disclosure mandates and enforcement.