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ERC

LTI Report Summary

Project ID: 638666
Funded under: H2020-EU.1.1.

Periodic Reporting for period 1 - LTI (Long-Term Investment)

Reporting period: 2015-04-01 to 2016-09-30

Summary of the context and overall objectives of the project

The problem/issue being addressed is the failure of firms to invest for the long-run. This has substantial consequences for many constituencies:
• Individual firm shareholders. Shareholders with a long-term perspective (e.g. pension funds) are worse off if managers prioritise short-term earnings over long-run investment.
• Individual firm stakeholders. Many long-run investments are in stakeholders, e.g. employees, customers, suppliers, and the environment. These investments are particularly “long-run” as they are intangible and so it takes many years for these fruits to appear. A short-run focus will lead to firms ignoring stakeholders.
• The overall economy. Many intangible investments have positive spillover effects into the rest of society. For example, if a firm trains its workers, they may subsequently leave; although the firm in question does not capture all of the benefits, society benefits. More broadly, the EU’s success in international competition will depend on whether it can invest better than other regions.
• The political climate. One major reason why businesses had so little impact in the Brexit referendum is that they are seen as out of touch. Donald Trump similarly ran a successful anti-establishment campaign in the US. Businesses are perceived to be focused on short-term earnings rather than society, and thus the public has very negative perceptions on them.
The goal of this project is to understand how we can improve firms’ incentives to invest for the long-run. I study incentives stemming from both financial markets and executive compensation contracts.

Work performed from the beginning of the project to the end of the period covered by the report and main results achieved so far

a) I have written a paper, “The Source of Information in Prices and Investment-Price Sensitivity”, on how financial markets can inform long-run investment decisions. After just 18 months it is already forthcoming in the Journal of Financial Economics, a top finance journal.
b) I have written a paper, “Equity Vesting and Investment”, on how the impending vesting of equity leads managers to cut investment. It is at the 3rd round at the Review of Financial Studies, a top finance journal.
c) I have written a paper, “Strategic News Releases in Equity Vesting Months”, on how the impending vesting of equity leads managers to manipulate news releases. It is at the 2nd round at the Review of Financial Studies.
d) I have written a paper, “Governing Multiple Firms”, on how the number of stakes an investor holds affects her ability to govern and ensure the firm is well managed for the long-run. It is under 1st round review at the Journal of Finance, a top finance journal.
e) I have written a paper, “Executive Compensation: A Modern Primer”, which surveys the literature on executive compensation, including how compensation can induce long-term behaviour. Unlike all other surveys, it builds a simple unifying model, to combine all the insights of the myriad existing models out there. It is forthcoming in the Journal of Economic Literature, the most cited journal in economics.

I am currently writing a paper, “Executive Compensation: A Survey of Theory and Evidence”, which is also a survey on executive compensation but much more empirically focused, and with new data that we have gathered. It will be published in the Handbook of Corporate Governance next year and the first version will be released later this year.

Progress beyond the state of the art and expected potential impact (including the socio-economic impact and the wider societal implications of the project so far)

“The Source of Information in Prices and Investment-Price Sensitivity” is the first empirical paper to come up with a new measure of the extent to which stock prices perform long-run investment.
“Equity Vesting and Investment” and “Strategic News Releases in Equity Vesting Months” are the first papers to develop a measure of CEO’s short-term concerns. This measure is the amount of equity that is about to vest. Both papers have become very influential in the real world – the first was profiled by The Economist and the latter by the Financial Times. I am testifying on this research at the Houses of Parliament on 15 November, as part of the UK Government’s Parliamentary enquiry into corporate governance. They are both cited by many practitioner papers on the importance of extending the horizon of CEO incentives.
“Governing Multiple Firms” is the first paper, to my knowledge, which argues that spreading an investor thinly (by giving her stakes in many firms, not just one firm) can improve governance.
The two survey papers summarize decades of dense academic research into simple language for a general audience. The first paper has already had impact on practitioners and I know that many practitioners have read it. The second paper is not out yet but I believe it will have even more impact, since it is more data-driven.
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