Compensation Duration, Shareholder Governance, and Managerial Short-Termism∗

In this paper, I investigate the interaction between the duration of executive compensation and shareholder governance. I show that short-term compensation can elicit shareholder intervention and thus enhance firm value. The central mechanism is that the use of short-term incentives enables informed incumbent shareholders to commit to using their private information to intervene (voice) instead of selling their shares (exit). Without a commitment to voice, incumbent shareholders might find, ex post, that exit is more appealing than voice if they privately observe that a firm’s type is bad. Short-term incentives encourage a good firm to take actions that reveal its type early on. This, in turn, reduces the information advantage of the incumbent shareholders and their ability to profit from exit. Effectively, short-term compensation serves as a commitment device for value-enhancing intervention.