Over an expansive period of time, different companies have lost their share value in a
wide range of industries (Milano) . This has led to the creation of a business environment that is
motivated by the need to meet short term earning targets. This indicates the existence of a bigger
problem referred as short-termism. Short-termism is defined as “the excessive focus by the
market analysts, corporate managers and investing public on the short term metrics at the
expense of future strategy and long term value creation” (Nikolov 16) . Under short-termism
decisions companies rely on short term incentives rather than long term incentives to make
decisions. For instance, the manager can reward themselves for meeting short term targets and
reject a value creating investment opportunity that would build the long term health of the
company. Short-termism is a significant concern facing the society and companies today. It
demands that managers maximize profits in the short run at the expense of long term
consequences. Thus it can destroy long run wealth generation, impede innovation, accelerate
layoffs and neglect environmental and social concerns.
Despite the wide concern over short-termism most companies do not genuinely invest in
the long run. The reason why short term investments are more prevalent can be understood
through the agency problem. This is because most companies invest under the principal-agent
arrangement especially in companies that involve multilayer of delegations. Long term
investments involve making decisions where the outcome of such decisions may not come soon
and such outcomes are subject to uncertainties. Long term decisions require forming future
expectation in the long run. The inherent challenges with long term decisions include
unpredictability and uncertainty. Regardless of how a manger is skilled at forecasting the future,
there exists the possibility for unforeseen changes along the way. Changes in the industry or
regime changes occur in the market and economic environment which are very difficult to
predict. Furthermore, the outcomes for long term plans are not realized in the near future.
Therefore there is a lack immediate feedback loop. Thus, when the management makes long term
investment decisions, it resides in an ongoing state of affairs on whether they are the right
trajectory (Rappaport and Bogle) . Thus the agency issue is exacerbated by the temporal gap
between the decision and the payoff especially when things do not turn as expected. The
challenge of aligning the principal and the agent is well recognized. For instance, in multilayered
investment companies, the exist a challenge of aligning the principal and the agent along the
entire chain of delegation in terms of risk appetite, investment goals, shared missions, beliefs and
cultures, and risk definitions (Ladika and Sautner) . Therefore ongoing monitoring of agents by
the principal is inevitable and necessary.
Mitigating the Principal-Agent Problem
When the managers act in the interest of the shareholders of a company, they bear the cost of
failing to pursue goal that interest them and only gain a few benefits. Therefore the management
should be provided with incentives to increase their willingness to make decisions that maximize
the value of the shares. Companies around the world are mitigating the principal-agent problem
through various ways which include;
a) Incorporating a large portion of debt in the capital structurer of the company the principal-
agent problems are common in companies that are profitable but have a profit growth that
does not meet their targets. In such companies there is a large amount of free cash flow
which can be utilized at the discretion of the management. The interest of the shareholders is
that free cash flow is either paid as dividends or invested in high return investments. The
senior managers might be willing to invest free cash flow in areas that increases the size of
the company. However, in a slow growing company, the management is more likely to be
willing to invest in investment that would have a negative NPV but would increase the size
of the company. One of the methods used to mitigate this problem is ensuring that the
company has a high proportion of debt in its capital structure since interests on debt must be
paid. The management must also ensure that investments undertaken are profitable so that the
company continues to meet the debt obligation.
b) Board of directors monitoring management Decisions. The agency problem can be reduced if
the boards of directors are effective at monitoring the activities of the management. If the
chief executive office of the company dominates the board. The board must consist of largely
independent executive directors who take the decision where a conflict of interest exists
between the directors and the interests of the firm. For instance the independent directors
should make the decision regarding the remuneration rates for the senior management.
c) Coming up with a remuneration strategy for the management that gives them the motivation
to act in the best interests of the company and the shareholders. The packages may provide
the rewards for a gaining long term and short term non-financial and financial goals.
d) Agent accountability; the agents should always be accountable for their actions to the
principal. The agent should report to the principal of what has been achieved, performance
achievement and the principal having the power to reward and punish for poor performance.
Accountability by the agent reduces the principal agent problem because it provides the
managers with the incentives to perform at that level that is in the best interest of the
shareholders. However, the cost of agent accountability should not exceed the benefit that the
monitoring provides. Accountability determines the center of authority. Therefore, in a
company, the accountability of the top management lies in the ability of the shareholders to
call the mangers into account and also in their right to do so.
Compensation Scheme to Reduce Short-Termism
One of the ways advocated by scholars to mitigate the conflict of interests between
managers and the problem of short-termism is aligning the interests of the employees through a
compensation policy. This can be done by tying the compensation of the employees to the
performance, which gives the employees an ownership in the company by offering them a
chance to buy stock (Alexander) . Under this approach, a compensation scheme is designed to
provide the employees with efficient incentives to maximize the value of the shares. In practice,
the employees can buy the company shares at a fixed price in the future. The results is that the
ownership of the company by the employees increases, thereby increasing their incentive to
invest in positive NPV and private consumption by the employees at the expense the company
reduces. As the company continues to gain more value in terms of options and profits, the more
the employees will earn. According to Alexander (2017), Stock options encourage the
employees especially those at the management level to make decisions which increase the
variance of the assets of the company thereby meeting the interest of the shareholders. The most
effective mechanism that can align the interests of shareholders and those of the employees are
executive compensation plans and their equity holding. Furthermore, a compensation structure
that comprise of stock options can be used to reduce risk aversion by the managers. In such a
structure, the managers are motivated to take risks since profits accrue to them when the firm
flourishes. When the employee especially the managers have stock ownership in the company,
an investment that increases variance can have various effects on the welfare of the management.
They include the decrease of the value of their human capital, increase in the value of stock and
options holding in the company, and the variability of their total wealth changes.
When top management employees have large options and stock holdings in the
company, it is more likely that the options and stocks will gain value. This is because the
management will ensure it gains value because it affects their money. Therefore large options
and stock holding by the management is more likely to induce them to select variance increasing
investments. Furthermore, executive ownership is associated with more focus to the company,
indicating that management risk aversion can be reduced by offering more equity in the
company. According to Rappaport and Bogle (2011), when the income of the managers is tied to
the changes in the values of the company, the value of the company is likely to increase. What
follows is an increase in the variance while certainty decreases that is equivalent to the stream of
employment income. Such decreases in human capital are dislike by the management therefore
they have an incentive to reduce the variance of returns in the total assets of the company.
Therefore, this is acts as the best alignment between the management and the shareholders
Employee Ownership Schemes Strengthen firm resilience and enable firms to better deal
with deep Recessions
Companies that incorporate ownership programs as a means of maintaining a long-term
relationship with their employees can be a means of maintaining credibility of the commitment
to the relationship between the employer and the employees (Rappaport and Bogle) . The
ownership by the employees provides job security as part of a big effort to build a cooperative
culture at the workplace and a sense of ownership. This type of culture may increase employee’s
effort as well as their willingness to adjust during times of financial distress both of which can
reduce the need for the company to layoff some employees and increase productivity during
downturns. Furthermore, the company can experience increased revenues because employees
may be willing to share information with the company which can increase efficiency in
production. Employee ownership plans instill a sense of psychological ownership which is
maintained by the company through a commitment to preserve jobs. This kind of culture
increases the willingness by the employees, to invest in skills that are valuable to the company.
Employee ownership provides pay flexibility to the company during financial distress
times. The contribution of the employer to the employee ownership plan can be flexible than the
other type of compensations (Milano) . This is so because when the company experiences
financial distress, sales decline or other demand shocks occurs, the company makes less
contribution to the employees’ ownership plan. The fact that the contribution is not made in cash
but in stock does not affect the perceived cost of labor from the perspective of the company.
Furthermore, the company also gains pay flexibility if the stocks of the company substitute in
whole or in part for fixed pay. The return of the shareholders is seen as part of the annual
compensation of the employees. In such a case, where there are negative shocks in demand, the
decrease in value of the stock of the company provides an automatic pay cut to the employees.
The company would have a lower incentive to reduce the number of workers since the fixed
component of pay would be lower, therefore the company has more chance of survival than firm
offering different compensation schemes.
Firms that have ownership compensation schemes have a greater stability and chance of
survival during recession times in part due to high productivity (Ladika and Sautner) . There is a
simple mediation effect when the ownership of the employees results to high productivity and
higher productivity leads to stability of the company therefore survival. Increased productivity
may be as a result of cooperation and increased effort among the employees. Furthermore, there
are more complex ways through which ownership by the employee can influence survival and
stability. Companies that offer stock and options to their employees create a culture with a great
sense of ownership. The sense of ownership is contingent with job security. Thus in such as case
ownership by employees is associated with greater productivity. Even when the company is
faced with productivity issues, there are more likely to discourage layoffs to maintain the
ownership culture so that employee stock ownership may have a positive effect on stability when
the company experiences productivity issues (Alexander) .
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Term and Long-Term Firms." CMC Senior Theses. 2017.
Ladika, T. and Z. Sautner. "The Effect of Managerial Short-Termism on Corporate Investment." Working
Paper . 2013.
Milano, Gregory V. Curing Corporate Short-Termism: Future Growth Vs. Current Earnings. Fortuna
Nikolov, Atanas Nik. "Managerial Short-Termism: An Integrative Perspective." The Journal of Marketing
Theory and Practice 26.3 (2018): 260-279.
Rappaport, Alfred and John C Bogle. Saving Capitalism From Short-Termism. Blacklick : McGraw-Hill