Long-Term Incentives to Underperform in the Short Term

A firm's manager may choose to underperform in the short-term in order to boost subsequent pay: the apparent value of subsequent incentive compensation is diminished, requiring more overall pay to meet the manager's outside option. A greater weight on short-term compensation can counteract these incentives, provided liquidity constraints do not bind. Shifting to more long-term compensation, such as restricted stock and vesting conditions, generally worsens illiquidity and incentive compatibility problems. An extension considers reporting: managers have an incentive to under-report the firm's value, which can be remedied by granting short-term stock-based compensation