Management Turnover and Myopic Decision-Making
Graber, Robert S., Academy of Accounting and Financial Studies Journal
This paper provides an agency theory explanation for the managerial myopia, or shortsightedness that is present in many corporations. Our premise is that corporate managers may not actually be short-sighted, but are acting in what they perceive as their personal long-term best interests, rather than maximizing shareholders' wealth. Managers may perceive an implicit contract, based on the experience of their predecessors, regarding their expected longevity with their current employers.
If managers believe their tenure with their current employer will be short, they are unlikely to undertake activities that are costly in the short run, and enrich the company only after a long period of time, since they do not longer expect to remain with their employer to share the rewards. Our hypothesis is that, all else being equal, the greater the rate of senior management turnover, the smaller the percentage of revenue that a firm will invest in long-term projects, such as R&D or employee training. Management and CEO stock ownership can have a mitigating effect, since the greater the percentage of the firm that is owned by management, the more management's incentives should be aligned with those of other shareholders. This paper provides a theoretical model to demonstrate that, the greater the probability that the manager will remain with the firm for a long period of time, the more the manager will invest in long-term projects that maximize shareholders' wealth.
This paper uses agency theory to explain the managerial myopia, or shortsightedness, manifested in many corporations, particularly in industries in which a long-term perspective is particularly important, such as technology-intensive industries. The hypothesis under investigation is that managerial turnover, and a corporate culture that facilitates rapid turnover, may be a cause of this myopic decision-making.
Under-investment in R&D may be one manifestation of managerial short-term orientation, due to rapid managerial turnover. Under-investment in other long-term ventures, such as employee training, and the cultivation of new markets, may be other manifestations.
The problem of short-term orientation has ramifications for international trade as well as corporate finance since rapid turnover of corporate management is more prevalent in the United States than in other industrialized nations. We look to agency theory, and specifically to management turnover, for a possible explanation of managerial shortsightedness.
Corporate culture engenders implicit contracts. In the absence of a written employment contract, if a manager is employed by a firm with a history of rapid turnover, the manager can reasonably expect to be with the firm for a relatively short period of time, and to plan accordingly. Conversely, when there is a corporate culture that fosters longevity, the manager can reasonably expect, even without a written contract, to have a relatively long stay with the firm.
It is noteworthy that the market appears to appropriately reward long-term investment, such as investment in R&D, especially in technology-intensive growth industries in which R&D expenditures have resulted in profitable new products in the recent past. While the market appears to be relatively efficient in valuing long-term investment, many corporate managers seem to have an inappropriately short planning horizon, as they under-invest in research and development and other long-term projects, presumably to maximize their firms' short-term profitability. Therefore, corporate managers' behavior appears to be inconsistent with their responsibility to maximize shareholder wealth.
We suggest that under-investment does not necessarily indicate a lack of managerial foresight. On the contrary, managers may be thinking long term, but acting in their own long-term best interests, not that of shareholders. Based on their predecessors' experience, many corporate managers may recognize the likelihood that their longevity with their current employer is limited. …